If Wall Street is going to run the economy into the ditch every once in a while, then government is going to have to impose speed limits or hire some more cops. The Administration’s plan is to hire more cops. I’m for more speed limits.
Even Alan Greenspan is in “a state of shocked disbelief” at the consequences of “the self-interest of lending institutions.” So once again the debate is about the speed limits and the cops. We’re not hearing so much about the glories of the open road.
There are both theoretical and practical problems with just hiring some cops. There are several practical problems. Some of the cops just hang around fruit stands eating the apples (see: Bernie Madoff and the SEC). Sometimes the word from headquarters is to spend more time polishing the patrol cars (see: Christopher Cox and the SEC). And sometimes budget cutbacks reduce the cops to invisibility (see: CPSC and Chinese toys).
The theoretical problems are far more serious. They stem from Ashby’s Law of Requisite Variety, a fundamental proposition in cybernetics and systems theory. Ashby’s law states that “only variety can absorb variety.” More simply stated, three basketball players will never be able to outscore five players. Just ain’t gonna happen.
Regulations and regulatory agencies are the cops in this story, and Ashby’s Law applies in both (1) space and (2) time. First, there are a lot more folks on Wall Street (read: the financial sector writ large) than regulators, and ‘twill be ever thus. The regulators can’t be everywhere.
Second, regulation as a ‘tool of government’ is effective only until the regulated evolve enough to evade the regulations. This happens quickly. In today’s world of instant information, we’ve even seen the financial markets evolve ahead of our imaginations. So today’s regulations can never prevent tomorrow’s problems. A recent Tom Toles’ cartoon captures this well.
This would be true even if we truly understood either (a) the financial system or (b) the governments’ interactions with it. Only a certified system dynamics simulation model would show we understand the financial system itself. And even though the Clinger-Cohen Act of 1996 mandated enterprise architecture for federal programs, there’s been no attempt to apply this form of systems analysis to the many and varied governmental agencies, taken together, that touch the financial system.
So that leaves “speed limits,” defined as any controls built into the system that don’t require cops (regulators) for enforcement.
All the attention has been on “executive pay caps” and whether these will destroy the motivation of the Masters of the Universe, and on and on. This is a wrong-headed approach.
Back to the highway analogy. Imposing executive pay caps is like putting a governor on a rental car driven by a teenager. It’s not his car, and he’s still out looking for thrills.
We need to have bankers act like a new father out driving with his baby daughter in a car seat in the back. We need them to have some ‘skin in the game.’ We need them to retain substantial personal liability so they act (drive) more cautiously. We need to add some fear; reducing greed alone won’t cut it.
Joe Nocera’s entrancing New York Times Magazine article, “Mismanaging Risk,” goes on for 7500 words about investors’ risks and firms’ risks but never imagines that risk might apply to the people running the firms.
Corporations are creations of governmental laws and regulations. So are partnerships, limited liability companies , and limited liability limited partnerships. It would not take “rocket surgery” to create and mandate a form of entity for firms capable of causing “systemic risk” that would retain personal liability for managers whose actions could put either their firms or the economy at risk.
Median annual household income in America was $50,223 in 2007. I think someone gunning for one hundred times that should be willing to put his Manhattan apartment, his house in the Hamptons, and both yachts at risk until he’s been out of the game for, say, ten (10) years.
Give me my choice of three Harvard professors, throw in one from MIT, and I’ll have a solid draft for you in a weekend.
I wouldn’t have more confidence in your four professors than in the Nobel Prize winners who drove Long Term Capital Management over a cliff and nearly took the world financial system with them.
We’ll never have enough “cops.” i’m not sure that’s the right metaphor. Cops only succeed where there are laws and just about everybody follows them voluntarily. We surely need new rules, including rules that keep people from gambling with other people’s money.
That was my point! We need structural change, and I’d say that the most effective is likely to be that which increases fear among the players, rather than attempts to restrain greed, as pay caps would do. I’d increase fear by increasing their liability for errors and overreaching. Everyone always says that “Wall Street” operates on fear and greed. We’ve seen where greed takes us — let’s try fear!
My comments could have gone unde the post “skin in the game”, but here goes. Below my comments are some comments by Paul O’neill that I think are right on the money, so to speak. Since I work in the mortgage lending industry as a real estate appraiser, I have a little different look at this end of things than most folks. It is interesting that I have been saying for years that government, specifically FHA (also FANNIE and FREDDIE), is part of the problem, not part of the solution! So, what are we doing now? Giving $8000 to people who cannot afford to buy a house so they can buy a house. Hmmm….any potential problems down that road? You might be interested that folks inside the industry refer to recently enacted FHA programs as “the new sub-prime”.
In my ever so humble view, there is one very good way to make sure all players have “skin in the game”, and that is to let it fail when it should. If credit default swaps were allowed to become worthless (which they appear to be) then rest assured, the people putting up the money, whether it be hedge funds, China, insurance companies, etc., would not pour more money in. If FHA would even stick to their original policy that ANY borrower had to have a lousy 3% of his own money in the deal, (not gift, not seller paid credits, and not my money given to him by the government) the default rate would plummet. But no—–the idea of home “ownership” is so politically popular that any and all means are used to make it appear that any given administration is fostering “broad based home ownership” for good or ill….
Well, Bob, I do see how this keeps you from getting the lawn mowed. I am going to hit the pause button now and go mow mine!
WASHINGTON, D.C – Former treasury secretary, Paul O’Neill said that congress should scrap plans for a new economic stimulus package and instead simply require mortgage lenders to only make loans for people with a 20% or higher down payment.
On Tuesday, O’Neill addressed reports and indicated that he was not surprised that neither presidential candidate supported his position.
O’Neill has not endorsed either presidential candidate but indicated that he reached out to the Obama camp and made a personal pitch last month concerning his idea to mandate down payments. He declined to characterize Obama’s response.
According to a published reports O’Neill also said, “Unfortunately we’ve gotten to a point where people that want to run for president don’t think they can tell the truth and still get elected. I’m hopeful whichever person gets elected, they’ll be better than what they’ve said. An awful lot of presidential campaigns now are pandering to the lowest common denominator. They promise people everything.”
O’Neill also indicated that he supported the recently passed $700 billion financial bailout, which has allowed the financial system to take a “deep breath.” He also stated that government action should have come earlier. According to O’Neill, as early as 2006 30 percent of home mortgages required no down payment and a large number of those borrowers had a first payment defaults.
“That was a strong enough signal we should have shut down this … flagrant abuse of the principles of home finance,” said O’Neill. “It was bound to crater. It was absolutely bound to come down around our ears, which it has.”
“If you can’t afford a home mortgage, we shouldn’t give you one,” he added.
O’Neill said he is disappointed in both parties. He also indicated that the wide support for another stimulus package rather than addressing the underlying cause, bad mortgages, was disappointing.
If another stimulus package was introduced he fears much of it will be bogged down by pet projects.
“It’s a dangerous time because every politician can imagine some additional money that they could put into a package that they believe will help them get re-elected,” said O’Neill. “It’s like a feeding frenzy when it looks like they’re going to have more stimulus programs. It’s almost as though there’s no connection and understanding that at the end of the day, we the American people are going to have to pay for this.”
O’Neill served as the 72nd United States Secretary of the Treasury for part of President George W. Bush’s first Administration. He resigned in December 2002 under pressure from the administration and became a harsh critic. O’Neill was chairman and CEO of Pittsburgh-based industrial giant Alcoa from 1987 to 1999, and retired as chairman at the end of 2000.
My comments could have gone unde the post “skin in the game”, but here goes. Below my comments are some comments by Paul O’neill that I think are right on the money, so to speak. Since I work in the mortgage lending industry as a real estate appraiser, I have a little different look at this end of things than most folks. It is interesting that I have been saying for years that government, specifically FHA, is part of the problem, not part of the solution! So, what are we doing now? Giving $8000 to people who cannot afford to buy a house so they can buy a house. Hmmm….any potential problems down that road? You might be interested that folks inside the industry refer to recently enacted FHA programs as “the new sub-prime”.
In my ever so humble view, there is one very good way to make sure all players have “skin in the game”, and that is to let it fail when it should. If credit default swaps were allowed to become worthless (which they appear to be) then rest assured, the people putting up the money, whether it be hedge funds, China, insurance companies, etc., would not pour more money in. If FHA would even stick to their original policy that ANY borrower had to have a lousy 3% of his own money in the deal, (not gift, not seller paid credits, and not my money given to him by the government) the default rate would plummet. But no—–the idea of home “ownership” is so politically popular that any and all means are used to make it appear that any given administration is fostering “broad based home ownership” for good or ill….
Well, Bob, I do see how this keeps you from getting the lawn mowed. I am going to hit the pause button now and go mow mine!
—————————————————————————————————————
WASHINGTON, D.C – Former treasury secretary, Paul O’Neill said that congress should scrap plans for a new economic stimulus package and instead simply require mortgage lenders to only make loans for people with a 20% or higher down payment.
On Tuesday, O’Neill addressed reports and indicated that he was not surprised that neither presidential candidate supported his position.
O’Neill has not endorsed either presidential candidate but indicated that he reached out to the Obama camp and made a personal pitch last month concerning his idea to mandate down payments. He declined to characterize Obama’s response.
According to a published reports O’Neill also said, “Unfortunately we’ve gotten to a point where people that want to run for president don’t think they can tell the truth and still get elected. I’m hopeful whichever person gets elected, they’ll be better than what they’ve said. An awful lot of presidential campaigns now are pandering to the lowest common denominator. They promise people everything.”
O’Neill also indicated that he supported the recently passed $700 billion financial bailout, which has allowed the financial system to take a “deep breath.” He also stated that government action should have come earlier. According to O’Neill, as early as 2006 30 percent of home mortgages required no down payment and a large number of those borrowers had a first payment defaults.
“That was a strong enough signal we should have shut down this … flagrant abuse of the principles of home finance,” said O’Neill. “It was bound to crater. It was absolutely bound to come down around our ears, which it has.”
“If you can’t afford a home mortgage, we shouldn’t give you one,” he added.
O’Neill said he is disappointed in both parties. He also indicated that the wide support for another stimulus package rather than addressing the underlying cause, bad mortgages, was disappointing.
If another stimulus package was introduced he fears much of it will be bogged down by pet projects.
“It’s a dangerous time because every politician can imagine some additional money that they could put into a package that they believe will help them get re-elected,” said O’Neill. “It’s like a feeding frenzy when it looks like they’re going to have more stimulus programs. It’s almost as though there’s no connection and understanding that at the end of the day, we the American people are going to have to pay for this.”
O’Neill served as the 72nd United States Secretary of the Treasury for part of President George W. Bush’s first Administration. He resigned in December 2002 under pressure from the administration and became a harsh critic. O’Neill was chairman and CEO of Pittsburgh-based industrial giant Alcoa from 1987 to 1999, and retired as chairman at the end of 2000.
I’ve met Paul O’Neill a couple of times, and he DOES have a bad habit of telling the truth, no matter who’s listening! I agree about the mortgage down payment idea — a variant of “skin in the game” — but I put more blame on the Masters of the Universe who came up wit the idea of “Don’t Ask – Don’t Tell” mortgages. I understand the desire to live in your own house. I just don’t understand the desire to live in (a) a big apartment in Manhattan, (b) a waterside mansion in the Hamptons, (c) a villa in St. Croix, (d) a small apartment in the VI Arrondissement, AND (e) a choice of yachts on two coasts.