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Rien Ne Va Plus - The 2007/2008 Credit Crunch and What Gambling Bankers Had to Do With It

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Author Info

  • Hofmann, Anett

    (Department of Economics, University of Warwick, and Department of Economics, London School of Economics.)

Abstract

The paper argues that the incidence of moral hazard played a significant role in the 2007/2008 credit crunch. In particular, bank traders subjected to asymmetric compensation structures have an incentive to take excessive risks even when the bank's shareholders would prefer prudent investment. Traders' incentives are shown to be unaffected by capital regulations, with the associated financial burden falling upon the taxpayer through deposit insurance or government bail-outs. Selected case studies further indicate that the phenomenon of “gambling traders” was widespread during the credit crunch, when high bonuses tempted bank employees to invest in risky subprime-backed securities. The intransparency of structured products and the inaccuracy of credit ratings contributed to the employees' ability to conceal the underlying risk from the banks' shareholders. The analysis points to an urgent need to reform compensation practices in the financial sector.

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File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2009/twerp_892.pdf
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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 892.

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Length: 43 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:wrk:warwec:892

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  1. Charles A. E. Goodhart & Haizhou Huang, 1999. "A model of the lender of last resort," Proceedings, Federal Reserve Bank of San Francisco.
  2. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  3. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
  4. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  5. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
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  1. Bonuses & ideology
    by chris dillow in Stumbling and Mumbling on 2009-12-04 12:56:43

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