Home > limited liability > Finally an LvMI commentator who sees the elephant in the room: effective reform to rein in rampant moral hazard at banks means removing limited liability!

Finally an LvMI commentator who sees the elephant in the room: effective reform to rein in rampant moral hazard at banks means removing limited liability!

[It looks like I’m having formatting problems; sorry, readers!]

I left the following comment on Kevin Dowd’s excellent April 9 Mises Daily piece, “The Current Financial Crisis – and After”, a transcript of a talk he apparently made at the Paris Freedom Fest on September 13, 2009 (emphasis added):

TokyoTom April 22, 2010 at 8:27 am

Kevin, many thanks for this lucid, spot-on and frightening piece.

No one else has mentioned it, so allow me to focus on a piece of your essay that I think has very wide implications that our leading lights at LvMI have been doing their best to ignore: the moral hazard and risk-shifting generation that is INHERENT in the state grant of LIMITED LIABILITY to corporate shareholders, and that has helped to encourage irresponsible behavior and increasing (and ultimately unsuccessful) regulation in the banking sector. It has also fuelled the cycles of corporate regulation, rent-seeking and political corruption.

I couldn’t agree more strongly with what you said here:

“the financial-services industry needs serious reform. Hard to believe as it might be, there was once a time when the industry was conservative and respected, when it focused on providing straightforward financial “products” to its customers and did so well. We have got to get back to that. No more financial hydrogen bombs blowing up the financial system.

The key to this is corporate-governance reform. I am talking, not about tinkering with the number of nonexecutive directors or a new Sarbanes-Oxley, but radical reform to make the banks accountable and to rein in the moral hazards that have run rampant. And the key to good corporate governance is to remove limited liability: we should abolish the limited-liability statutes and give the bankers the strongest possible incentives to look after our money properly.”

I believe that, as argued by James Glassman and William Nolan in a Wall Street Journal op-ed last February that referred to von Hayek, unless and until owners and executives have “more skin in the game” – like the conservatively managed private partnership Brown Brothers Harriman, we will continue to ride a tiger of selfish risk-shifting, moral hazard, and ever more disruptive government regulation.

I have argued in a series of posts, starting with my review of Huebert and Block’s criticisms of Long, the state grant of limited liability to shareholders (in particular the grant vis-a-vis those injured by corporate acts and involuntary creditors, which is a pure grant from the state and cannot be contracted for) has led to a number of perverse results, which can be fairly clearly seen in the financial crisis.

I hope your post will contribute to a much more serious examination by Austrians of the role played by the state grant of limited liability to corporate shareholders in facilitating flawed and irresponsible risk-taking by executives and traders, as well as in perversely fuelling a vicious cycle of rent-seeking and further counterproductive regulation, both within and outside the financial sector.

[But I’m not holding my breath.]



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