Please explain to us lay people what "skewed incentives" means.

Reply Sun 28 Dec, 2008 04:51 am
How could the world have arrived at such a humiliating impasse? And why, in the words of Queen Elizabeth II, did none of the experts see it coming? The answer lies in a toxic combination of failures in risk management and regulatory oversight, as well as skewed incentives, particularly in the area of credit derivatives " the sophisticated financial products which dispersed rather than concentrated risk in the system. These systemic failures were compounded by a more basic and familiar weakness: the infinite capacity of human beings living in periods of excess credit to delude themselves into believing that prices will invariably head upward.

Please explain to us lay people what "skewed incentives" means.
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Reply Sun 28 Dec, 2008 05:17 am
An example that come to mind is say you have a warehouse full of grain and rats.

You offer the employees a bonus for every dead rat they turn in.

Now if they do a good job of killing the rats this source of income will drop to zero so you have a skewed incentives as your employees now have an incentive to find ways to have a large and increasing number of rats in your warehouse.
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Reply Sun 28 Dec, 2008 02:22 pm
A skewed incentive is simply money to do an evil act: I'll give you a huge bonus if you sell mortgages to people who cant pay them back.
Reply Sun 28 Dec, 2008 08:56 pm
In the case of the mortgage business the system was bad however the people on the front lines was working inside of a legal if very unwise system that they did not set up. Calling them evil and is a little must. Congress and the other branches of government knew what was going on but the business model was that homes prices would keep increasing and bail evreyone out of a very unwise business model.

The incentive here was to sell as many mortages as possible and there was no need to worry about the ability of the borrowers to repaid. The mortgages would be package into a pool and resold in short order lomg before the **** could hit the fan and with constant raising prices the **** might never reach the old fan in any case.
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