Wednesday, April 16, 2008

Incentives Count-For Bankers Too?-2

"Last week's congressional hearings on the Bear Stearns [BS] 'non-bailout' were fascinating, and frightening. Our leading financial regulators said the [Fed's] unprecedented action was necessary to ensure the stability of financial markets which would have melted down had nature taken its course. ... That raises the question of when [BS] became unsound, especially in light of the public statements about the company's strength by their CEO only days earlier. If Bear was under-capitalized and over-leveraged, shouldn't red flags have gone up long before? ... The unstated premise is that, with better government oversight, we would not be suffering today's bear market and financial chaos. Of course, during the previous outsized boom, no one was calling up his congressman to complain that home values were appreciating too quickly. ... Leverage--and the rapid creation of dollars--fueled the boom we all seemed to love. But leverage cuts both ways, accentuating the benefits of a bull market and the pain of a bear market. The lesson we all must take away now is that leverage is not a one-way path to wealth with no risk of loss. ... But as [Sen. Jim Bunning [R., Ky]] implied, isn't it the regulators' job to ensure that we don't end up here again? That is the dilemma of 'moral hazard'. Conseqences not suffered from bad decisions lead to lessons not learned which lead to bigger failings down the road. And so we have the insidious modern trend to shirk responsibility and blame others for out missteps. This trend, this 'victim mentality,' is a path toward personal disaster", my emphasis, Ethan Penner (EP) at the WSJ, 11 April 2008.

"As the credit crisis has slowly expanded and worsened, there has been a flurry of activity in Washington to reduce the damage from it. There are bailouts and tax breaks, and even checks to parents of school-age children. But there is remarkably little action aimed at getting the credit system functioning again. In part, that is because there is a scarcity of ideas. Paul Volker [former Fed head] ... was right this week when he said the financial engineers had created a 'demonstrably fragile financial system that has produced unimaginable wealth for some, while repeatedly risking a cascading breakdown of the system as a whole.' ... For the time being, the solutions being pushed would not seem unreasonable to an old-fashioned socialist. ... The Basel II capital rules for commerical and investment banks clearly need to be strengthened, and regulators need to develop the ability to do their own risk assessments, rather than leaving the task to the banks and the credit rating agencies. That will take time and cost a lot of money, and it will require the derivative markets to be much more transparent. ... Most of the critics--myself included--did not anticipate the severity of the credit collapse, and we should not act as if the executives and regulators who failed to prevent it were blind or stupid. ... Volker, who knows how inflation can get out of hand, said the current situation reminds him of the early 1970's when inflation began to accelerate", my emphasis, Floyd Norris (FN) at, 11 April 2008.

Right on EP!. What does, "ensure the stability" mean? Why is stability good? "Meltdown" sounds frightening. What does it mean? I only know who gains and who loses. In today's America responsible savers lose, irresponsible bankers and borrowers gain. The regulators' job is to ensure politically favored classes have the public bear their losses. If we want to prevent this, shut down the regulators! Let investment banks fail! No, no, no! That might mean Lloyd Blankfein of Goldman Sachs might have to find a real job. Like shining shoes in Grand Central Station. See my 12 December 2007 post. Alcoholics Anonyomous (AA) has a concept, "hitting bottom". AA preaches an alcoholic won't sober up until he hits bottom. Similarly, bankruptcies may make our investment banker overlords hit bottom. I read terms like "meltdown" and think of Andrew Jackson's (AJ) war with Nicholas Biddle (NB) over the Second Bank of the US recharter. NB threatened to plunge the US into a depression unless the bank was rechartered. AJ was not dissauded. He launched his pet banks program and eventually killed the "moster". See my 24 December 2007 post.

I largely disagree with FN. First, the damage is, now! The "activity" intends to redirect the damage to politically disfavored classes. As for socialism, I agree, noting Karl Marx favored creating a central bank, see my 17 September 2007 post. The financial engineers were either fools or knaves, but created a system to redistribute wealth. The idea of regulators doing risk assessments is laughable. Why not have CPAs do it? Supposedly we should under Generally Accepted Auditing Standards. "Stuff and nonsense" said Alice. What does Mark Olson think about this? CPAs can't do it, even if they publish documents like that Francine McKenna cited at, 8 April 2008.

Why not think the executives and regulators were "blind or stupid"? I saw the collapse coming. So did others. So? Will FN suggest making me say, Comptroller of the Currency? I agree with FN, the executives and regulators were neither blind nor stupid: they knew what they were doing and planned to "cry wolf" to Congress all along if and when the credit markets blew up in their perennial game of "financial chicken" played with the real economy! Well, FN, fools or knaves? My vote: knaves.


Anonymous said...

@i.a. wrote: The idea of regulators doing risk assessments is laughable. Why not have CPAs do it?

You have my vote, now get to it. :)

Independent Accountant said...

I was being facetious. CPAs are no more capable of doing "risk assessment" than Alice's Mad Hatter. I was criticizing the SEC, PCAOB, AICPA for "feel goodism" for the public. It's the capital markets that assess risk, not CPAs. In my opinion. CPAs pay lip service to this and create workpapers to indicate they did something to make Mark Olson & Co. happy. So?
That I saw the collapse coming is explained in part at my 9 January 2008 post and by some interactions with clients, each of whom thought he could become a millionaire by investing in real estate. I thought, "this is the same nonsense people were saying about tech stocks in 2000". I was right this time. So? The public errs to trust any regulator to do this. Or me.

Anonymous said...

Hello again i.a.,

I was being humorous as well. The real problem is that there is no risk. Managers bet OPM, then collect fees. If the whole thing blows up they get huge severance checks and the gubbermint picks up the mess. It is the wild west out there, and Wall Street isn't fit for decent folk. Best of everything. [/buzz saw]