Bankslaughter won't work

In reaction to the U.K.'s Financial Services Authority's Turner Review, The Guardian's Paul Collier has offered up a solution to deter bankers from risky behavior. The remedy would be to not only hold them responsible for shareholders' losses if a bank goes under, but also criminalize activity that led to a failure and imprison them, even if they are no longer at the helm of the company when the collapse occurs. Collier seems to think this will balance out the bankers' bonus system, which have become correlated with promoting risky behaviors.

Here's Paul Collier's argument in The Guardian:

On Turner's proposal a manager can still benefit from recklessness - as long as the bank does not blow up within three years. After that, if the bank crashes he can be off playing golf. With bankslaughter, when the bank blows up - even if it is a decade later - a criminal investigation traces back to determine whether crucial decisions were reckless. If a reasonable banker faced with the information available at the time would not have taken those risks, the person responsible is dragged off the golf course and jailed.

Once bankslaughter was on the books, bonuses would be less dangerous. Managers would have to weigh the balance between risk and return and take defensible decisions. I doubt hyper-caution would be a problem: the overly cautious would not get bonuses. Surely we can rely on our bankers to exhibit the necessary degree of greed.

Reuters' Felix Salmon seems to agree that Collier has a point and bankers should be criminally liable to shareholders:

Is it reasonable to hold professionals criminally liable if they take reckless risks with other people's money? I don't see why not. Especially if they work at a leveraged and systemically-important institution. After all, people can be jailed for insider trading, which is far more of a victimless crime than bankslaughter

This has John Carney and Joe Weisenthal over at Clusterstock in an uproar, calling bankslaughter the "worst idea of the week." Carney states:

The relationship between shareholders and the executives who run banks is mostly a contractual one. Executives can live up to their obligations and the expectations of shareholders, or they can fail to live up to those standards. The typical resolution for this failure would be a civil lawsuit. Bankslaughter introduces some kind of objective test that neither shareholders or executives agreed to. Because bankslaughter is backward looking but conducting business is forward looking, it would almost certainly result in wrongful convictions. Lots of activity that looks reckless after the fact can seem perfectly sensible ahead of time. Unless the crime required bankers to know they were being reckless--in which case it would deter almost no-one and result in approximately zero convictions--it would wind up punishing bankers for just being wrong.

Carney and Weisenthal outline why in several posts, which you can check out here, here and here:

• 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

I agree with Carney and Weisenthal. Bankslaughter won't work and, in fact, is a ridiculous idea that if ever implemented could cause more damage to the economy in its vulnerable state than good. As it is, when shareholders disagree with the way a company is run, they always have the right to pull out. Remember how Lehman Brothers Inc.'s stock tanked in September? Remember the run on Bear Stearns & Co.? Those shareholders all suffered losses, but they chose to invest, and with investing comes a responsibility as a stakeholder in the business. If they ignored the proxies mailed to them, then they are partially to blame for the debacle. Collier doesn't seem to address this issue and instead sheds tears for Northern Rock plc shareholders who were wiped out when the firm was nationalized.

To add to Clusterstock's argument, if bankslaughter were applied to all bank failures, it would basically put all bank executives from Lehman's former CEO Dick Fuld to Citigroups Inc.'s (NYSE:C) former CEO Sandy Weil under investigation at all times. That's pretty exhausting. It could also criminalize those executives of all the regional failed banks that the FDIC insures.

And with the banking industries propensity to merge, where does it begin and end? For example, if Wachovia's troubles stemmed from its Golden West purchase, which CEO is to be blamed?

Bankers are getting a bad rap, aren't they? Bankers jobs are to get shareholders the most money they can and sometimes bet against the odds and take risks. Essentially, when you invest in the stock market, you are gambling. That's the thrill. Well, that and making money. Most shareholders don't put their eggs in one basket and know that a diverse portfolio is essential and loss is always a risk. - Maria Woehr

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