Incentives Can Be Counterproductive

This article provides examples of what can happen in society when incentive systems are perverse. She gives several examples but our recent financial crisis is still the best example of perverse incentives.  The problem started at the mortgage origination level when they had an incentive to make high risk mortgages.  They collected fees for originating the mortgages, and then passed the risk on to the banks who purchased the mortgages.  The banks turned them into securities, which they sold to investors who believed that they could earn higher yields without taking additional risk.  The whole system was corrupted by the incentive system.  High profits were available at each link in the chain, and risks were ignored. Countrywide shareholders, and bank shareholders lost big time, and so did the investors who purchased the securities.  Most of the executives, who chased after the excessive rewards, have suffered much less.  From a sheer risk versus reward analysis, they did just what the incentive system encouraged.  Perhaps the biggest losers from this folly have been those who have suffered from the ensuing global recession.  It will take a long time to fix the hangovers that followed the collapse of the financial system.