What went wrong?
The G20 countries are trying to figure out how to prevent future financial crises. They are exploring new regulations, guidelines for compensation, and requirements for more transparency.
But before we accept the common wisdom of the G20 that greedy, over-compensated bankers are the root cause of all problems, let’s consider the following. If you are offered a ridiculous amount of money to do your job, would you accept even if you know that are not worth more than a fraction being offered? So why blame bankers and CEOs who have pocketed tens of millions of dollars or more? Many might have been under the delusion that they actually deserved the money, but otherwise they did act rationally to take the money and run.
The blame for the crisis that engulfed the world lies elsewhere. The prolonged, low interest rate policies of the Greenspan Fed, and its unwillingness to prick the housing bubble are at the top of the list. Dreadful corporate governance likely comes second. Where were the Boards of the major financial institutions? Not only did they offer absurd compensation packages, but they also appeared to be lost in understanding the risk profiles of their companies.
Regulatory failure probably is a close third. There are more than enough regulations in place. But they were not enforced, in part, because the political overseers did not want them enforced (accepting political contribitions from the finance industry will do this to politicians), and the various agencies did not share information and were not willing to work together (where else did we see this type of behaviour?). Finance 101 should have told regulators that credit default swaps are a type of insurance, and as such, the sellers (notably AIG) should have been required to keep large reserves against them. This would have taken the steam out of this market. Instead, idiotic tax, accounting and regulatory rules made them a gravy train for some, but with a very short and explosive fuse.
Providers of all types of debt relaxed their standards. What happened to loan covenants and due diligence? In Canada we had BCE bondholders sue the company when it agreed to sell to a group of private equity firms because the sale would have greatly increased the risks for these bondholders. Blinded by greed, the original bondholders did not include covenants to restrict the ability of the company to do this. So they tried, unsuccessfully, to have the courts save their asses.
Buyers of the toxic assets created by the rocket scientists on Wall Street did not do their homework. Many admitted that they had no idea what they were buying. They too were driven by greed and the prospect of getting something for nothing ( a few more basis points for no additional risk). How did these people get their jobs in the first place?
Overall, there were massive governance and policy failures. New regulations will not help! Nor will artificial constraints on compensation!