Wednesday, November 05, 2008

Subprime crisis: who are the real villians?

I argued in my last post that sub-prime loans per se - and the entire apparatus that made it possible, including low interest rates engineered by central banks, were not primarily responsible. Deregulation was by far the bigger villain.

Ben Heinemann, senior fellow at Harvard's Kennedy School of government and Law School, argues that there has been a serious management failure at financial institutions:

But can there be any question that the root cause was the failure of financial-industry leaders to provide the balance between risk-taking and risk management needed for sound, sustainable growth? In short, there was a failure to fuse high performance with high integrity.

No one made these companies pile on leverage, create incomprehensible financial instruments, sideline robust risk assessment, fail to stress-test portfolios, assume housing values would only go up and award gargantuan compensation for churning paper.

Why did CEOs and business leaders so abjectly fail? Why did good corporate governance, which at its core is about checks and balances, fall short in financial services?

Obviously, public and government trust in industry decision-making has eroded. Now corporate leaders must honestly discuss their mistakes and propose how checks and balances can work before the slow process of rebuilding trust can begin.

1 comment:

Krishnan said...

There is plenty of blame to go around. I have no problem with dumping on financial managers who only saw the easy money and devised ever so complex instruments to make more money while pretending that prices will always increase. I have a real problem with ignoring the big gorillas called Fannie and Freddie and the way they were set up - direct profits to shareholders while letting taxpayers taking the losses all the while allowing legislators to feed at the trough. In the US, neither party is blameless for using Fannie and Freddie for their political ambitions, I do not expect anything to change. If there is never, ever a price for failure, there will be more failures.

On the heels of the bank bailout, Detroit is looking for one and they will get not just one, but a lot more. With Obama talking about trade being fair and with the next Congress intent on dismantling much of the structure that generated so much world wide wealth, it looks to me like we are in for one long, never ending economic nightmare.

I will also watch and see how business schools change (if they do) how they teach - about wealth creation and the expansion of the economy - and what role innovation plays in such - whether wealth can be generated simply by devising even more complex instruments that shove money around in strange unimaginable ways and then asking for help.