Sat, 02 Mar 2013
Too Little "Skin in the Game"

An article at Scientific American,Why It’s Smart to Be Reckless on Wall Street, considers the reward structure in Wall Street banks and concludes that, to many bankers, it makes sense to take very large risks. As Taleb would note, there's no downside.

So, an unhealthy amount of risk, both for the long term future of the bank itself, and unhealthy for all of us if a banking crisis ensues.

Join a business that has an established track record. Start small, building up a few solid years of making decent profits. Do this for six or seven years. It’s called “milking the franchise.” Soon you will have respect and, most of all, expanded limits on what you can trade. Wait for a year when everyone is bullish. Then swing big. Really big. Don’t take judicious risk; take the most risk the firm will allow you. Follow the momentum, piling into trades others are doing.

If you win, since you followed the herd, Wall Street will be flush with cash and you will get paid well, tens of millions well. If you lose you may get fired, but since everyone lost they will understand.

This strategy is certainly not in the long-term interest of the firm, but it’s the smartest strategy to benefit the trader.

We have to make sure that there is a downside when a bank takes big risks, and to the individual gambler/banker making the bet. The risk should be taken by the bank with their own money, not the retail client or tax payer. As the author says, most bankers are doing nothing wrong, let alone illegal, but a minority are. They need to be reined in and the best way of doing that is to make sure the banks themselves have enough skin in the game.

It needs to be greatly in their interest to be more prudent.