Feedback: Incentive-Pay Article Ignored a Key Fallacy

I found Mark Olson's Viewpoint ["Expect Scrutiny of Incentive Pay," Jan. 27] troubling because he seems oblivious of the fallacy of composition. In "The Origin of the Financial Crisis: Central Banks, Credit Bubbles and the Efficient Market Hypothesis," George Cooper points out that during a credit bubble all financial ratios tend to look adequate. What might work for one bank does not work for all banks should asset values decline quickly throughout the world. Thus, looking at peer group pay scales fails the fallacy of composition test.

At a conference last April of ISACA [an information technology governance and control trade group], an outside director from a local bank in Maryland stated that the directors did not rely solely on internal reports on loan quality and loan collectibility.

They used outside experts to evaluate the loan portfolio. It seems that better methodologies exist that look at the overall governance issue: credit analysis, loan review, market concentrations, property appraisals when market conditions change and sources of funding to set pay scales. However, Mr. Olson seems oblivious of these issues.

I wonder why? Does his lack of insight suggest one of the reasons the Federal Reserve System failed to act when the credit bubble started to emerge?