•Saubhik Chakrabarti: How would you approach the question of managers’ risk taking?

It’s a question that has no definitive answer. It’s a question that bothers me. But take the situation in Bear Stearns where the chief executive saw his net worth in terms of his options and shares in Bear Stearns come down from $1.6 billion to $60 million. Now to say that he didn’t take a haircut would be unfair. Nobody, however, has pity for anyone who has $60 million still left with him. In people’s minds if you have more than a million you are in a funny money territory. If you look at most of these institutions, shareholders have lost billions.

Some people argue it’s a disproportionate hit given the fact that the problem had actually originated with the regulator. There was a moral hazard of regulation. The Federal Reserve obviously in retrospect, everyone agrees, printed far too much money and the regulators did not regulate the market which is the easiest market in the world to regulate, the US mortgage market. Also, I have reservations about Alan Greenspan’s role (as the Chairman of the Federal Reserve). I think he was absolutely wrong to believe that central bankers should not interfere with asset bubbles, that they should instead deal with the consequences of asset bubbles bursting. Frankly, I think we have been through three cycles of that and by now we should say that the cost is too high.

Of course, the issue of incentives in financial firms—whether the kinds of bonus systems we have provide perverse incentive for risk taking—is a very legitimate question. Whether these bonuses should be taxed, whether these should be exercisable in the short term, if exercised in the short term should they be taxed at ridiculous rate, whether they should accrue upon the retirement of the people—all these issues are legitimate questions. But there are questions of theory which impinge upon practise. At the end of the day if you de-motivate a good manager and you turn a very good bank executive into a hedge fund manager, I don’t know whether you have actually added to the net contribution of human welfare. The reason I am answering in this bizarre sort of way is that I honestly have been grappling with this issue for the last 17 years and there is no definitive answer. Any professor of finance who comes up with one doesn’t know what he is talking about.

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