Another way the rich are different

Here is another big difference between the 1 percenters and everyone else. They get paid to co-sign loans.

Ever co-sign a loan? Maybe your kid is in college and you needed to co-sign for the student loans from Sallie Mae. Or maybe a friend or a relative’s car broke down and the only way they could get a new one in order to be able to get to work was for you to co-sign the loan.

Now, here’s the question: Is Sallie Mae paying you for co-signing that loan? How about the auto finance company, are they sending you regular checks for having co-signed that auto loan?

Probably not. Not if you’re part of the 99 percent.

For most of us, co-signing a loan is a very strange transaction. We agree to provide a valuable service to the lender, in exchange for which the lender gives us nothing. Very strange indeed.

The lender wants to make a loan. This is their business model. It’s how they make their money — no lending, no profits. But every loan they make entails taking on a bit more risk. What if the borrower defaults? To insure themselves against that risk, lenders can buy insurance against defaults. Or they can just take it without ever paying for it.

The latter is what they’re doing when they get you to co-sign a loan. They’re making you provide them insurance for free.

Like most people, for the past four years I’ve been reading and hearing a great deal about credit default swaps and trying to wrap my head around what exactly those are and how they work. And from what I’ve figured out,* they seem to me to be not much more than a way of getting a third party to co-sign a loan. They don’t call it that, but it works the same way. If the borrower defaults on the loan, the co-signer — the finance or insurance company selling the CDS — becomes liable for paying off the balance.

But no finance or insurance company is going to accept that potential liability free of charge. The lender wants to get rid of some risk so the seller of the CDS offers to take on that risk instead — for a price. The lender pays that price willingly because this service is extremely valuable.

Basically it’s loan insurance. That’s what those companies are offering when they sell each other credit default swaps. And that’s what you are offering when you co-sign a loan.

The only difference is that those companies are getting paid to take on the risk of this potential liability. You are not. You’re just doing a huge favor for Sallie Mae or the auto finance company because you’re such a nice person.

Or because you’re getting ripped off.

If every parent, friend, relative or roommate who’d ever been suckered into co-signing a student loan, car loan or mortgage had been paid even half the market rate that lenders pay each other for this kind of insurance, that gap between the 1 percenters and the rest of us might not be quite so huge.

– – – – – – – – – – – –

* People who understand this better than I do, please feel free to correct me if I’m getting this wrong.

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  • MikeJ

    Here’s the way I always looked at it: the banks knew that the loans were potentially risky, and when that risk was figured into the books, they weren’t really making any money.  So what they did was find somebody to say they were insured against loss.

    If you get pulled over by a cop, one thing he’ll ask for is proof of insurance.  AIG sold “proof of insurance” for investors afraid of getting pulled over.  Anybody could print up something that looks like an insurance card, good enough to keep a traffic cop off your back anyway.  Perhaps your friend has a better color laser than you, so you pay him $5 to print it. Also, if your friend prints it, you can say without lying, “I paid a third party for this proof of insurance.” Your home made proof of insurance won’t do you any good when there’s a crash.  And in that way it’s just like what AIG sold.

  • Actually, a Credit Default Swap is more like a gambling bet than insurance. Companies like AIG are like bookies, covering the bet and taking their vig.

    A borrows money from B. B can buy a CDS that covers them in case A defaults. That sounds like insurance, but it’s more like the kind of insurance you buy at the blackjack table than what you’d get at your local Allstate office.

    Real insurance comes with all kinds of rules: who can buy it, how much they can buy, what kind of reserves the insurer must hold, etc. CDS are nothing like that.

    For example, I can’t take out insurance on your house that will pay me if it burns down. But I can buy a CDS that will pay be if A defaults on his loan to B, even if I am neither A nor B.

    Now I have The Mikado playing in my head.

  • Gospodin Dangling-Participle

    A big difference: if you’re cosigning for me, it’s because the lender won’t give me the money without your signature on the loan. Without you, the loan doesn’t happen.

    A CDS, by contrast, is always written on an existing loan. Nobody is told, “No, we won’t loan you this money unless you get a CDS on it.”

    This is, of course, in addition to the whole third-party thing that Chuchundra pointed out.

  • Anonymous

    Well if there is one thing I learned so far: don’t own anything to anybody.

  • Yup, I think Chuchundra’s got it right. CDS acted like insurance policies, but the buyer of the policy didn’t have to own the underlying asset being insured. Therefore, the CDS acted more like bets on the health of that underlying asset made between third and fourth parties (and ultimately fifth and sixth and seventeenth and eighty-fourth, etc.).

    Let’s say Person A bought a senior tranche of a Mortgage Backed Security worth $100M from Person B, and the prospectus on that tranche said that it had a 2% chance of default. Then Person C could buy a CDS from Person D that would pay out in full in the event that the tranche defaulted. In exchange, Person C would pay Person D a monthly payment (let’s say $20,000, though that is just a random number I pulled from nowhere) commensurate with the risk of default.

    The point of these wasn’t to provide insurance. The point was to be able to profit off of shifts in the risk profile of the underlying asset. If all of a sudden the tranche were projected to have a 4% chance of default, then Person C, could sell his own CDS to Person E on this tranche, and now the monthly cost of the CDS would be $40,000, and C would pocket the $20,000 difference. If the risk went up again, then Person E could sell his own CDS to Person F, and on down the line.

    But let’s stop here and see the problem. Let’s say that the thing went bust. Now assume the tranche defaults (this is exactly what happened). Now by the terms of the CDS, C owes $100M to E, and D owes $100M to C. But if for some reason D’s balance sheet is trashed, he can’t afford to pay C, and then C can’t afford to pay E, and on down the line. Complicating issues is the fact that these things weren’t regulated, and so nobody knew exactly who owed whom.

    Complicating things even further is the fact that sometimes these CDS were bundled together, sliced up, and sold as “synthetic CDOs”. Basically, they operated roughly like Mortgage Backed Securities, in that there was a regular payment stream coming in, etc. So not only was it unsure who was responsible for paying the underlying assets since so many people were both buying and selling CDS, it often wasn’t clear who owned them, since some were bundled and sliced just like the assets against whose failure they were meant to insure.

  • Anonymous

    Yeah, a CDS is only like co-signing a loan in the sense that they are both sort of like buying insurance against a default of the loan. The major difference is that insurance and co-signing are both established businesses with well-developed risk models, ensuring that neither Allstate nor the bank will go out of business because too many people default at once. AIG, on the other hand, sold so many CDSes on the same item that it couldn’t cover them all when the market slumped.

  • My parents have always had a very middle class income.  My father is blue-collar, setting up stages, backstage work, making props and furniture in his home studio, along with rigging for events or occasionally construction.  My mother is white collar, working as a business manager, first by helping people organize and select health plans, then by running the business end of a non-profit venue for cultural expression (authors, music, book readings, etc.)  

    Despite the income level, my parents have a high net value.  They have gotten this by doing everything “right”.  Nearly half their income goes into savings or “safe” investments with low risk that give good return in the long-term, and they have been doing this since they got married several decades ago.  They bought a house a couple years before the birth of their first child (me) and have never moved since, paying off the house, upgrading it, and holding onto it as the neighborhood gentrified, such that it is now a valuable asset.  I was informed that, should my parents liquidate all their assets at once, they would technically be millionaires (albeit only just and even then they would own nothing practical.)  

    The reason why they did this was twofold.  First, it allowed them to provide for their children’s future.  They set up special accounts for their children’s education, and (tying in with what Fred mentioned) it allowed them to be co-signers if anyone in the family needed a loan, allowing them to get a much lower interest rate than would otherwise be insisted upon because they had a lot of assets to back it up.  The second reason was that it would allow them to support themselves.  When they had enough money tucked away, the interest on that money would be sufficient to meet their living expenses, and they could retire.  Both still intended to remain active and work, but they would be free to just work the jobs that they want to work as far as they want to work them, rather than feeling the pressure of impending bills forcing them to remain in jobs that they are unhappy with.  

    And to add a little rant, because of the economic downturn, many of their supposedly safe investments which had been slowly gaining value across the decades now are worth much less, and their retirement plans have been put on hold when they were only a few years away from being self-supported retirees.  

    Just goes to show, even if you do everything right, never live beyond your means, and set a great example of responsible financing, a deregulated finance market can still screw you over.

  • And now “I’ve got a little list”

  • Lori

    What Chuchundra and G D-P said. CDSs aren’t really like cosigning a loan. IIRC Matt Taibi does a pretty good job describing how CDSs work in Vampire Squid Griftopia.

    Edited for clarity, Vampire Squid being part of the subtitle, rather than the main title of Taibi’s latest book.

  • Lewin

    The cosigning service isn’t to the bank, it’s to the lender. And some people do charge to cosign; I have heard of it happening on college campuses where students need an employed cosigner in order to get a credit card.

  • Anonymous

    The third-party thing is an issue, but of course a lender /can/ use an instrument like a CDS as insurance on a loan that the lender owns.  Like Gospodin said, though, this is done after the fact.  Why would anyone agree to “co-sign” a loan which has already been made if they weren’t going to get compensated for it?  And that’s exactly why a lender won’t pay someone to co-sign – it works out to being the same, for the lender, as offering a lower interest rate.  The primary borrower can always promise to pay the co-signer using savings from the lower interest rate, but typically a co-signer is someone who knows the primary borrower very well and is willing to let them keep all of the surplus.

    I think that co-signing is almost always dumb, and, if it’s at all possible, informally loaning a family member some money yourself is generally going to be a lot better for everyone involved (lower/zero interest rates, much less trouble in the event of primary default), but lenders aren’t really being abusive by demanding a co-signer.  They’re certainly not getting a loan co-signed for free relative to a loan which is not co-signed but which does not default – the whole point of co-signing is that the lender will be willing to offer a lower interest rate.  Obviously this could be done in such a way that the lender ends up making more money, on average, from co-signed loans, but in that case the borrower needs to be shopping around and generally pushing for a lower rate.

    Edit: To be clear – there are times when co-signing makes sense, when you basically use it as a means of borrowing money from a bank which you then turn around and informally lend to someone else, but too often people co-sign loans without really understanding the risks involved. You co-sign when you’re really, really, really sure that the primary borrower is good for it or when you really want to loan them the money yourself but aren’t liquid enough to do so.

  • Lori

     Well if there is one thing I learned so far: don’t own anything to anybody.  

    Refusing to ever borrow money can actually be absolutely the wrong thing to do. I think the rules to live by are more along the lines of, “If it looks too good to be true it almost certainly is” and “Hope for the best, but plan for the worst”. 

  • Anonymous

    The thing is there is no limit on how bad things can get.

  • muteKi
  • Lori

     The thing is there is no limit on how bad things can get.  

    Yeah, there sort of is. We’re a long way from that limit, but it does exist. And the thing is, if things get that bad not having any debt is going to be of trivial benefit. In fact, in one of the worst case scenarios (runaway inflation) it’s at least marginally better to owe than to be owed. 

  • Anonymous

    @facebook-507398586:disqus has got it right.

    Futhermore (and this is in my limited understanding) the best part of the whole thing (and the reason you basically have to have TARP) is that each of those parties puts the value of the CDS income on their books, but not the value of the CDS default on their liabilities.  So in the ABCDE situation above, C gets to right down his $20,000 monthly income on his SEC statements, but doesn’t have to show the $100M liability.

    So, you follow this on down the line, and you’ve got $500M in liabilities on a $100M mortgage tranche.  Bad news.  When the tranche defaults suddenly all of those CDS are now due, but nobody actually has the money to pay them.  To the entire tune of about $60 Trillion dollars – or about 3 times global GDP. 

    So, the government steps in and basically buys the original security for it’s face value so none of the CDSs have to pay out – thereby avoiding financial Armageddon.

    Now, here’s where it gets fuzzy for me.

    Nothing is actually done about the CDSes outsanding on that security.  They are continuing to pay the same amount to the originators, and the liabilities that it is literally impossible to meet are still out there.  Dodd-Frank prevents any MORE third party CDSes from being issued, but right now, the financial industry and the global economy in generally is basically running out the clock on the maturity of all of those mortgage securities.

  • Anonymous

    Well, yes. The whole point of buying a CDS is to remove a liability from your balance sheet by paying someone (Company D) to assume that liability for you. This is fine as far as it goes; Tim Fargus correctly points out that the problem arises when CDSes are themselves resold and repackaged so that several companies have exposure to the same risk. Eventually, Company D becomes too big to fail regardless of what its balance sheet says.

  • Ken

    Don’t forget how incestuous this all is.  When company A is insuring itself against default with company B, and B is insured with C, and C is insured with A – well, none of them are really safe, whatever their books may show.

  • Kukulkan

    On a basic level I think Fred has it right.

    As others have pointed out, Credit Default Swaps (CDS) are basically a form of insurance, but insurance is just a monetization of a moral relationship.

    That is, if someone suffers a mishap, friends and family would help them out. If my house burns down, people I know would step in to help. They would give me a place to stay, they would feed me, lend or give me clothing, when I was rebuilding they might come over and help, lend or give me old furniture for the rebuilt place and so on. What insurance does is replace this mutual obligation with a financial relationship. You pay the insurance company a regular fee and in return, when you suffer a mishap, they provide a chunk of money to pay for the various things you need to deal with that mishap — a place to stay, food, buying replacement clothing, paying builders, buying replacement furniture, and so on.

    The differences between mutual obligation and insurance are:
      i) the insurance relationship lasts only as long as you keep paying fees;
     ii) the amount that insurance will pay out is limited to a pre-defined amount, while mutual
         obligation is open–ended, but limited to what others can provide — which may be more or
         less than the pre-defined amount of insurance.

    In that sense, co-signing a loan is an example of a mutual obligation; you do it for people you have a relationship with — family members, friends, flatmates, and the like. Sometimes, if you have the money, rather than co-signing the loan, you just lend them the money. They then pay you back when they can and at zero interest. In that sense, you could say that banks get paid to help people out whereas the rest of just do it out of moral obligation or personal generosity.

    A lot of businesses are built on monetizing normal human relationships. People write letters to one another or give gifts. If you write a letter or prepare a gift for someone in a distant location you could find someone going to that location and ask them carry the letter or gift with them and pass it on as a favour, or you could get the post office or a private company to do so in return for a fee.

    (For what it’s worth, in my family, if someone were going to a distant place where other family members live, it was not uncommon for the traveller to be loaded down with lots of gifts to be passed on. The personal connection — this came from your aunt through me to you — was seen as important, if not more important — than the convenience of commercial delivery.)

    So, CDS can be seen as a monetization of the mutual obligation sometimes expressed as co-signing for a loan.

    The other differences flow from the monetization. Once something is monetized it becomes a commodity, which means it cam be bought and sold. This can create complicated tangles of ownership in which a commodity passes through several parties and it’s not clear exactly who owns what when the crunch comes. That’s why business requires much more detailed record-keeping than personal relationships do.

    It also opens up the possibilities of fraud. People can sell a commodity they have no right to, or they could sell the same commodity to multiple parties. And since CDS are a form of insurance, which is a promise to pay in case of a mishap, they are open to the problem all insurance faces: because of the payment, sometimes a party may be better off if the mishap occurs than if it doesn’t. Burning down a failing business of the insurance money, or killing an disagreeable spouse for the life insurance.

    Most of the problems with CDS stem from these factors:
      i) tangled ownership because they’re commodities;
     ii) poor record-keeping making the tangles of ownership even more difficult to unravel;
    iii) poor record-keeping allowing out-right fraud, where the same CDS (or part of the same
         CDS) were sold to multiple parties creating a situation where the same amount of money was
         counted several times, creating an illusionary total amount of wealth;
     iv) creating conflicts of interest, where some parties had more to gain if the underlying loan
         defaulted than if it were paid off.

    The details are messy and complicated — and various parties benefit from that, so there’s no great urgency to simplify things down — but I think Fred’s insight does cut down to the basics.

  • Anonymous

    * People who understand this better than I do, please feel free to correct me if I’m getting this wrong.**

    ** Beatrix, this is not an invitation to engage in your boilerplate ass-babble.

    (Just heading things off.)

  • P J Evans

     It’s even worse than that: at least one seller of CDSs lied outright about the product. They said that another party had selected the parts of the product, and that it was safe, while knowing that neither was true: they had selected all the contents themselves, and they knew most of it was going to default.

  • Many of the problems we are dealing with today have, ultimately, to do with the fact that the 1% (and even the 10% who do what the 1% does) make a lot of their money being natural speculators.

    As such, volatility – any volatility – is good. This is an odd perversion of the usual human preference for stability and routine. Even the most free-spirited of people would be agitated and disturbed if the sun failed to rise tomorrow, or if the seasons failed to follow one another.

    It doesn’t matter what the item is. It can be stocks, bonds, currencies, and even more exotic financial instruments. In fact many exotic financial instruments oriignally intended to deal with the increased volatility of things in today’s world (i.e. derivatives) have turned into drivers of extra volatility of their own!

    All this is ultimately rooted in the paper economy: the unproductive sector that depends exclusively on “financial services” (what a misnomer! Canadian banks made 50%+ of their profits not on basic loans and other ordinary banking services, but on the money, bond and stock markets!) of ever more exoticized instruments that have little to do with the underlying assets on which they are based.

    The 1% who depend on the wild swings of any market anywhere would be terrified of the 1950s and 1960s for all that their sycophants on the political right gyrate to positive paeans of that era as a time when everybody knew their place relative to white males.

    The 1950s and 1960s, you see, were an era of highly regulated banking services, fixed exchange rates, and controls over capital flows.

    In short, the highly stable situation that characterized that era is as much a political creature as is the toxic, unstable situation of today. Governments actively chose to pursue policies which are just as viable today (we can have a 2010s society and a 1950s-era version of economic stability). Just as governments have actively chosen, in the last generation, to pursue policies which succour the wealthy – those who have no sense of social obligation and wouldn’t even understand the concept if it walked up and belted them one in the face.

    Those on the right insist that we must bring people to heel because someone (usually Daddy) knows best*.

    Well, it appears that it’s time we applied that philosophy to the rich: the 99% know best, and it’s time they were brought to heel. And we will not brook opposition. It’s high time a great many of these so-called “financial vehicles” were killed dead, buried, and made very illegal. We didn’t need all these fancy things to turn the gears of commerce for 200 years prior to the time some snot-nosed kid in some financial services house came up with a new way to rip people off.

    * It’s kind of odd that they freely follow a Government knows Best philosophy when it comes to orgiastic pronouncements of ever greater punishments for people who break laws. The Government might also Know Best when it comes to things like higher taxes.

  • Anonymous

    If you want to see a film that really breaks down what happened and how all of those financial instruments worked, take some time to watch “Inside Job”. Fantastic documentary.

  • Tonio

    Even before I saw The Smartest Guys in the Room, I had suspected that those “financial vehicles” and other tools to capitalize on volatility have the effect transferring wealth instead of creating it.

  • Anonymous

    Rent seeking plutocrats.  Public enemy #1.

  • Anonymous

    Off topic:

    Weird – Disqus says I have 612 comments and 13 likes.  (Which is… not correct unless I’ve been unliked a LOT in the last 24 hours, and is also, pretty much a troll ratio.)  Also, 328 comments on Mother Jones (actual number — 1)

    Now I’m concerned that someone is going around posting shit like “I do so love Rick Perry” on my account.

  • It does that sometimes. What I think happens is it dumps all your “likes” in the “replies” column and then later realizes that’s not right and resets it to normal.

  • Anonymous

    That’s really scary behavior from a programming perspective. It says that not only is there some fairly normal bug that is confusing “likes” with “replies”, but that someone wrote a quick fix that scans for these issues and resets the count rather than fixing it in the first place.

  • Anonymous

    ** B—–x, this is not an invitation to engage in your boilerplate ass-babble.

    (Just heading things off.)

    My mind works in very odd ways, but … all I can think of is that I wish it took invoking hir name three times before xie showed up….

  • Anonymous

    A market, never mind The Market, blessed be It, doesn’t even admit the existence of a ‘you’, in any meaningful sense of the word.

    It’s every bit as impersonal as gravity, only gravity is less malign, because we couldn’t engineer F to equal (MA)/2 if we wanted to. Markets aren’t like that.

  • Anonymous

    If ‘ass-babble’ isn’t already a Schimpfwort in German, than German she is broke.

  • Yeah. frankly, I find it continuously shocking the very strange ways in which very simple things are entirely broken with disqus. As a programmer, there is a certain class of broken that is actually *very hard* to achieve, since it requires a kind of fundamental incompetence that should have precluded the system from ever having worked in the first place. It’s like someone dying of starvation in the vacuum of space — sure, sucking on hard vacuum stops you from eating, but anoxia should have killed you days before starvation was an issue.

  • Lloyd

    Here’s a splendidly designed short film that clearly explains the outline of what happened in 2008:

  • P J Evans

     Can we get Nicky San Gabriels to mind-whammy the 1% into chasing after something like tulip bulbs?

  • Anonymous

    Okay, hold on a second here! What the hell is a “tranche”?! It doesn’t help to try to “explain” something to us if you’re going to use some bit of specialized jargon without defining what that bit of jargon means.

  • Lori

     Okay, hold on a second here! What the hell is a “tranche”?!  

    My first response was, “A word that sounds remarkably like a swear when Matt Taibbi says it.”  Invisible Neutrino’s link is, of course, far more useful. 

  • Two things that’re interesting about the stuff on Wikipedia:

    1. The guy pointing out how fiduciary duty is actually an important real-world concept and not just a fancy legal term, because fiduciary duty includes being someone who faces consequences if something goes wrong with the contract (in this case, a mortgage).

    2. The “mixing” of whatever items you want to pool together. In insurance, pooling risk by expanding the total number of insured is how Canadian health insurance, for example, manages to be fairly cost competitive even though both high-risk (the elderly, patients with AIDS) and low-risk (young people, for the most part) people are in the same group.

    But that mixing doesn’t work when you need/want to make a profit. The same failure of American health insurance (in part, due to companies having to purposely cherry-pick their clients to remain profitable) is also what drives the failure of the use of tranching as a way to securitize mortgages, stocks, bonds, whatever. Losses from high risk sectors may still overwhelm low risk sectors, but now someone’s desire to make out like a bandit is at stake here.

    Also, we’ve seen that a related issue with tranching and securitization generally is that it breaks one of the key factors that drives the efficiency of Western economies: A clear, unbroken chain of ownership that proves who owns what.

    With this method of packaging up items that were never meant to be securitized and turned into volatile speculatable commodities, the chain of ownership becomes blurred and broken.

    And we start running into the same problem as bedevilled centrally planned economies: When “no one” owns an asset except perhaps a very distant party somewhere else, there’s no incentive to keep an eye on it, especially if the asset seems to be performing acceptably (think about the Soviets lying to themselves with the gross material output figures from the Five-Year Plans, and the ultimate owner of a sawmill in Siberia being Gosplan and related agencies in Moscow).

    And then when the bills finally do come due, someone has to take responsibility for, well, something that’s not worth a helluva lot. Cue a long period of slow restructuring as the old crap has to get cleared out of the way for more reliable stuff.

  • Lori

     1. The guy pointing out how fiduciary duty is actually an important real-world concept and not just a fancy legal term, because fiduciary duty includes being someone who faces consequences if something goes wrong with the contract (in this case, a mortgage).  

    The thing that’s noteworthy about this is that there are people who are paid to write about financial issues who clearly don’t actually understand how and why this is true. Megan McArdle comes most readily to mind. 

    The other problem with tranching is that it’s supposed to provide information to the investor. Knowing if something is the top or bottom tranche is supposed to tell you something about the safeness of the investment. The problem is that a lot of deals were packaged specifically to use tranching as a weapon against investors instead of information for them. 

    Take a bunch of B tranches for primary deals, lump them together into a secondary deal and tranche that. Suddenly you have loans bumped up to AAA without any underlying improvement in their risk profile. The kindest interpretation of that is that it’s a problem. The less kind (and more realistic) interpretation is that it’s fraud. 

  • It’s interesting how the whole situation of obscuring the true ownership of something, either by means of indirection (numbered companies are legal here in BC, for example) or by means of securitization, is considered a benefit to the workings of the capitalist economic system rather than a potentially hazardous hindrance.

  • Lori

    The thing is, it’s not supposed to benefit the capitalist economy and really it doesn’t. It’s a benefit to a few people in a position to benefit from having information that others don’t have. 

    For example, the system doesn’t benefit from this, but a very small number of people can:

    IOW, people are cheating:

  • Kukulkan

    Invisible Neutrino wrote:

    It’s interesting how the whole situation of obscuring the true ownership of something, either by means of indirection (numbered companies are legal here in BC, for example) or by means of securitization, is considered a benefit to the workings of the capitalist economic system rather than a potentially hazardous hindrance.

    It’s considered a benefit because it spares people from having to suffer from the consequences if they get something wrong. It distances and diffuses decisions so much that no individual or group can be held accountable.

    This is a “benefit” because, as the old saying has it:
              Success has a thousand fathers, failure is an orphan.
    People don’t like taking responsibility when things go wrong. They work very, very hard to find ways to avoid doing so. A lot of the complexity in bureaucracies and regulations and record-keeping is to help people not take that responsibility.

    The reason for this is, of course, that the reasons for success or failure are many and varied and beyond the control of any one person. People are aware of this in the case of failure — things fail because of all sorts of reasons outside their control, so it’s unfair that they should get the blame. However, people manage to ignore all those outside factors when something succeeds — it succeeded because of their actions and it’s unfair if they don’t get the credit, reward or bonus that comes as a consequence of that success.

    This means that if people are forced to take responsibility, they become very cautious. Better to have a small success if it’s a sure thing, than to go for a big success if there’s a risk of an equally big failure that they will get the blame for. That’s why those charged with a fiduciary duty are so conservative and careful.

    However, the same mental quirk that lets people ignore outside factors as a cause for success comes into play, and people start treating unrealised hypothetical successes as real losses. That is, when someone’s actions result in a real $1,000 profit, rather than a possible $10,000 profit with the accompanying risk of a $20,000 loss, people look at it and instead of saying “I made a thousand dollar profit” instead say “I could have made ten thousand dollars, so I’ve actually suffered a nine thousand dollar loss!” In those cases, the person charged with the fiduciary duty gets blamed for the loss, even though they actually made a profit.

    When that happens, the only sensible thing to do is to separate oneself from the fiduciary duty as much possible since you’re screwed no matter what happens.
    Take big risks, get the blame when things go wrong.
    Take small risks, get the blame for not realising the benefits of taking big risks.

    When a system is set up to depend on the benefits of risky behaviour with no buffers built in to absorb the consequences of the inevitable failures, what you get is something very much like the current state of global finances.

  • *chinhands* May I buy you an Internets? :D