I think Buce has a very good point.  There were many causes of the Global Financial Meltdown (GFM) in 2008 and it’s siamese twin, The Great Worldwide Recession That Won’t Recover (TGWRTWR).  Some causes are superficial and others are more systemic.  Certainly perverse incentives in the banking industry were among them.  This is the stuff of “institutional economics”.  One of the least-talked about changes in the last few decades has been that major Wall Street firms have converted from business partnerships (each of the senior managers is personally liable for the mistakes of the firm as a partner-owner) to corporations.  As a corporation, the shareholder-owner at most loses the actual cash they put in.  If they lose the borrowed money, there’s no consequence for them.  It’s heads-I-win, tails-somebody-else-loses.  Senior managers of these large Wall Street enterprises don’t even put any personal cash into the business since their “ownership” stakes are largely the result of stock options and stock grants they give to themselves as “compensation”.  No wonder they took outrageous risks and behaved irresponsibly.  Let Buce at Underbelly say it:

There is indeed something problematic about the asymmetric heads-I-win, tails-you-lose structure of non-recourse finance.

The trouble is, once you start looking for it, you find “non-recourse” under almost every rock in the capitalist garden. I’m sure Perry would be happy to show you how the same problem underlies the bankruptcy discharge, where the debtor gets to walk away from his just debts. I’ll bet (although I do not know) that he feels the same way about bank insurance, like the free-handed taxpayer guarantees that allowed the mischief-makers to bring down the Savings & Loan industry in the 80s/90s.

But it doesn’t stop there. When I buy a call option on LittleCo stock, I acquire the right to take the stock or throw it away–analytically no different from my right when I buy my home on a nonrecourse mortgage. I have not heard Perry howling for the abolition of the conditional claims market, and I am not holding my breath.

Or consider the corporate limited liability form itself, the greatest social invention, so Bertrand Russell is supposed to have said, of the 19th Century. Restated: the equity stake in a leveraged company is a call option on the assets–you can take or walk away, just as with stock options, just as with the nonrecourse mortgage.

Probably nobody ever understood this better than the bankers. Look at that picture above of Mr. Banker Himself, J.P. Morgan Jr. Why does he look like he is ready to explode? Because it’s his own skin in the game. He was a general partner. If the deals went sour, he stood to lose every penny. No wonder he was a prudent lender. No lwonder he staked so much on personal character.

Sadly, his successors appear at last to have grasped the full implications of his insight. What caused the late meltdown? Of course you can’t bring it down to one cause, but if you had to name just one, I’d say–incorporation of investment banks, the great tectonic shift from unlimited to limited liability.* That’s when the bankers stopped having skin in the game: when they shifted to heads-I-win, tails-you-lose. They bankers didn’t worry about taking lunatic risks because they knew the downside was yours, or rather ours (indeed, any first semester MBA student can show you, the greater your capacity to shift he losses, the greater the inducement to take a risk and the more lunatic the risks you take).