Sunday, March 16, 2008

Moral Hazard

[Hypothetical future investor]: I own a major stake in an investment bank, and I’m getting concerned about their risk management. Should I bring this up at the shareholders’ meeting?

[Hypothetical friend]: I don’t see why. What’s the worst that can happen? The bank will go sour, the Fed will arrange a bailout, and you’ll only lose 95 percent of the money you invested, 96 tops. What’s the big deal?

[Hypothetical future investor]: You’re right. Isn’t the [Hypothetical future Fed chairman] put great?

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10 Comments:

Anonymous Anonymous said...

I wonder how many shareholders knew just how bad things were at Bear? The entire company seems to have been run as a very high leverage hedge fund (30 to 1 even before derivative counter party risk is added in). At high leverage, a small loss in the collateral could have wiped them out, and there was a large loss. Its hard to imagine that the people who paid 30 on Friday had any real idea of the magnitude of the problem.

Transparency doesn't seem to be very transparent for prospective shareholders.

Mon Mar 17, 03:07:00 AM EDT  
Anonymous mike said...

brilliant.

Mon Mar 17, 07:49:00 PM EDT  
Blogger curiouscat said...

Nice post. Yeah the transparency is horrible. I would wager no shareholders new close to how bad it was. If they did they would have become non-shareholders in a hurry. And it is very easy to buy your own hype that massive leverage and pretending financial markets never act irrationally for periods of time... Therefore our model that relies on stability, liquidity, low short term rates, massive leverage, highly complex deals, paying ourselves huge bonuses... can't possibly fail.

Few seem to have any idea of how financial market predictably destroy such investment strategies spectacularly every few decades.

Mon Mar 17, 10:41:00 PM EDT  
Anonymous san diego bail bond said...

"Should I bring this up at the shareholders’ meeting?" Well, Ofcourse!

Great post.
Cheers,
Lolin

Wed Jul 30, 09:26:00 PM EDT  
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Anonymous Los Angeles Bail Bonds said...

Transparency is going to continue to be an issue. At least the current administration is pushing for more transparency on many levels.

Sun Mar 21, 03:56:00 PM EDT  

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