November 6, 2007
A writer at the Wall Street Journal today asks "Why Street Bankers Get Away with Repeating Old Mistakes." He ask why banks lended long and borrower short without accurately assessing the risk. He misses two obvious explanations: First, those inside banks get paid fees for placing exotic instruments who defects take time to show. In other words, there is a short term incentive to produce sales with a long term instrument. The optional strategy? Take fees, move up the ladder before the crisis and blame those who are left in your old job. Second, those outside banks who dream up exotic instruments sell them to those inside banks who do not fully understand them. In other words, the drive to create exotic instruments is, in part, a drive to sell stuff to people who are dazzled and who are ignorant. The two incentive, to take fees and to dupe, combing to make bank vulnerable to under appreciating risk. This has been going on for centuries.
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