Ruminations on the aftermath of the Credit Crisis

As the FIX Community and FPL struggles with deciding what level of involvement it must take in the current regulatory reaction to the Great Recession, I ponder the basis of regulation, alas concluding little other than the elimination of agency problems and conflicts of interest are much more effective than data collection, surveillance, pages and pages of procedural rules and that the Chicago listed derivatives market offers a successful example of enlightened regulatory-business behaviour.

Here is the thing I grapple with being very much a believer in small government and unencumbered market places, there were no regulations over OTC derivatives and the industry completely and totally ran amuck with incompetence, irrational levels of greed, irresponsibility, absolute disregard for the overall well being of the global economy. There is no escaping this fact. I don't have any answers other than to say that structural rules - such as "this is how the game will be played - now go play" make sense to me - the listed derivatives market which originated in Chicago for instance has structural rules that were created to eliminate agency risk and conflict of interest - therefore intervention by regulators is minimal. If we simply eliminate agency and conflict of interest problems we would solve the majority of problems. Make sure people cannot transfer the consequences of their decisions to someone else. If you make a loan you have to keep some of the exposure to that loan should it go bad. Make sure that people are not incentivized and rewarded for "bad" behaviour and decisions. Also, note that the modern public company - corporate structure - inherently creates an agency problem and a conflict of interest problem between those that run the company and those that own the company. The CEO is rewarded for near term results but business need long term decision making. The ultimate risk of CEO decisions now in reality is owned by the shareholders. The board of directors are supposed to represent the shareholders but they are usually handpicked by the CEOs and are usually CEOs of other firms (conflict of interest).

I hate to say it but the only model that I see that works consistently well is when you have a single creator-entrepreneur that does not abdicate control over the business entity - this engine of commerce - that they created. All other forms are fraught with failures, inefficiencies, and worse. HP vs. Apple. Microsoft post Bill Gates (as an example of what can go wrong when the leader abdicates). Dell Computers when Michael Dell was there, when he stepped away, and after his return. There is a reason Ford Motors did not need to be bailed out. There is a reason GM ran completely adrift after the US Government successfully prosecuted the anti-trust case against the DuPont family.Would AIG have been so blind as to take on the risks of insuring sub-prime loans had Hank Greenberg, the builder of AIG, not been forced out of  the company by the ludicrously ambitious Eliot Spitzer? Maybe so but I wonder. 

None of these people at the large investment banks were creators or entrepreneurs and all, even if they did ultimately lose their jobs, were left wealthy beyond all imagination, largely escaping the consequences of their actions.

There is a strong case made by Michael Lewis in the "The Big Short" that the ruin of Investment Banks lay at them moving from a partnership model to a public corporation model - where the executives running the organization were not the ultimate owners and were not responsible to other partners. Although this alone is not sufficient as we saw Arthur Anderson was a partnership and we saw its demise come from the same behaviours.

I worked for a fringe character at The Options Clearing Corporation who was not without redeeming principles and the one relevant here was "Treat the company's money as if it were your own and take care of it in the same manner." He was not saying treat the company's money as your own to take - but to treat it as though it was yours and you needed to manage it accordingly, use it wisely, and protect it. The antithesis of behavior exhibited across the spectrum of the financial services industry.

The Big Short by Michael Lewis