Mon 22 Sep 2008
In a recent article about the ongoing financial crisis in the US, Michael Lewis makes an interesting observation:
[Merril Lynch CEO O'Neal] took a business that wasn’t well designed to take huge trading risks and wagered it all on a single bet. [...] But interestingly, if any of these [Wall Street CEOs] had behaved well and resisted the pressures and temptations of the moment, his firm would have, for several years, dramatically underperformed the competition. Probably he would have lost his job.
Of course, Lewis doesn’t seem to understand the implications of what this truly means, and how important it is to understanding the fundamental reason for the collapse.
Deregulation left the entire financial industry (and others) at the position where their self-interest did not coincide with that of society at large. If you apply the thought process of Adam Smith’s invisible hand, you can can see that in this case the natural process of the deregulated system led to an unstable equilibrium where people took on too much risk, and was fated to inevitable collapse. Everyone involved did the “right” thing for themselves, but ended up being bad for everyone.
The villains in this case are not the CEOs who directed their companies towards failure — given the parameters of the system they had no other choice. The villains are the millions of Americans who worship at the altar of deregulation, who have bought the pre-packaged lie that the free market is the solution to all problems. They are the ones who chose leaders who created the system that has come to its inevitable failed conclusion.
And the solution? To produce sensible regulation so that the invisible hand will promote a positive and stable equilibrium. With such regulation, CEOs and investors would have incentives to act in their self-interest without causing huge bubbles destined to pop. I do not expect this to happen, instead I expect to see token actions which save the asses of the specific firms currently in trouble but does little structural work to actually prevent something like this from happening again.
September 23rd, 2008 at 1:50pm
Astute observations. Especially “instead I expect to see token actions which save the asses of the specific firms currently in trouble but does little structural work to actually prevent something like this from happening again.
A realist is doomed to a tough life under a modern republican government.
September 26th, 2008 at 2:56am
As always, an excellent rant with lots of truth. I’d steer clear of assigning “reasons” (in the sense of a single cause for such-and-such) to such collapses as this, though; I agree on the other hand that a major contributory factor is deregulation + the short term mentality of most CEOs (and shareholders).
While Australia’s less “immune” to a similar collapse (or a spread of the existing one) than many here would like to believe - our house prices are actually more overinflated than those in the US were, at least in terms of ratios against actual income - one of the contributory factors as for why Australia has so far avoided any major banking issues is heavier banking system regulation.
So, any bets on who’s next to fall, and/or how much further this crisis has to go? I’m betting on at least one more major bank, and I’m also betting that this is just the start of quite a big shakeout. (I’m also not betting on the end of the market as we know it, for what it’s worth.)
You, and geekpdx, would probably enjoy reading The Black Swan, by one Nassim Nicholas Taleb, as it goes over events such as this in much detail. Heck, it even mentions one FNMA by name, and was written & published while the market was still in love with that particular institution.