You're assuming that the occasional gigantic bankruptcy isn't a natural outcome of the smartest strategy as a bank. But when you're comped on this year's profits, and a large chunk of your comp is cash, it makes sense to take huge risks that result in near-term profit, or immense long-term profit, and largely ignore the potential for a total collapse. (Not to mention most of the employees found jobs at other banks, or even just stayed at Barclays after the bankruptcy.)
If you're making $1M-$10M a year, the downside to a 5% or 10% chance of your employer going bankrupt is not so large that you're going to reduce your income to prevent that. And if you are, they'll just replace you with someone who is less "risk averse."
You bring up a great point, which is actually an excellent alternative answer to OP's question, "what do you expect?"
What we should expect is for banks to protect themselves as businesses by changing compensation to account for long term risk. And if they fail to do that organically, we should acknowledge that the market is failing in a dangerous way and more regulation around compensation is needed.
I don't know that you need to regulate compensation. You just need to not bail them out when they blow up, and it will self-correct. And you shouldn't let them gamble with federally insured (FDIC) money - either be a investment bank or a commercial bank, but not both, so that regular consumers don't get caught in the middle.
I totally agree. Had everyone been allowed to fail, we would've been well on the way to recovery already. It's frustrating to watch the government keep this pathetic lifeline going which will fail in the end anyway.
But isn’t this scenario impractical for reasons shown by the current problems in Europe? On Cyprus, the banks were considered “too big to fail”, meaning that they would take the whole economy with them if they went down.
Cyprus is not a good case study - the banks there actually are the whole economy, to some degree. Aside from tourism, they were supporting themselves by banking a lot the money coming of Russia, etc. The assets of Cypriot banks were ~9X their GDP, and the size of the estimated bailout was about 1X GDP.
If you don't let big banks fail, then nobody ever has to worry about counterparty risk, and they won't keep an eye on each other to see if one bank is taking too much risk or backing too many bets.
This is known as a partnership, where the partners' personal assets are at risk. This is what the investment banks used to be, way back when. (Consulting firms too, for that matter)
If I had some sort of magical power to enact this kind of reversal to where ibanks were once again partnerships, I'd do it in a heartbeat.
Ironically for the great-grandparent post, both the grandparent and parent post are "both completely true" as well.
We quite correctly should expect governments to (have) ensured that these corporations could be allowed to collapse, indeed they (bravely) did with Lehman, just AIG was worse.
We also should expect that if you give someone 10-40 years salary each year, then that bonus really really should be well aligned with the stockholders own goals, or they will act in their own best interest (correctly).
The only thing that turned a disaster into a once in a century clusterfk was being unable to let them collapse.
If you're making $1M-$10M a year, the downside to a 5% or 10% chance of your employer going bankrupt is not so large that you're going to reduce your income to prevent that. And if you are, they'll just replace you with someone who is less "risk averse."