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ThoughtsOnline

Monday, September 14, 2009


Even though the passengers on United flight 93 had already shown that 9/11 was a one-off event, that America was no longer at risk of hijacked passenger flights being flown into hi-rises, the government went and set up the Transportation Security Agency and gave it all sorts of power to do what it felt was needed to prevent another 9/11.

So tens of thousands of government workers were hired at a cost of billions and billions of dollars, and millions upon millions of fliers were inconvenienced - if not worse - as the government went about putting into effect all sorts of rules and regulations... all with the goal of preventing something that wasn't going to happen again anyway.

And the same holds true in the aftermath of the financial crash last year. Left to itself, the market would self-correct for what happened.... but the government, determined to throw its weight around, is looking to institute all sorts of rules and regulations in order to prevent a recurrence... a recurrence that wouldn't have happened anyway.

Let's review the failings that contributed to the crash... and how the market would have self-corrected... and how government is, ironically, making a relapse more rather than less likely.

The biggest failure involved institutions buying assets of unknown quality. Financial institutions bought mortgages and other assets without knowing the underlying fundamentals of their holdings. They bought 'insurance' from companies without knowing whether the provider had the resources to cover claims. They extended credit to one another without knowing if their trading partners were solid. They relied on ratings without knowing the basis on which those ratings were issued.

The second failure was in the supervisory structure. Employees were allowed to operate without adult supervision. Stockholders didn't monitor the boards of directors, the directors didn't properly monitor management and senior management didn't properly monitor and manage the traders and bankers. Mortgage providers didn't monitor and manage their brokers. Hedge fund and mutual fund investors didn't monitor and manage their investment managers.

The third failure was with the compensation structure. Not so much with the amount of money but rather with the way in which compensation was paid out in ways that de-linked the interests of the employee from that of ownership.

The fourth major failure was management's failure to keep single business units from threatening the health of the entire company. Companies - and especially large, diversified companies - ought to be able to survive problems in any given area - or even more than one area at a time - without running the risk that the entire company could collapse.

And the fifth major failure was the belief (not always accurate, as in the case of Lehman Brothers) that government would keep companies from failing, that these companies could do what they wanted without suffering the consequences.

Now... given that most people are not stupid, 'Wall Street' would have learned from its mistakes and taken the steps to keep those problems from recurring. Note: this isn't to say that they would be able to keep other problems from arising, just that they wouldn't let the same problems hurt them again.

Financial institutions would have taken the steps to understand what assets they held. They would have insisted that mortgage originators retain some degree of risk for the securities. They would have done a better job of due diligence on the financial health of their trading partners. They would have investigated the ratings firms, there would have been no more blind reliance on ratings from S&Ps and Moodys. They would have better aligned employee incentives with the long-term financial health of the company. They would have kept from placing any more bet-the-company maneuvers. The boards would have instituted systems and controls to better monitor management and management would have been monitored and controlled staff. Investors would no longer hand money to hedge funds without getting more information and control over the investment.

Contrary to what most people in government believe, they are not the pendulum that corrects for out-of-balance situations in life. People do... and on our own... and without the need for a village to do so for us.

In fact, having government fiddle about keeps people from doing what we would otherwise do. Management won't stop making bet-the-company investments if they continue to believe that government will protect them from the consequences of making bad investments. Unions won't take a long term view if they believe government will save them from not having done so. Investors won't do the due diligence on their financial advisers if they think government will make them whole if they guess wrong.

There isn't anything that comes to mind where government trying to fix a business does in fact make it better. Taking over GM and Chrysler and 'cash for clunkers' did not 'fix' the auto industry. Taking over AIG hasn't fixed the financial industry. Instituting tariffs on Chinese-made tires won't fix the domestic tire industry.

But that inconvenient fact will not keep Congress and Presidents from acting as if they possess the special insight and power to succeed where their predecessors have all failed. Their arrogance is only matched by their lack of basic business sense.