Foolish Bankers and Burdened Taxpayers

Abstract

Perhaps the most troubling aspect of the Credit Crisis of 2007–08 was the continuing impact that the crisis has had on global financial markets and the attendant slowdown in economic growth in many countries. The US disaster did not stop at the water’s edge. Interconnected global finance guaranteed that our credit market difficulties would be transmitted around the world. Buyers of securitized assets were everywhere: foreign banks and insurance companies; pension funds; even municipalities in Iceland which were sold Triple A paper with better interest rates than could be obtained from local government issues! Current financial troubles in Europe seem rooted in another class of credit instruments (sovereign debt), much of which resides on the balance sheets of banks and other financial intermediaries in Europe. In its principal features, the sovereign debt crisis in Europe bears a striking similarity to what was experienced in the US as a result of the collapse of the housing bubble. Sovereign debt’s analogous role to the debts of the American GSEs is both striking and not surprising. It is all about risk, implicit guarantees, the compensation achieved by performance pay systems, the risk tilt that performance pay incentives produce, and the massive failures of corporate governance.

“Why do you rob banks?” “Because that’s where the money is.”¹