Risk and Reward

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"Risk and Reward"

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A whole lot to chew on in today’s New York Times piece on Citigroup, but this graf is of particular interest to me:

“Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,” a former Citigroup executive said of the bank’s big C.D.O. push. “Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’”

Obviously not what you want on your epitaph as the company goes under. But at the same time, it’s perfectly true. The more risk you take on, the more potential for profit. And this is what’s so disturbing about what’s going on in terms of financial institution bailouts. I’m happy to believe the folks who say these kind of interventions are necessary. But if they’re going to be done, there’s both the practical question of how to regulate so as to avoid moral hazard, and also a huge question of social justice. If people can get very rich taking on risks that are partially offloaded onto the public at large, we have a problem. Or, more specifically, we need to tax those people and use the revenues to better-assist ordinary people in dealing with risks.

Consider the contrasting fates of a financial sector CEO who earned tons of money and through mismanagement caused his firm to go bankrupt and that of someone who operates the cash register at Circuit City and through no fault of her own wound up laid off. Both are looking at unemployment; perhaps even a prolonged spell of unemployment. But the CEO was living very high on the hog throughout the fat years, the woman at the cash register not so much. And the CEO, even with a large swathe of his fortune wiped out by the crash, will still be left with savings and assets that dwarf those of the average American. And why? Skill-biased technological change? Was the woman running the cash register really not competent enough to run Citigroup into the ground? Anyone can make money while the market goes up and lose it when the market goes down.

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