Bankers Need to be More Susceptible to Risk


A piece in last Wednesday’s Wall Street Journal argues that Wall Street’s casual approach to risk was due to the abandonment of the partnership model in favor of the corporation.

[I]n a $14 trillion economy, you can’t hire enough overseers to pore over everyone’s books. There is, however, a better solution: expose players in the financial game to greater personal loss if their risk-taking fails. When you worry that a mistake will cause you to lose your second home, your stocks and bonds and your club memberships, then you’re less likely to take the kinds of risks that expose the rest of society to your failures. A simple mechanism exists to achieve this purpose: the private partnership. Partners face liability that extends to their personal assets. They aren’t protected by the corporate shield that limits losses to what the corporation itself owns (as well as the value of the stocks and bonds the corporation has issued).

[I]nvestors — and governments — should recognize the extra safety inherent in doing business with partnerships. In the end, the partnership — not more regulatory intrusion — is an efficient, even elegant, answer to the thorny risk-mitigation problem. Partnerships are less likely to make big mistakes, but, even if they do, their smaller size means they pose less of a threat to the financial system as a whole, and to the taxpayers who have to pay for the clean-up.

Indeed a compelling argument. On the other hand, Professor Larry Ribstein, of Ideoblog, thinks otherwise. While he does strongly believe that the role of the corporation needs to change, he states that “[o]ver the last generation, better governance technologies have evolved through private equity, venture capital and hedge funds. This should be the model for the reorganization of Wall Street.”

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