In finance, actions can be both individually prudent and collectively disastrous. On June 10,Queen Elizabeth II opened the high-tech Millennium Bridge, which traverses the River Thames from the Tate Modern to St. Thousands of people lined up to walk across the new structure, which consisted of a narrow aluminum footbridge surrounded by steel balustrades projecting out at obtuse angles.

Within minutes of the official opening, the footway started to tilt and sway alarmingly, forcing some of the pedestrians to cling to the side rails. Some reported feeling seasick. The authorities shut the bridge, claiming that too many people were using it.

The next day, the bridge reopened with strict limits on the number of pedestrians, but it began to shake again. Two days after it had opened, with the source of the wobble still a mystery, the bridge was closed for an indefinite period. The real problem was that the designers of the bridge, who included the architect Sir Norman Foster and the engineering firm Ove Arup, had not taken into account how the footway would react to all the pedestrians walking on it.

When a person walks, lifting and dropping each foot in turn, he or she produces a slight sideways force. If hundreds of people are walking in a confined space, and some happen to walk in step, they can generate enough lateral momentum to move a footbridge—just a little. Once the footway starts swaying, however subtly, more and more pedestrians adjust their gait to get comfortable, stepping to and fro in synch.

What does all this have to do with financial markets? Quite a lot, as the Princeton economist Hyun Song Shin pointed out in a prescient paper. Most of the time, financial markets are pretty calm, trading is orderly, and participants can buy and sell in large quantities. Whenever a crisis hits, however, the biggest players—banks, investment banks, hedge funds—rush to reduce their exposure, buyers disappear, and liquidity dries up.

Where previously there were diverse views, now there is unanimity: And the process is self-reinforcing: This is essentially what happened in the lead-up to the Great Crunch. The trigger was, of course, the market for subprime-mortgage bonds—bonds backed by the monthly payments from pools of loans that had been made to poor and middle-income home buyers. In August,with house prices falling and mortgage delinquencies rising, the market for subprime securities froze. An immediate collapse was averted when the European Central Bank and the Fed announced that they would pump more money into the financial system.

A number of explanations have been proposed for the great boom and bust, most of which focus on greed, overconfidence, and downright stupidity on the part of mortgage lenders, investment bankers, and Wall Street C. According to a common narrative, we have lived through a textbook instance of the madness of crowds.

If this were all there was to it, we could rest more comfortably: Unfortunately, the real causes of the crisis are much scarier and less amenable to reform: Consider the freeze that started in August of Each bank was adopting a prudent course by turning away questionable borrowers and holding on to its capital.

But the results were mutually ruinous: This round of selling caused stocks, bonds, and other assets to decline in value, which generated a new round of losses.

In hindsight, that looks like reckless lending.

In most cases, lenders had no intention of holding on to the mortgages they issued. After taking a generous fee for originating the loans, they planned to sell them to Wall Street banks, such as Merrill Lynch and Goldman Sachs, which were in the business of pooling mortgages and using the monthly payments they generated to issue mortgage bonds.

As long as investors were eager to buy subprime securities, with few questions asked, expanding credit recklessly was a highly rewarding strategy. When the subprime-mortgage market faltered, the business model of giving loans to all comers no longer made sense.

Nobody wanted mortgage-backed securities any longer; nobody wanted to buy the underlying mortgages. Sharp-dealing companies like New Century may have been reprehensible. The same logic applies to the decisions made by Wall Street C.

In the midst of a credit bubble, though, somebody running a big financial institution seldom has the option of sitting it out. Privately, he may harbor reservations about a particular business line, such as subprime securitization. But, once his peers have entered the field, and are making money, his firm has little choice except to join them. In July,he intimated as much, in internet surveys earn money interview with the Financial Times.

But the private-equity business, in which Citigroup had become a major presence, was still thriving, and Blackstone, one of the biggest buyout firms, had just issued stock on the New York Stock Exchange. Prince conceded that a collapse in the credit markets could leave Citigroup and other banks exposed to the prospect of large losses.

Despite the danger, he insisted that he had no intention of pulling back. The reference to the game of musical chairs was a remarkably candid description of the situation in which executives like Prince how to send money order to usaa themselves, and of the logic of swhc stock options irrationality.

And there are some, I believe, who practice the fourth, fifth and higher degrees. The beauty-contest company stock market rationality and legal reform helps explain why real-estate developers, condo flippers, and financial investors continued to invest in the real-estate market and in the mortgage-securities market, even though many of them may have believed that home prices had risen too far.

According to orthodox economics, management stock option plan adalah speculators play a stabilizing role in the financial markets: Markus Brunnermeier, an economist at Princeton, and Stefan Nagel, an economist at Stanford, obtained data from S. In the third quarter ofthey discovered, the funds raised their portfolio weightings in technology stocks from sixteen to twenty-nine per cent.

By March ofwhen the Nasdaq peaked, the funds had invested roughly a third of their assets in tech. But their strategy was to capture the upside of the bubble while avoiding most of the downside—and, with timely selling, many of them succeeded. Much of the work done at RAND was initially applied to the logic of nuclear warfare, but it has proved extremely useful in understanding another explosion-prone forex diblokir Imagine that you and another armed man have been arrested and charged with jointly carrying out a robbery.

The two of you are being held and questioned separately, with no means of communicating. You know that, if you both confess, each of you will get ten years in jail, whereas if you both deny the crime you will be charged only with the lesser offense of gun possession, which carries a sentence of just three years in jail. The worst scenario, accordingly, is if you keep quiet and he confesses. What should you do? The optimal joint result would require the two of you to keep quiet, so that you both got a light sentence, amounting to a combined six years of jail time.

Any other strategy means more collective jail time. And you know that your partner is bound to be making the same calculation. Hence, telus smartcall option rational strategy, for both of you, is to confess, and serve ten years in jail.

In a situation like this, what I do affects your welfare; what you do affects mine. The same applies in business. When General Motors cuts its prices or offers interest-free loans, Ford and Chrysler come under pressure to match G. If Merrill Lynch sets up a hedge fund to invest in collateralized debt obligations, or some other shiny new kind of security, Morgan Stanley will feel obliged to launch a similar fund to keep its wealthy clients from defecting. A hedge fund that eschews an overinflated sector can lag behind its rivals, and lose its major clients.

So you can go bust by avoiding a bubble. If Citigroup had sat out the credit boom while its rivals made huge profits, Prince would probably have been out of a job earlier.

The same goes for individual traders at Wall Street firms. If a trader has one bad quarter, perhaps because he refused to participate in a bubble, the results can be career-threatening.

As the credit bubble continued, even the credit-rating agencies, which exist to provide investors with objective advice, got caught up in the same sort of competitive behavior that had persuaded banks like Citigroup, UBS, and Merrill Lynch to plunge into the subprime sector.

As the boom continued, investment bankers played the agencies off one another, shopping around for a favorable rating. To stay in business, and certainly to maintain market share, credit analysts had to accentuate the positive. The invisible hand becomes a fist. In February ofthe Millennium Bridge was reopened.

The engineers at Company stock market rationality and legal reform Arup had figured out how the collective behavior of pedestrians caused the bridge to sway, and installed dozens of shock absorbers—under the bridge, around its supporting piers, and at one end of it. Our system of oversight fails to account for how sensible individual choices can add up to collective disaster. Rather than blaming the pedestrians for swarming the footway, governments need to reinforce the foundations of the structure, by installing more stabilizers.

Not modest repairs at the margin, but new rules of the game. Much of what the Administration has proposed is welcome. If there is any wiggle room, excessive risk-taking and other damaging behavior will simply migrate to the unregulated sector. Limiting the development of those securities would stifle innovation, the financial industry contends. Acharya and Matthew Richardson, two economists at N.

We use reasonably advanced aircrafts whose designs have proved to be reliable. During the Depression, the Glass-Steagall Act was passed in order to separate the essential utility aspects of the financial system—customer deposits, check clearing, and other payment systems—from the casino aspects, such as investment banking and proprietary trading.

That key provision was repealed in And, since the federal government has now demonstrated that it will do whatever is necessary to prevent the collapse of the largest financial firms, their top executives will have an even greater incentive to enter perilous lines of business.

How Markets Respond to Tax Reform - Bloomberg

If things turn out well, they will receive big bonuses and the value of their stock options will increase. If things go wrong, the taxpayer will be left to pick up some of the tab. Executive pay is yet another issue that remains to be tackled in any meaningful way. Even some top bankers have conceded that current Wall Street remuneration schemes lead to excessive risk-taking.

Lloyd Blankfein, the chief executive of Goldman Sachs, has suggested that traders and senior executives should receive some of their compensation in deferred payments. Although Wall Street as a whole has an interest in controlling rampant short-termism and irresponsible risk-taking, individual firms have an incentive to hire away star traders from rivals that have introduced pay limits.

The compensation reforms are bound to break down. In this case, as in many others, the only way to reach a socially desirable outcome is to enforce compliance, and the only body that can do that is the government.

Company Stock, Market Rationality, and Legal Reform by Shlomo Benartzi, Richard H. Thaler, Stephen P. Utkus, Cass R. Sunstein :: SSRN

It does mean that the Fed, as the agency primarily responsible for insuring financial stability, should issue a set of uniform rules for Wall Street compensation. The Fed has a congressional mandate to insure maximum employment and stable prices. In creating this state of unreadiness, the role of free-market ideology cannot be ignored. Many leading economists still have a vision of the invisible hand satisfying wants, equating costs with benefits, and otherwise harmonizing the interests of the many.

In a column that appeared in the Times in May, the Harvard economist Greg Mankiw, a former chairman of the White House Council of Economic Advisers and the author of two leading textbooks, conceded that teachers of freshman economics would now have to mention some issues that were previously relegated to more advanced courses, such as the role of financial institutions, the dangers of leverage, and the perils of economic forecasting.

These topics will remain the bread-and-butter of introductory courses. Builders constructing homes for which there is no demand? Mortgage lenders foisting costly subprime loans on the cash-strapped elderly?

Wall Street banks levering up their equity capital by forty to one? The global economy entering its steepest downturn since the nineteen-thirties? Mankiw was referring to the textbook economics that he and others have been teaching for decades: In the world of such utopian economics, the latest crisis of capitalism is always a blip. Incentives for excessive risk-taking will revive, and so will the lobbying power of banks and other financial firms. The next time the structure starts to lurch and sway, it could all fall down.

John Cassidy has been a staff writer at The New Yorker since He also writes a column about politics, economics, and more for newyorker. Sign up for our daily newsletter: Shop Sign in Link your subscription. October 5, Issue. Daily Cartoon Daily Cartoon: Ask the Author Ask the Author Live: Listen to the New Yorker Radio Hour Buy the Cover Play the Jigsaw Puzzle.

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