Sunday, May 3, 2009

Heavy Cost Of The Principal-Agent Divide

Good article in Financial Times, "The heavy cost of the principal-agent divide" by John Authers on how principal agent problem contributed to the current financial crisis and mortgage mess.

"When we invest or borrow, we are at least one remove from the producer. The person who decides to lend you a mortgage will not bear the risk of your failing to repay it. Instead, that risk is securitised and sold in the form of a bond on the securities market.

But the splitting of principal and agent over the past few decades has exacerbated the financial problems that now bedevil us. Most obviously, this affects mortgage lending. The people who authorised “toxic” subprime mortgages in the US did so knowing that they would not have to bear the risk. They had an incentive to lend as much as possible but not to ensure that as much money as possible came back."

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