The Need for Punitive Measures

I see that the Bush administration is framing its strong stand in defense of unlimited compensation for the corrupt and inept CEOs who’ve trashed the world’s financial system as an opposition to “punitive measures” in a time of crisis.

On the contrary, it seems to me that punitive measures are essential. The normal punishment for failed business leadership is that your company goes bankrupt. But the crux of the current situation is that everyone agrees that it would be unwise to simply let these financial firms fail. The spillover damage to the rest of the economy would be too great. So one way or another, they need to be saved. But rescuing companies in these kind of situations creates a “moral hazard” problem. You want to prevent the firms from folding, without creating an incentive for future executives to engage in irresponsible behavior.

In the limiting case, you could just straight-up bail out the company, but then take all the executives and subject them to a brutal flogging. Thus, financially it’s as if the problems never arose. But thanks to the harsh punitive measures, there’s still an incentive for executives to avoid misbehaving in the future. Even better, though, is to find punitive methods that also accomplish something socially useful. Forced restructuring of mortgages to help people who stay in their homes would be an example. Or having the public take over equity so that we own more of the upside. Limitations on CEO pay also, I think, fit this model. But whatever the method may be, the point is that punitive measures are essential.