Eight Failures

Stiglitz listed the following Crisis' Triggers:

1) Too-big-to-fail banks have perverse incentives; if they gamble and win, they walk off with the proceeds; if they fail, taxpayers pick up the tab.

2) Financial institutions are too intertwined to fail; the part of AIG that cost America's taxpayers $180 billion was relatively small.

3) Even if individual banks are small, if they engage in correlated behavior – using the same models – their behavior can fuel systemic risk;

4) Incentive structures within banks are designed to encourage short-sighted behavior and excessive risk taking.

5) In assessing their own risk, banks do not look at the externalities that they (or their failure) would impose on others, which is one reason why we need regulation in the first place.

6) Banks have done a bad job in risk assessment – the models they were using were deeply flawed.

7) Investors, seemingly even less informed about the risk of excessive leverage than banks, put enormous pressure on banks to undertake excessive risk.

8) Regulators, who are supposed to understand all of this and prevent actions that spur systemic risk, failed. They, too, used flawed models and had flawed incentives; too many didn't understand the role of regulation; and too many became "captured" by those they were supposed to be regulating.

[...] These are not matters of black and white: the more we limit the size, the more relaxed we can be about these and other details of regulation. That is why King, Paul Volcker, the United Nations Commission of Experts on Reforms of the International Monetary and Financial System, and a host of others are right about the need to curb the big banks. What is required is a multi-prong approach, including special taxes, increased capital requirements, tighter supervision, and limits on size and risk-taking activities.

Such an approach won't prevent another crisis, but it would make one less likely – and less costly if it did occur.