Increasing Liability of Bank Executives
By Arnold Kling
In the early days of fractional reserve banking, bank owners were subject to unlimited liability. In the US, double liability for bank shareholders was common up to the Great Depression. All American investment banks were partnerships into the 1970’s and the last one, Goldman Sachs, only converted itself into a limited liability corporation about a decade ago. Back in the 70s, US financial sector liabilities were less than 20% of GDP. Today the figure is close to 120%. Leverage has increased enormously. Back then, stringent liability rules inhibited risk taking. In the days when such liability provisions applied to banks, “conservative” was the adjective habitually attached to “banker.” It does not fit the high-stakes gambling “quants” of recent years.
Thanks to Mark Thoma for the pointer.
I agree that there is a problem with giving financial executives only limited liability, particularly when they enjoy nearly unlimited taxpayer bailouts. I also agree that Leijonhufvud’s gimmicky approach to create a financial penalty for executives of failed financial institutions is only, as he describes it, a “modest proposal.” Although I cannot seem to find the original post, I believe that at one point I suggested that in order to ensure compliance with the spirit of conservative banking, executives of insured institutions that fail ought to be shot.