Leverage And Risk

In a 9/23/09 WSJ op-ed, Andy Kessler, a former hedge fund manager, argues against the current administrations proposal to curtail excess bonuses that reward employees of banks and investment firms for taking excessive risks.

Mr. Kessler writes “It wasn’t reckless schemes and excessive risk that sunk banks and Wall Street; it was excessive leverage.” Wall Street investment firms had used that excessive leverage to make what they thought were fairly low risk bets. The complexity of oversight and of rule making to control employee pay makes it difficult to manage.

Kessler’s proposal is a sound one. Instead of a cap on bonuses, Wall Street firms should be charged appropriately for the “insurance” that the Federal Reserve and the FDIC provide Wall Street. That risk adjusted insurance charge will reduce the profit for more leveraged trades, effectively squeezing an employee’s pay on the trade. Kessler argues “let the Fed and the FDIC use to market to protect the market.”

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