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Banking crises rooted in a system that rewards excessive risk-taking

42 points by bikenaga 4y ago

jschveibinz 4y ago
…by incentives-compensated employees with insufficient oversight.
GenerWork 4y ago
Hot take: There's nothing inherently wrong with excessive risk taking. There is something wrong with a lack of consequences for having those risks fail.
- bluepizza 4y ago
  There is something inherently wrong with the excessive risk taking: financial markets go through fashions, moods, and phases. If a manager's particular risk taking style fits the current moods of the markets, this manager will seem like a genius. Once the moods changes and the manager start taking massive losses, oh, seems like this guy should be fired. But his replacement will be just someone kinda aligned to the current moods. Once they change, this one will also be fired. The financial system is unpredictable. Even the best and most refined models fall apart. Excessive risk taking must be curbed because regularly taking losses due to flawed predictions is not a professional way of managing money.
- gumby 4y ago
  If you can handle the consequence of failure, the risk is by definition not excessive.
- Maarten88 4y ago
  What should the consequence be for bankers who take too much risk, their banks' failure spreading to the wider banking system, sending the economy into a recession and millions of people into poverty? Consequences (claw back) is the least that should happen, but it doesn't help the victims and might still incentivize short term risk taking (I win vs you loose). The solutions that the article offers (only allow long term incentives, include the interest of the entire banking system) might actually stimulate better risk-taking behavior. The real economy is slow, bankers' incentives should be too.
  - s1artibartfast 4y ago
    There should be no consequences. They should simply carry insurance for to make investors whole.
- reese_john 4y ago
  Banks are not hedge funds. There is a lot wrong with excessive risk taking by banks, that's why it's heavily regulated. Systemic risk is bad. But excessive risk taking by hedge funds might be _net_ good, since it reduces inefficiencies in the market by removing bad money managers and investors from the system.
- danielmarkbruce 4y ago
  Depends on your definition of "excessive".
avsteele 4y ago
This article misses the mark IMO. It really doesn't seem like the bank was taking on risks that a ton of banks aren't also exposed to just doing normal 'bank stuff' The banks primarily invest in mortgages, and treasuries, and so a lesser extent business loans. That's about as 'safe' as it gets! If they wanted inflation protection they could invest in, what? Securities? Then they'd be an investment bank. Even if this was legal, then if market went down and there was a run and there would be an article about how the bank should have held bonds and treasuries. If they held cash they wouldn't be a 'bank' anymore and couldn't offer what few services they do. Banks are exposed to interest rate risk. They borrow short and lend long. Anybody taking a look at their checking account today will see they can get higher yields by moving their money around from their traditional bank to new high yield accounts from e.g. Synchrony and many others. Based on this I don't see this ending with First Republic. Now, I am sympathetic to claims of mismanagement, but I don't see it at the bank level. I'm just a amateur here but if I had to point my finger at something that exacerbates these problems its the US government's continued support for long (15yr+) fixed-rate loans. These really appear to be US government creation. Meanwhile our federal gov is running record peacetime deficits. If interest rates remain high (and its hard to see them coming down very quickly) its going to blow a gaping hole in the federal budget.
- danielmarkbruce 4y ago
  This isn't right. Banks have always needed to manage interest rate risk. They do this by owning a range of securities with different maturities. It is bad practice to hold too much long dated stuff (as a %). Most banks have managed their book appropriately. They've taken some losses, but not so much they wiped themselves out (as First Republic have done, and SVB did too).
  - junofan 4y ago
    Hold on a second. I thought the Fed opened a special loan program for precisely this situation after SVB. Why isn’t that program sufficient for First Republic?
    - 4y ago
friend_and_foe 4y ago
It's not about risk taking. It's about not leaving people with the natural consequences of their own decisions. We are afraid to let things ride, and it creates this environment where we are held hostage by people who have no incentive to be cautious.
yieldcrv 4y ago
Excessive risk taking = owning the safest US treasuries Ok, yes, the business of banking is incompatible with the fight against inflation
- danielmarkbruce 4y ago
  Owning too much of a very long dated fixed rate bond isn't safe. Interest rate risk is a thing all on it's own, independent of credit risk.

42 points by bikenaga 4y ago

…by incentives-compensated employees with insufficient oversight.

Hot take: There's nothing inherently wrong with excessive risk taking. There is something wrong with a lack of consequences for having those risks fail.

bluepizza 4y ago
There is something inherently wrong with the excessive risk taking: financial markets go through fashions, moods, and phases. If a manager's particular risk taking style fits the current moods of the markets, this manager will seem like a genius. Once the moods changes and the manager start taking massive losses, oh, seems like this guy should be fired. But his replacement will be just someone kinda aligned to the current moods. Once they change, this one will also be fired. The financial system is unpredictable. Even the best and most refined models fall apart. Excessive risk taking must be curbed because regularly taking losses due to flawed predictions is not a professional way of managing money.
gumby 4y ago
If you can handle the consequence of failure, the risk is by definition not excessive.
Maarten88 4y ago
What should the consequence be for bankers who take too much risk, their banks' failure spreading to the wider banking system, sending the economy into a recession and millions of people into poverty? Consequences (claw back) is the least that should happen, but it doesn't help the victims and might still incentivize short term risk taking (I win vs you loose). The solutions that the article offers (only allow long term incentives, include the interest of the entire banking system) might actually stimulate better risk-taking behavior. The real economy is slow, bankers' incentives should be too.
- s1artibartfast 4y ago
  There should be no consequences. They should simply carry insurance for to make investors whole.
reese_john 4y ago
Banks are not hedge funds. There is a lot wrong with excessive risk taking by banks, that's why it's heavily regulated. Systemic risk is bad. But excessive risk taking by hedge funds might be _net_ good, since it reduces inefficiencies in the market by removing bad money managers and investors from the system.
danielmarkbruce 4y ago
Depends on your definition of "excessive".

avsteele 4y ago

This article misses the mark IMO. It really doesn't seem like the bank was taking on risks that a ton of banks aren't also exposed to just doing normal 'bank stuff' The banks primarily invest in mortgages, and treasuries, and so a lesser extent business loans. That's about as 'safe' as it gets! If they wanted inflation protection they could invest in, what? Securities? Then they'd be an investment bank. Even if this was legal, then if market went down and there was a run and there would be an article about how the bank should have held bonds and treasuries. If they held cash they wouldn't be a 'bank' anymore and couldn't offer what few services they do. Banks are exposed to interest rate risk. They borrow short and lend long. Anybody taking a look at their checking account today will see they can get higher yields by moving their money around from their traditional bank to new high yield accounts from e.g. Synchrony and many others. Based on this I don't see this ending with First Republic. Now, I am sympathetic to claims of mismanagement, but I don't see it at the bank level. I'm just a amateur here but if I had to point my finger at something that exacerbates these problems its the US government's continued support for long (15yr+) fixed-rate loans. These really appear to be US government creation. Meanwhile our federal gov is running record peacetime deficits. If interest rates remain high (and its hard to see them coming down very quickly) its going to blow a gaping hole in the federal budget.

danielmarkbruce 4y ago
This isn't right. Banks have always needed to manage interest rate risk. They do this by owning a range of securities with different maturities. It is bad practice to hold too much long dated stuff (as a %). Most banks have managed their book appropriately. They've taken some losses, but not so much they wiped themselves out (as First Republic have done, and SVB did too).
- junofan 4y ago
  Hold on a second. I thought the Fed opened a special loan program for precisely this situation after SVB. Why isn’t that program sufficient for First Republic?
  - 4y ago

friend_and_foe 4y ago

It's not about risk taking. It's about not leaving people with the natural consequences of their own decisions. We are afraid to let things ride, and it creates this environment where we are held hostage by people who have no incentive to be cautious.

yieldcrv 4y ago

Excessive risk taking = owning the safest US treasuries Ok, yes, the business of banking is incompatible with the fight against inflation

danielmarkbruce 4y ago
Owning too much of a very long dated fixed rate bond isn't safe. Interest rate risk is a thing all on it's own, independent of credit risk.