I always wonder if the people making the decisions actually had these thoughts, i.e. if they explicitly made decisions based upon the assumption that there was a large possibility of a bailout if they blew things up. Do you think they did?
My guess would be, "No." They thought they were too brilliant to blow things up. I honestly blame arrogance and what I call the "suits vs. geeks" divide, rather than incentives.
Moreover, to the extent that there are problems with executives looting corporations, I doubt that government is the solution. If you want to see real looting, watch what happens when Progressive Corporatism kicks into gear.
The incentives after things blow up are worse than the ones that existed before. Now, some financial executives seem to think that they are entitled to a bailout. This is where I part company with the conventional wisdom. The conventional wisdom is that letting Lehman fail was a mistake. I still think it was the right thing to do.
The conventional wisdom is that unless there is a bailout, Really Terrible Things will happen to the rest of us. So far, I think that the most terrible thing that has happened to the rest of us is the bailout.
The bailout crowd keeps changing their story. A few weeks ago, we were being told that the institutions were sound--it's just that the securities were temporarily illiquid and underpriced. I'm not hearing that theory propounded much any more. Instead, we are hearing that banks need capital. My idea of what to do with insolvent banks isn't to inject capital. My idea is to close the doors and tell the executives, "Don't let the door hit you on the way out."
If there are banks that are borderline because their securities are not trading, then put them on a watch list, quarantined from other banks, until their situation clarifies. My hunch is that the healthy portion of the banking system is sufficient for the economy, but we have to get rid of the zombie banks first.