The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

122 9 Financial Wagers, Hyper-Speculation and Shareholder Primacy
necessary part of an experimental process, in which even the less successful attempt
yields a knowledge-enlarging effect. In the developmental wager, both wagering
approaches are integral to the necessary development process and its costs. Value is
always added, not only by successful wagers but also by the less successful ones.
The Productive and the Unproductive Wager on Derivatives
In the case of unproductive wagers, it is less clear how much value is added. The
underlying wager generates no new knowledge. Therefore the loss of the wager
represents a cost only. The writer who sells an option for hedging creates more certainty
for the option buyer, for which the latter pays an option fee. If the conditions
specified in the option contract occur, the buyer’s need for certainty is satisfied. The
seller loses the wager, but keeps the option fee. Macro-economically, the risk is
not reduced, just redistributed between option sellers and buyers. If the insured risk
turns into an actual loss, the overall risk is not reduced by a gain in knowledge from
the wager but only reapportioned between the option seller and the option buyer.
The option seller bears the risk minus the option fee, which remains as the residual
risk with the option buyer. It can be useful to redistribute risk in this way. The
value that it adds is minimal, however. It becomes even more negligible if the risk
is further divided up among other option buyers, without any reduction of risk on
the macro-economic level through a modification of behavior or new knowledge.
Further costs are the opportunity costs of time and attention to the option contracts.
The added value of the option contracts is equally doubtful, because they represent
costs that are not matched by any macro-economic risk-reduction resulting from this
option trading. Furthermore, if the consequence of this trading is a reduction of riskmonitoring,
because individuals are less concerned about risk, additional damage is
occasioned in the allocative efficiency of the economy.
This process of de-monitoring risk by trading derivatives becomes particularly
visible in the case of collateralized debt obligations. When the bank wants to pass
on the credit risk to the investor, packaged as a CDO, in order to increase its capitalization
or ratio of equity to balance sheet total, both the bank and the investor
transfer the monitoring function to the rating agency that issues the rating for the
CDO. The rating agency does not, however, bear the risk of a mistaken rating; that
remains with the investor. The rating agency has a minimal incentive to carry out due
diligence, to fulfill the duty of care, while it is virtually impossible for the investor to
do so, since he has no knowledge of the original debtor and has to rely on the assessments
of the originator and the rating agency. It was also common for the bank to
sell a securitized bond, a synthetic CDO, to another bank, from which it would go
on to buy a similar synthetic CDO. This, of all practices, is most obviously motivated
by the interest in reducing the equity to balance sheet total requirement. The
transaction takes on attributes of self-dealing between the two banks. 3
3 Cf. also POSNER (2009), p. 321.