The dam burst of banking disasters and federal bail-outs of firms “too big to fail” has brought to light the fragility of our banking and investments system. Like a tropical depression that forms in the eastern Atlantic ocean and gradually feeds on the warm waters and moist air until it makes landfall as a rampaging storm, the combination of greed, financial deregulation, and enthusiastic liquidity on the part of the Fed has now spun up into a full fledged economic storm.
In an essay posted on CNN.com, Columbia Professor Joseph Stiglitz, among others, points to some causes of the present calamity on the banking and financial businesses. Stiglitz says-
“One can say the Fed failed twice, both as a regulator and in the conduct of monetary policy. Its flood of liquidity (money made available to borrow at low interest rates) and lax regulations led to a housing bubble. When the bubble broke, the excessively leveraged loans made on the basis of overvalued assets went sour.”
“The new “innovations” simply hid the extent of systemic leverage and made the risks less transparent; it is these innovations that have made this collapse so much more dramatic than earlier financial crises …”
The mess that taxpayers and investors are left with is the result of greed and recklessness on the part of elite “business leaders” in conjunction with Federal officials only too anxious to deregulate and discount. This is not a failure based on physical reality. It is a failure based on greed and poor judgement. It rests on a morally shallow and sadly misguided philosophy that mere acquisition of currency is reason enough for being and is the sole measure of success.
As a start, it is my hope that the Deans and faculty of our business schools can summon some kind of movement to reform their admissions standards and refine their ethics curricula.
Perhaps certain finance practitioners need to be trained and certified in a manner similar to actuarial professionals? Seems to me that the people who launch financial instrument schemes with the potential to collapse an economy should be at least as well trained in risk management as an actuary.
A firm proposing a financial instrument for sale to the public should be required to prepare a mathematical model with macroeconomic inputs to model the potential for instability. The kind of discipline needed to do this modeling could help people refine the fund structure so it remains manageable in a broader range of economic conditions. This would also provide for a real transparency to regulating agencies and possibly even investors. But most importantly, if you want to model it, then you have to understand it. And that is part of what has been lacking.
Lamentations on Chemistry 
No mr. Gaussling , they’re all laughing because they knew what they were doing at the time and socked away the cash in Swiss bank accounts. We’ve created a business aristocracy which can do no wrong. Since B-schools are the prime recipients of donor dollars from these people, I see no reason why they should change.
Why in God’s name do we send NIH dollars to Harvard when their endowment reached 37 billion last year? Answer that!
I see your point. But it seems inevitable that changes will follow this sorry episode. Those who contributed to it may be laughing all of the way to the bank now, but eventually their reputations will be smeared and their wealth will fail to buy them the respect their egos will crave. They will be associated with one of the biggest financial catastrophies of all time. Nobody can hide from that.
B-Schools will not want any association with this mess. They will posture themselves to be out in front of the reform parade.
As an unsuccessful serial entrepreneur (three time loser with $73m hard fought but eventually wasted venture capital) I can only say that the rot that took hold of the U.S. financial institutions in the 1980s has finally come to roost.
In 1997 I co-founded my third startup that got tagged as a candidate for IPO by Lehman and other sick financial organizations. These people tortured us for years with their sheer ignorance of our mission, market and capability in spite of dozens of trips to San Francisco, Newport (CA), London, Paris and New York to explain (yet again) what it is to be a software company engaged in chip design automation in Silicon Valley.
Although I seriously (did I say seriously?) enjoyed the amazing views from conference rooms perched above the 40th floor in these fine cities, it has always unsettled me to think that these self-righteous people, sat before their displays of trade activity, could actually understand what we were telling them.
They tended to pay more attention to their real time displays of market data than what we were trying to tell them. Displays that show a 50 x 40 matrix of data, updating every second and showing the recent activity of some 200 different stock tickers (red == down, green == up, black == unchanged).
Consider for a moment that on your best possible cognitive day, you cannot possibly take in 720,000 data points per hour and make any rational, long-term decisions about what is happening and that each decision you make affects hundreds if not thousands or millions of employees, shareholders or customers.
While the human eye/brain is clearly well developed to recognize trends, it is not possible through hyperactive, blinky Christmas tree displays, that you can recognize any trend in enough detail from some to make rational long-term decisions about the health of a company or about the capability of that company’s employees or the needs of your customers.
The only possible conclusion that I can draw from this is that these people are simply too close to the problem, or too stupid to recognize the failure of their very busy (6-year-old soccer player busy) business practices. The last few days I have simultaneously grit my teeth and smiled as Lehman, Merrill and others have had a taste of the evil they have become.
Business school my ___: Consider this column in today’s NYTimes where Roger Cohen reports that Wall Street has been sucking up Ivy League undergrads of any stripe (47% of Harvard’s 2007 class went to consulting or the financial sector). And, I agree with Larry- it’s time to reconsider sending tax dollars to institutions already sitting on financial resources sufficient to ensure their continued operation in perpetuity without charging tuition. They should fund their own research and probably will soon as all the fed money dries up…
. “You can’t believe how intensely companies like Merrill would recruit at Ivy League schools. I mean, when I was a sophomore, if you could spell your name, you were guaranteed a job.”
Yep, that’s my experience. In both business and Academia. You are a brand imparted with mythical powers when you buy an Ivy degree. There is a strangle hold on the American culture by these cults. There is the Harvard Cult, the Yale Cult, but also a slew of sub-religions in smaller private colleges.
But here’s the clincher. If you don’t have 40,000 a year to pay for it, you don’t get to play. It’s a product of structured scarcity. Similar to
a work of art, hyped by rich backers.
Good article.
http://www.bloomberg.com/apps/news?pid=20601039&sid=a9xtBHJoZTOw&refer=home
I don’t know what the threat of reduced confidence in the markets (below what confidence one should have in them?) is, but if the feds will bail you out when you make knowingly risky investments (NINJAs? What is the risk? Do we have any idea? Do we even care? NO!) then it seems that the people who invested in these instruments were not the stupid ones – they’re safe. Stocks will take this into account and enable larger levels of risk to be swallowed by investors, because if you’re big enough to have friends, your risk is zero.
I don’t think my biggest fear is European-style social welfare (I’m a liberal), but their tax structure without the social safety net that makes it worthwhile. From where will the money come to pay for these things? – apparently lowering taxes isn’t quite working (or the increases in revenue are being outspent). The people who undertook these investments were probably rational (other than in their ability to assess risk) – they didn’t need to worry about anyone else, and they will get out fine. If other people don’t matter and their is no external constraint to remind people of that, then bad things will generally happen, and whatever happens will be ugly, and earned.
Lots of good comments. I like the term “Structured Scarcity”. It applies to the medical profession as well.
This smacks of what happened in the 20’s just before the GD. Banks ignored reserve requirements (cash were supposed to keep in their vaults in the event of demand), and loaned out much of what was in the vaults. Much of it on businesses that had no math to support what they were doing with it.
Once the first person requested a withdrawal and their wasn’t enough on hand, the emperor’s clothes soon vanished, and the system stood vulnerable in the nude.
Government MUST maintain oversight for consumers. Free markets are good, assuming everyone is SMART and most importantly ETHICAL. But because we’ve proven time and time again, that when dad leaves the house, the kids break out the keg (so to speak).
Just as government’s job is to secure our borders, and our liberty. It too should monitor our public safety, and financial security from would-be crooks.
And parents…..geeze…don’t even get me started. We need to NOW start teaching by example that honestly, fairness, and ethics are more important than riches, status, and being CEO.
The executives and government leaders that actively or passively allowed this to develop and happen should all be A) fired B) criminally and civilly prosececuted then C)thrown in jail. Then these should be the stories we teach for future business leaders and government officials. That America…the land of the free, the brave, that can accomplish anything…is NOT the land of the greedy theives, liars, cheats, and responsibility schuckers! And it will no longer be tolerated!!
Can ya tell I’m a little pissed?
Gaussling:
You raise an interesting point. I confess I have not looked up your bio etc (if it is here) so I do not know of your affiliations. So I assume nothing when I write this.
In the recent past, there have been attempts to make the MBA a ‘professional degree’ sort of like a CFA or CPA. This would come with all manner of responsibilities and duties, including doing continuing professional development (CPD). For various reasons – including the disagreement over whether management is an art or a science; indeed there is a very different debate on whether b-schools teach business administration or management but I digress – this attempt has not gained traction.
As for whether b-schools are paying attention, I would say in some manner, they are. I am just wrapping my PhD in University of Cambridge’s b-school (which is its new branding; it was earlier an institute of management studies) and we are trying hard to help our alumni through the mass-layoffs etc.
Interesting post though. Got here through WP Business News page.
Business schools will always try to teach about ethics and common sense and good old fashioned fiscal conservatism. They will teach you that when giving a loan, you should do due diligence. They will teach you that you should own as much capital in your own company as possible and that you shouldn’t rely on raising money through exotic and fancy financial footwork. I know, that’s what they taught me at a college that specialized in educating business managers and marketers.
But they will never be able to combat greed and poor decision-making. No college can teach someone not to be too greedy and no regulatory body in the government can teach someone to be competent. As long as people are greedy, selfish and their judgment can be obscured by thoughts of a fat check being cradled in their wallets, we will continue to have such problems and the only thing we can do is try to put the pieces together and move on.
Hi gfish- I think you are right about the matter of greed inevitably creeping in. It is the same problem as getting people to be nice to each other.
But the question of devising a new certified professional category is still open. I imagine something along the lines of a licensing requirement. The people who ascend to the ranks of leadership in the investment banking industry must be accountable in terms of their training, character, and performance.
Physicians have to pass their board exams and lawyers have to pass the bar exam. Both are subject to license revocation in the event of malpractice.
The banking industry needs to clean up. Real estate agents and stock brokers are subject to license requirements. Why not mortgage bankers?? I.e., a Bankers license.
Actually Gaussling, bankers are licensed. Every state has its own rules but yes, mortgage lenders are supposed to be registered with the local Real Estate Board and go through a series of procedures to get a license and renew it, just like a real estate agent or broker.
Previous articles (MSNews, ?) seemed to imply that the people who estimated the risk for the investments backing the mortgages had substantial guilt in the failures. It doesn’t seem to take a genius to figure out that lending money to people with no assets is about as secure as “delivering lettuce by rabbit”, but the terminal investors might not have known how risky the mortgages being sold actually were. That was the job of the credit agencies, and apparently they had no idea exactly how much risk was involved (or were unable to estimate reliable quantitative risk assessments for others based on the data). They set lower risks on the intruments then they should, and the implication that their assessment was reliable enabled the securities to be sold widely because people believed they knew – or at least someone knew – what their risks and likely payouts were, and the money ran far and wide, magnifiying the failure. The assessments enabled those who knew how risky the bundled mortgages were to justify investments in them that made little sense otherwise. Others probably did not know how much risk was involved, and found out too late. I thought that the assessors were like home inspectors, having little incentive to kill a sale, and so the unwillingness to tell backers that the subprime market was risky led the backers to find out for themselves (what they were supposed to have done).
I would think regulation might be a good idea, but regulatory capture in financial markets might be a problem. If the people paid a lot to assess risk couldn’t do so, I don’t know if those who would regulate would know better, The perception that information on the risks of the mortgage investments was reliable when it was not would seem to have been the problem (well, some of it – I have to assume some was Bushitis as well), and government regulators would be more prone than the private ones to give this impression, so that larger failures would be enabled if their information was not totally accurate (or its limitations were not completely known).
If this story is inaccurate, please tell me.
Hap said-
“that was the job of the credit agencies, and apparently they had no idea exactly how much risk was involved (or were unable to estimate reliable quantitative risk assessments for others based on the data).”
No Hap, it’s even worse than that. Companies hire an assessor such as Moodys, Fitch or S&P to gauge their credit worthiness so that a third party can make a credible investment decision. So how do they choose which company to rate them? Why they hire the one which is willing to give them the highest rating!
http://www.nakedcapitalism.com/2008/05/defective-moodys-program-issues.html
Hi gfish- I guess that shows what I know \;-). I’m glad you told me that. Thanks.
There has to some kind of remedy that will stave off onerous regulation, but retain enough potency to work most of the time.
But then again, how much more control of the market should there be?
good article.thansk
http://www.wcs.com.tr
lots of good comment.ı like.
http://www.fqcert.com
Hi Barry- There has to be some simpler model of operation rather than just adding more layers of regulation. I occasionally have to read certain CFR’s and I am left stupified (more than my normal level!) by the experience. The CFR’s are quite complex just based on a plain reading, much less, any interpretation that an attorney might slather over it. The whole regulatory system is just getting too complex. Perhaps the opaque aspect of the regulations and operating standards contributed to this somehow.
One of the people I knew from the bar I used to hang out at was in business school when Enron hit the fan. He said that his professor had said (roughly, “I have a PhD in accounting and I can’t understand Enron’s financial statements.” It seems possible that the complexity of the instruments involved rather tahn of the regulations dealing with them makes them difficult to deal with, and considering the intentions of the people involved, the complexity may be intentional, to confuse regulators and investors alike.
People can make a lot more money gaming the system than they can regulating it (or, at the point when such is not the case, we are not going to get anywhere), so regulations aren’t going to be able to catch up. Paying off the people who invested in risky things might be a bad long-term strategy because they will tolerate more risk than they should (based on their own financial state) if they are effectively investing someone else’s money (at no cost to them). If investments are based on circular logic rather than rational assessments, then one way to check bad investments (or limit their consequences) is to ask questions that clarify the amount and quality of information available. I don’t know if regulators are competent enough to ask them, but it doesn’t seem as if the people seeking investors would have answered such questions willingly.
Actually Gaussling, bankers are licensed. Every state has its own rules but yes, mortgage lenders are supposed to be registered with the local Real Estate Board and go through a series of procedures to get a license and renew it, just like a real estate agent or broker.
ELD Danışmanlık İnternet Yazılım Tekstil San. Ltd. Şti Türkiye’nin her noktasına hizmet verebilen bağımsız bir kuruluştur. 2004 yılında firmaların internet sitesi ve yazılımları geliştirmek üzere iş dünyasına atılan firmamız, bugün, ELD Danışmanlık adı altında, internet sitesi ve yazılımlarının yanı sıra ISO9001:2000 Kalite Yönetim Sistemi, ISO22000 (HACCP), OHSAS, CE, TSE, Marka Patent, Logo Tasarım, Grafik Çalışmaları ve ayrıca Tekstil (Rivet Baskı) konularında aktif olarak hizmet veren bir firma haline gelmiştir.
ELD Danışmanlık 80 ‘den fazla referansıyla müşterilerine güven vermektedir.