Brad DeLong considers various issues in using financial regulation to improve incentives and ends up offering this observation:
Managers and traders are, however, where I would focus most of my attention. I believe we need compensation reform: compensation schemes that make it a complete personal catastrophe for the CEO and all other employees if their bank fails. If managers and traders are, personally, wiped out–reduced in assets to their last two cars and their last four-bedroom house–if any financial institution they worked for goes bankrupt anytime in the next two years, then we have a chance of creating sufficient caution. Otherwise, I don’t see how we do it.
This seems to me like something that would be pretty feasible to implement. You could create special liability rules for the employees of what will in the future be classified as Tier-One Financial Holding Companies establishing something along the lines of what DeLong suggests. In the event that the government needs to intervene with a bailout, everyone will have their personal assets above $X wiped out as recompense. This would both create an incentive for Tier-One Financial Holding Companies to be cautious and also create an incentive for managers to consider whether they don’t want to downside (or streamline or simplify or whatever it may take) their operation so as to avoid attaining that lofty regulatory status.
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