Risk, Reward, and Accountability


From a speech by James Grant to the New York Federal Reserve Bank, March 12:

[W]hat makes a good banker is more than skill. It is also the fear of God, or, more specifically, accountability for the solvency of the institution that he or she owns or manages.

To stay out of trouble, the general partners of Brown Brothers Harriman, Wall Street’s oldest surviving general partnership, need no regulatory pep talk. Each partner is liable for the debts of the firm to the full extent of his or her net worth. My colleague Paul Isaac, who is with me today—he doubles as my food and beverage taster—has an intriguing suggestion for instilling the credit culture more deeply in our semi-socialized banking institutions.

We can’t turn limited liability corporations into general partnerships. Nor could we easily reinstate the so-called double liability law on bank stockholders.

But what we could and should do, Paul urges, is to claw back that portion of the compensation paid out by a failed bank in excess of 10 times the average wage in manufacturing for the seven full calendar years before the ruined bank hit the wall.

Such a clawback would not be subject to averaging or offset one year to the next. And it would be payable in cash.

The idea, Paul explains, is twofold. First, to remove the government from the business of determining what is, or is not, risky—really, the government doesn’t know.

Second, to increase the personal risk of failure for senior management, but stopping short of the sword of Damocles of unlimited personal liability. If bankers are venal, why not harness that venality in the public interest?

For the better part of 100 years, and especially in the past five, we have socialized the risks of high finance. All too often, the bankers who take risks don’t themselves bear them.

By all means, let the capitalists keep the upside. But let them bear their full share of the downside.

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