Wednesday, June 1, 2011

Gamble !

If you're high up in a company largely based on financial interests, you are often rewarded high bonuses when your company makes a big profit. Naively, there's nothing wrong with this. We all know though that one can choose a high risk strategy that can either pay off a lot or make for a large loss. The trouble is that if the first scenario plays out, the strategist gets a big bonus, while if the second option is realized, he loses no money from his bank account. Sure, he could get fired, but that punishment is considerably less direct than the money reward he obtains when his risky move strikes gold. In particular, the punishment is not to withdraw millions of dollars from the strategist's account. It is my claim that this strongly encourages people high up in the finance industry to gamble very heavily.

Moreover, their leverage is huge, which means that the gambles that don't pay off can make their company collapse, and others with it. Their gambles have real consequences for ordinary working people. Yet, when their company and others go bankrupt, there is no real consequence for the top finance people's bank account.

The present reward system for top people in finance benefits the rich, and disadvantages the poor.

We can boil this down to a form of exploitation of the law on business and individuals. An individual will remain responsible for his debt. A company can go bankrupt, and no creditor will see his money back. Therefore, it is advantageous to create a business, gamble heavily, and reward oneself if one wins, and let the business go bankrupt if one doesn't.

Of course, I'm simplifying things enormously, but the basic mechanism at work is real, and destabilizes our financial system. That was evident in 2008, and it is still evident now.