European Financial Review: It’s not over ‘til the fat tail zings

posted on June 20th 2012 | 0 comments

There are idiots. Look around.

Harvard’s Larry Summers famously began a draft paper with these words during his early days in academia. Markets aren’t rational. Assuming otherwise has been one root cause for the financial and economic mess we are now in, with consequences on a planetary scale. The opposite holds also true: Too many of us acted all too rational in our narrow little worlds.

That goes up and down the financial sector food chain, where everyone it seems has been facing the wrong incentives – from lowly mortgage brokers to credit rating agencies to Chuck Prince, the CEO and chairman of what was once the world’s largest bank. Shortly before collecting a $40 million golden parachute, Prince uttered his famous last words that, “As long as the music is playing, you’ve got to get up and dance.” Emphasis on: “you’ve got to.”

Don’t vilify Prince. Bankers ought to be dancing to the music. There were plenty of crooks and even more who checked their moral compass at the door, but fiduciary responsibility or the profit motive aren’t at fault here. Management is supposed to maximize shareholder value. Investors are supposed to demand the highest returns possible. The regulatory goal may be to slow down the dance a bit, but mainly it is to change the beat. First and foremost, the task is to make sure that everyone faces the full consequences of their actions.

The same goes for environmental problems. No one wants entrepreneurs and businesses to stop dancing. There are certainly some environmentalists who would rather have all business grind to a halt. That cannot be the goal, though. Free markets aren’t the problem. The true problem is that markets aren’t free enough but instead are woefully rigged in favor of pollution.

Continue reading at