Now that we know that many of our financial institutions have proved to have been disastrously managed, people have been looking to find strict new rules they hope will improve things. The latest idea proposed from the pages of the Guardian is a new crime called “bankslaughter.”
We’d hoped this terrible idea would go away after we explained its stupidity. Unfortunately, it’s getting some support from otherwise bright people like James Kwak and the guys who write the Free Exchange blog for the Economist.
- We already explained (here, here and here) what’s wrong with criminalizing bank failure. Maria Woehr at DealScape put up a nice summary.
- Bank executives faced with the prospect of a criminal investigation and possible conviction would likely be overly cautious.
- Being unlucky in the markets becomes a criminal matter.
- This may not deter the true rogues who take the riskiest bets.
- The criminal process is not well-suited to settling the kind of complex financial investigation.
- As failures multiply during an economic downturn and prosecutors begin to launch bankslaughter investigations, banks would reign in their own risk-taking.
- Hedge funds blow up all the time, and nobody calls for their head
- Shareholders want bank managers to take on enormous risks. If anything, the problem is that they want bank managers to take on too much risk
James Kwak actually disagrees with our arguments far less than he thinks he does. Our main objection to bankslaughter was to it’s criminal aspects. Kwak agrees that this is “overkill.” Instead, he favours a watered down version of bankslaughter that would work like tort law, punishing negligent or wreckless bank management in civil courts. This would be a vast improvement over the criminal version but there are still serious problems with this proposal.
To begin with, who is the injured party with standing to bring a suit? In the examples proposed by Kwak, the injured are innocent bystanders. Shareholders of banks have entered into a agreement with the managers voluntarily. We know they don’t object to risk taking by bank managers because they bought shares. If they want to change the terms of the agreement they have an easy way to do this: sell their stock and buy shares of a company that promises to be more conservative. Why impose this new duty of care on bank managers if shareholders don’t want it?
To but this more seriously, the corporate form is designed to divorce risk taking from management. The shareholders take the risk, while the management runs the company under various duties intended to maximise shareholder returns. We try to further align the incentives of managers with shareholders by making them risk-takers as well, through things such as incentive pay. Making the managers bear unlimited liability, however, would divorce management interests from shareholders. Instead of business judgment, companies would be governed according to a regulatory judgment. This would obviously diminish investor appetite for capitalising banks.
More plausibly, the injured parties are the taxpayers who are forced to bailout failed financial institutions. This makes some sense. With banks operating under an implicit government guarantee, shareholders and creditors have incentives to permit banks to take on too much risk. In this circumstance, it might make sense to impose an additional liability on firms whose blowups have large societal costs.
This would basically operate as a claw-back of wealth from managers whose firms failed. There are still problems with this idea—which we’ll save for another post—but reimagining it as a civil tort with taxpayers as the injured parties ameliorates some of the more severe problems we mentioned earlier.
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