Nassim Nicholas "Black Swan" Taleb has an NYT op-ed arguing that the best way secure the financial system from future collapse is to eliminate bankers' bonuses altogether. Taleb says bonuses reward risk-taking behavior without any counterbalancing punishment for bad risks, which provides an incentive for bankers to take stupid risks and hide their mistakes with financial engineering and book-cooking.
Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups, which I have called “black swan” events. The meltdown in the United States subprime mortgage market, which set off the global financial crisis, is only the latest example of such disasters.
Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust. The question of talent is a red herring: Having worked with both groups, I can tell you that military and security people are not only more careful about safety, but also have far greater technical skill, than bankers.
The ancients were fully aware of this upside-without-downside asymmetry, and they built simple rules in response. Nearly 4,000 years ago, Hammurabi’s code specified this: “If a builder builds a house for a man and does not make its construction firm, and the house which he has built collapses and causes the death of the owner of the house, that builder shall be put to death.”
This was simply the best risk-management rule ever.
End Bonuses for Bankers
(Image: IMG_0624, a Creative Commons Attribution (2.0) image from 11201702@N06's photostream)
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