More on Housing Blues

The New Yorker blames performance-pay, which makes hedge fund managers willing to take gambles that are good for them, bad for investors. The problem, the writer argues, is that they receive 20% of all gains to the fund they manage, but do not lose some proportion when the fund goes south. It's hard to imagine how you could structure the downside risk realistically into performance-pay. A hedge fund might receive an annual bonus of tens of millions of dollars if his fund does very well. But will he be expected to pay out tens of millions when the fund fails to do well? No, he won't, and thus the argument is that he does face the right prices. He only really faces the positive variance price, which means he can do really well once and be very wealthy, and never do well again and not lose any of that wealth. I suspect there is some truth to this. It sounds like some variation of a principlal-agency problem.