Using the Law to Reduce Systemic Risk‪.‬

The recent financial crisis has put into focus how financial innovation can lead to the implementation of financial sector business models that are potentially unsustainable. While these business models are not necessarily bad if there is no viable alternative, policy makers and regulators need to make sure the financial sector is not overinvesting in such models as they may create unnecessary nodes of systemic risk. To minimize overinvestment, policy makers and regulators must focus on and regulate practices that encourage financial sector participants to be indifferent to the use of unsustainable business models. one possible practice originates from the large, frontloaded bonus arrangements provided to Wall Street employees (traders, investment bankers, and asset managers). These arrangements provide incentives for employees to focus on maximizing their personal short-term returns at the expense of their employers' and society's long-term interests.