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FT.com / Comment & analysis / Comment - Bankers’ pay is deeply flawed
For example, an investment manager who bought AAA-rated tranches of collateralised debt obligations (CDO) in the past generated a return of 50 to 60 basis points higher than a similar AAA-rated corporate bond. That “excess” return was in fact compensation for the “tail” risk that the CDO would default, a risk that was no doubt perceived as small when the housing market was rollicking along, but which was not zero. If all the manager had disclosed was the high rating of his investment portfolio he would have looked like a genius, making money without additional risk, even more so if he multiplied his “excess” return by leverage. Similarly, the management of Northern Rock followed the old strategy of taking on tail risk, borrowing short and lending long and praying that the unlikely event of a liquidity shortage never materialised. All these strategies essentially earn the manager a premium in normal times for taking on beta risk that materialises only infrequently. These premiums are not alpha, since they are wiped out when the risk materialises. True alpha can be measured only in the long run and with the benefit of hindsight – in the same way as the acumen of someone writing earthquake insurance can be measured only over a period long enough for earthquakes to have occurred. Compensation structures that reward managers annually for profits, but do not claw these rewards back when losses materialise, encourage the creation of fake alpha. Significant portions of compensation should be held in escrow to be paid only long after the activities that generated that compensation occur.
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FT.com / Comment & analysis / Editorial comment - Bankers are fallible but not replaceable
Bankers are fallible but not replaceable
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Plus ça change: Subprime crisis and historical lessons | vox - Research-based policy analysis and commentary from Europe's leading economists
In many of these cases financial innovation which increased leverage and was often devised to circumvent regulations was an integral part of the story of the boom. Examples include Penn Central in 1970 with innovation in the commercial paper market; the savings and loan crisis of the 1980s with junk bonds; LTCM with derivatives and hedge funds and today with the securitization of subprime mortgages. In this episode risk has been shifted from the originating bank into mortgage-backed securities which bundles shaky risk with the creditworthy. Asset backed securities were absorbed by hedge funds, offshore banks and commercial paper. The shifting of risk from the banks to the financial markets as banks tried to avoid regulated capital requirements did not reduce systemic risk and increased the risk of a more widespread meltdown. Indeed the exposure of the non bank financial sector has ultimately put pressure on the banking system.
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FT.com / Columnists / Martin Wolf - Why the credit squeeze is a turning point for the world
Second, these events have called into question the workability of securitised lending, at least in its current form. The argument for this change – one, I admit, I accepted – was that it would shift the risk of term-transformation (borrowing short to lend long) out of the fragile banking system on to the shoulders of those best able to bear it. What happened, instead, was the shifting of the risk on to the shoulders of those least able to understand it.
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FT.com / Columnists / Martin Wolf - Why banking is an accident waiting to happen
banks free-loading on subsidy
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FT.com / Comment & analysis / Analysis - Does not compute: How misfiring quant funds are distorting the markets
Does not compute: How misfiring quant funds are distorting the markets
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FT.com / Comment & analysis / Comment - Central banks should prick asset bubbles
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Islamic Banking: Is It Really Kosher? — AMERICAN.COM: A Magazine of Ideas, Online
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