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Rien Ne Va Plus - The 2007/2008 Credit Crunch and What Gambling Bankers Had to Do With It

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  • Hofmann, Anett

    (Department of Economics, University of Warwick, and Department of Economics, London School of Economics.)

Abstract

The paper argues that the incidence of moral hazard played a significant role in the 2007/2008 credit crunch. In particular, bank traders subjected to asymmetric compensation structures have an incentive to take excessive risks even when the bank's shareholders would prefer prudent investment. Traders' incentives are shown to be unaffected by capital regulations, with the associated financial burden falling upon the taxpayer through deposit insurance or government bail-outs. Selected case studies further indicate that the phenomenon of “gambling traders” was widespread during the credit crunch, when high bonuses tempted bank employees to invest in risky subprime-backed securities. The intransparency of structured products and the inaccuracy of credit ratings contributed to the employees' ability to conceal the underlying risk from the banks' shareholders. The analysis points to an urgent need to reform compensation practices in the financial sector.

Suggested Citation

  • Hofmann, Anett, 2009. "Rien Ne Va Plus - The 2007/2008 Credit Crunch and What Gambling Bankers Had to Do With It," The Warwick Economics Research Paper Series (TWERPS) 892, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:892
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    File URL: https://warwick.ac.uk/fac/soc/economics/research/workingpapers/2009/twerp_892.pdf
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    References listed on IDEAS

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    1. Mr. Haizhou Huang & Mr. C. A. E. Goodhart, 1999. "A Model of the Lender of Last Resort," IMF Working Papers 1999/039, International Monetary Fund.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Bonuses & ideology
      by chris dillow in Stumbling and Mumbling on 2009-12-04 18:56:43

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