Summary |
The book discussed the consequences of rapid innovation and breakdowns in the intermediation process. Innovation affects compensation, for without measurement or adequate risk controls, senior management has difficulty discerning skill from risk taking. Innovation leads to seeming moral hazard issues. Lenders often don’t spend resources in the short run to monitor instances in which other will step in to protect them. (For example, since AIG posted collateral to each of its counterparties and bankruptcy laws allowed them to seize the collateral in the event of AIG’s default, the counterparties did not have to monitor the credit or the size of AIG’s business. This was obviously true of government foreign debt holders, for example.) The true moral hazard in the system is that debt holders suffer little loss during a financial crisis. If they did, they would monitor or force management to monitor innovations.
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