The Threat to Our Financial System Is Alive and Well

Hubris.

Day-to-day, most of us think of pride and excessive self-confidence when we hear that word. And when it comes to financial executives, that's a fitting definition.

But with its roots in the Greek "hybris," the word has a much more violent, aggressive lineage. It was considered hubristic, for instance, when the wealthy Meidias publicly slapped the robed orator Demosthenes. Hubris was at play when suitors descended on Odysseus' house in Homer's The Odyssey. And in Rhetoric, Aristotle wrote:

Hubris consists of doing and saying things that cause shame to the victim ... simply for the pleasure of it ... Young men and the rich are hubristic because they think they are better than other people.

Perhaps historian Thomas Martin put it best when he defined it as "aggressive arrogance." It was because hubris was such a high-order offense that gods like Zeus were known to save their harshest reprisals for such offenders.

With the failure of MF Global (OTC: MFGLQ), we're left with yet another major financial company that was leveraged to the hilt, took on risks that it didn't have the balance sheet for, and found itself buried by the market when its weakness was revealed. The ink is barely dry on the accounts from the financial crisis in 2008 and yet here we are again watching the all-too-familiar scene of a pedal-to-the-metal financial company going down in flames. MF Global's demise could be a picture illustrating the word "hubris" in the dictionary.

Don't know
Nassim Taleb, the author of Fooled by Randomness and The Black Swan, has been harshly critical of financial executives for their fundamental ignorance of risk. When I first started reading him, I thought he was being unfair or exaggerating to make a point.

The financial crisis taught me otherwise.

Looking back, when Goldman Sachs (NYSE: GS  ) CFO David Viniar referred to 25-standard-deviation events occurring several days in a row -- which as likely as "a real black swan fly[ing] out of Mr. Viniar's posterior," in the words of fellow Fool Seth Jayson -- it's easy to see that the rot of overconfidence in mathematical models of risk is endemic at the highest levels of the industry.

Plato identified the problem over 2,000 years ago in Meno. These "lucky fools" don't know what they don't know. Lacking a holistic approach to risk, they are convinced it has been conquered by mathematics. The problem is "aggressive ignorance" as much as it is "aggressive arrogance," because it has very costly consequences -- particularly when you are playing with other people's money.

In the case of MF Global, leverage, liquidity risk, and financing risk conspired to bring the house down (bets were financed by short-term borrowings that vanished once the firm lost its investment-grade credit rating). This is the very same configuration of risks that annihilated Bear Stearns (before being acquired by JPMorgan Chase (NYSE: JPM  ) ) and Lehman Brothers in 2008. That CEO Jon Corzine and other MF Global executives seemingly didn't learn anything from these recent failures is jaw-dropping.

Don't care
As much as it's a problem that Wall Street executives seem ignorant to some of the risks they're taking, it's likewise a problem that, for many of them, the prospect of failure isn't particularly threatening.

Some people argue that the rewards of working in the financial services industry are simply consistent with the level of risk associated with the job. There is a grain of truth to that -- job security is lower than in many other industries. However, what is your true level of personal risk when you earn enough money in a single year to be able to retire?

The former CEO of Bank of America (NYSE: BAC  ) , Ken Lewis, retired on a cushion of dynastic wealth shortly after his firm averted failure thanks only to the support of the taxpayer. Morgan Stanley's (NYSE: MS  ) John Mack couldn't have been too worried about going broke -- in 2006, he was handed total compensation north of $37 million. And as for Corzine at MF Global, he was given nearly $3 million in cash compensation in 2011 (plus more than $11 million in MF Global options), but that pales in comparison to his already-considerable wealth accumulated during his days running Goldman Sachs.

And if pre-existing personal wealth isn't enough, experience suggests that the greater the magnitude and profile of their failure, the easier it is for top executives to find alternative, highly lucrative positions. The former CEO of Lehman Brothers, Dick Fuld, had no trouble finding gainful employment post-bankruptcy. Citigroup's (NYSE: C  ) crisis-era CFO found a cushy new spot at B of A that paid her $6 million in 2010. Heck, even Brian Hunter, the disgraced trader who blew up hedge fund Amaranth, managed to find new opportunities after Amaranth folded.

As for Corzine, even though he has officially left MF Global, he is still an operating partner at the private equity fund led by Goldman alum J. Christopher Flowers -- he just wasn't collecting a salary from there while running MF Global. And while the MF Global bankruptcy will no doubt be a black mark on his record, as a former CEO of Goldman Sachs, U.S. senator, and governor of New Jersey, there will no doubt be businesses lining up around the block willing to pay him big bucks as an "advisor."

It's all still there
In the wake of the catastrophic financial crisis of 2008 and 2009, there are those that want to us to believe that the answer lies with the market.

"Regulations?" they cry. "Bah! Executives will be sufficiently chastened by seeing what happens when they screw up. What we need are fewer regulations and more trust in the market."

Not if Jon Corzine and MF Global have anything to say about that. We were lucky this time around. MF Global was small enough that its failure was easily digested by the market. And it happened as an isolated failure.

But the hubris, ignorance, and lack of serious personal downside that fueled much of the idiocy leading up to the crisis can be seen in spades in the implosion of MF Global. Regulators have clamped down on the big financial players in the wake of the crisis, so those executives are playing it very safe right now. But make no mistake about it -- in this high-octane industry with trillions on the table, the ingredients for the next crisis are all still as prevalent as ever.

Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the companies mentioned. Fool contributor Alex Dumortier doesn't own shares of any of the companies mentioned. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On November 08, 2011, at 4:39 PM, fooltopian wrote:

    "<i>took on risks that it didn't have the balance sheet for</i>"

    Great article, amusing and informing at the same time. But if I was to reduce the frequent sightings of Black Swans to a single cause, it would be summarized in the statement above, that under the guise of mathematical modeling, highly enriched traders with no skin in the game took risks with money which wasn't theirs. Plain and simple. They neither forfeited their salaries, nor risked jail time, and in the best cases, their firms were bailed out. Who can blame them for taking wild gambles with others' money!?

  • Report this Comment On November 08, 2011, at 4:53 PM, fooltopian wrote:

    "We were lucky this time around. MF Global was small enough that its failure was easily digested by the market."

    On this prognosis, I'd say it's too early to tell. To take the financial industry and even our entire system of currency as a whole, it's centrally underpinned to trust. We only accept fictitious checks and Federal Reserve Notes in exchange for tangibles of real value because we have a deeply seated faith that someone else further down the line will accept the same instrument from our hands. Further abstracted, we put the wages of our labors in accounts that are nothing but bits held in state by PNP junctions (or magnetic particles infused on glass platters, flipped one way or another) because we trust the integrity of the technology and the custodians.

    When someone with as big of a name as Jon Corzine (or Bernie Maddoff) abuse the trust, however, our faith is rattled. There is no infinite elasticity to our faith and some individuals get rattled pretty easily. The banks were rattled in 2008 when the Bond market froze and real estate started plummeting, resulting in many borrowers walking away from their debts. The result was massively constrained borrowing.

    In the last three years, the general public has taken a pretty wicked beating. Lots of malfeasance, very little prosecution, regulatory agencies asleep at the wheel (when they weren't engaged in titillating web sites), circumvention and outright end-runs around bankruptcy law, and now, missing accounts. People are starting to ask what happens when a large firm goes under, where did the money in their accounts go? Are the powers that be, both government and large corporations going to default on contractual obligations?

    If the system is as highly leveraged as suspected, it isn't extremely resilient to even modest withdrawals. Any efforts to prop up failing institutions, even countries, can quickly erode. So, it's premature to celebrate our luck that MF Global wasn't "too big", because it was big and represents another reason not to trust those who have shown themselves as untrustworthy.

  • Report this Comment On November 08, 2011, at 5:21 PM, whereaminow wrote:

    This is one of those articles where I get all the way to end, mostly in agreement, expecting a certain conclusion, only to be baffled as to how the author's made the jump from A to B.

    The market did not bail out firms, increasing moral hazard. The market did not invent the "Greenspan Put" - the recognition that the Fed would step in and bail out any firm big enough to disrupt stability (Google Greenspan Put), as they did for Long Term Capital Management in the late 1990s.

    The market did not create a central bank with the ability to create "assets" out of thin air, and ties and interests comingled with every giant financial firm in America.

    Furthermore, the financial industry was already regulated by several agencies, the aforementioned Federal Reserve had COMPLETE regulatory oversight over every instrument created by the financiers. And they even gave implicit and sometimes explicit approval for the riskiest instruments.

    Yet, incredibly, our authors have determined that the market is at fault, and not the very institutions that husband and supposedly regulate these industries.

    It's truly amazing to watch otherwise intelligent people repeat the same analytical errors over and over again. In fact, just by their own track record of predicting the outcome of the bailout and regulatory reform policies (which the authors were certain would succeed in stemming the crisis), you would expect them to question their beliefs. I guess they're just not very good at economic science.

    David

  • Report this Comment On November 08, 2011, at 5:29 PM, Tiingall wrote:

    A very interesting read that confirms what I've been concerned about for years; that there is no personal accountability for the actions of traders, accountants, auditors, advisors, managers and executives who are supposed to be looking after our savings, investments and pension funds; re-cycling our money back into productive activity in the capitalist system.

    It's time people in the banking and finance industry were licensed. Lose your license because you make bad decisions that have bad impacts on other people, and your license is revoked. So you can no longer work in the industry; forever.

    The risks for the rest of us - who have no choice but to place our savings and investments in the hands of these people - is just too great. And so too are the risks for the national and international economy, jobs, families and individual life opportunities.

    If you fly a plane, drive a car or truck, or a ship, you are licensed. That's because the rest of us need to know that others who we are dependent upon will act responsibly, so we are safe. We all know that if we make an irresponsible decision as a driver we can lose our license.

    A license system also helps keep the wrong people out of places where they can do a lot of damage; like the cockpit of the plane you are flying in.

    The people presently gathered in large numbers in the banking and finance industry have demonstrated, again and again and again, that they do not care about our welfare, only about their personal greed. They are probably the wrong people psychologically, because they seem to think that gambling with our money and future is just a game. A game with no bad consequences for them. They lack a sense of duty or responsibility towards the rest of us who must trust them with their hard earned savings, pension funds, investments etc.

    The very emphatic evidence is that too many of the present occupants of positions in banking and finance have no business ethics, no morality, and no personal accountability or responsibility. Therefore they are happy to take big risks with our money and our financial future.

    We are paying them big salaries, bonuses etc because we expect them to be looking after our best interests. If they are not, then they should not be involved.

    A license system would protect us in the first instance - by sifting out the unethical, irresponsible and well as incompetent - and then ensure that anyone who fails to maintain the expected standards are tossed out, permanently.

    And risk jail too. Just like a licensed car driver, pilot etc.

  • Report this Comment On November 09, 2011, at 9:45 AM, TMFBane wrote:

    @fooltopian, I think you may be right about it being to early to tell. Trust is fundamental to our financial system, and it appears to be eroding by the day. There could still be some very negative effects from this event.

    One issue that several of you raised relates to what sort of consequences/punishment should a CEO face, after blowing up his company? Jon Corzine has caused a lot of pain and suffering for his customers, employees, and shareholders. Should he be able to just walk away from this, even if there wasn't specific criminal activity?

    It's clear to me that he knew the risks he was taking. But he also knew there was very little downside for him, if his bet went south. Until we change that mindset, this sort of thing will continue.

  • Report this Comment On November 09, 2011, at 10:41 AM, lctycoon wrote:

    Thank you, David.

    I too was wondering just why the "market" was getting blamed for things here. The market did not make regulators asleep at the wheel. That housing was a bubble that would blow up and seriously hurt the American public was obvious to anyone with a basic knowledge of economics.

    The "market" did not make regulators to be in bed with company officials... or in bed with prostitutes! The market is not the reason why guys like Corzine will find another job. The reason why he'll find another job is because he knows how the system (largely created by expanding government regulations and corporatism) works. In a free market, Corzine would never find a job again because nobody would be stupid enough to hire him.

    How is the market to blame? Corporatism and the government perhaps, but the market? America does not have a free market. If it did then the bailouts never would have happened.

  • Report this Comment On November 09, 2011, at 11:00 AM, kwl1763 wrote:

    This article hints to the one thing I find most frustrating about the whole crisis.

    Too big to fail = too big, in reality we have gone the other way with consolidation. Capitalism and "the free market" is based on being able to fail.

    Blowups happen because of excessive leverage. Now I'll give you many of the big banks are significantly better off then they were a few years ago but any institution over a set amount (I have no idea if that is $1B or $10B) should only be allowed to lever to x times (others much smarter then me should define what that number is)

    Stuff hits the fan when big things fail, its so complicated very few in the world know how intertwined it is. Add that to the fact that there is little risk given you lever up and reap all the gain and only your capital for the losses and its a recipe for disaster that is only marginally better today.

    So in my opinion the only way you solve the issue long term is to limit leverage and prevent anything being big so that it can fail in an orderly manner.

    I'm no advocate huge of gov't intervention. I'm usually as capitalistic free market as you can get but when you start bailing things out and having systemic risk it's not capitalism anymore anyway. Let regulate it to be close as we can to pure capitalism which is where all the competitors have a fair chance and if they fail, they fail, it's unwound and someone else tries.

  • Report this Comment On November 09, 2011, at 11:39 AM, Eerkes wrote:

    im with david, its amazing how authors almost never engage or acknowlege his responses, unless their is some ticky-tack typo or generally benign statement that isn't fully referenced. They will jump all over that. What's up David, are they afraid of you?

    Executives need more skin in the game, that is fairly clear. There are a variety of solutions, but I think it could come from the boardrooms stepping up, if these type companies deemed that a high percentage of both current wealth, and current compensation were tied to true long-term performance of the company, i think you would see some real progress. An owner-operator culture is badly needed.

  • Report this Comment On November 09, 2011, at 12:14 PM, cattywampus wrote:

    Looks like they have just moved their boiler room operation to the pent house and brought the crack pipes with them. This is the oldest con game in the world dressed up with computers and shell game misdirections.These guys are no better than the creeps who call your granmother and try to swindle her out of her life savings.

  • Report this Comment On November 09, 2011, at 12:40 PM, slpmn wrote:

    The solution is to end bailouts. If a company is too big to fail (and there are several), they need to be broken up so the individual pieces can fail when they screw up. It is that simple. The fact that we can't do that is evidence of who is running the show. Compensation is correlated with the size of the company you work for. Breaking up a giant bank only hurts the top executives who would no longer be able to justify their massive compensation packages.

    Smaller companies that don't pay dynastic (perfect term, by the way) compensation would result in a sustainable system in which unreasonable risks are avoided because it would impact the people making the decisions. Within those parameters, "the market" can take care of itself. Absent that, the next best thing you can hope for is that the unwieldly, absurdly complicated regulatory responses known as Dodd Frank and Basel III will work.

  • Report this Comment On November 09, 2011, at 12:51 PM, ejazz2095 wrote:

    I hate Jon Corzine, this couldn't happen to a better person.

  • Report this Comment On November 09, 2011, at 1:14 PM, dctodd27 wrote:

    To all those who think the authors are blaming "the market" - what article were you reading? I didn't get that impression at all. In fact, I got the opposite impression. The point of the article was to point out that because the free market was NOT allowed to operate as it should have in 2008, idiot CEOs like Corzine never learned the lessons they should have and hence took too many of the SAME risks and ended up (or will end up) blowing themselves up.

  • Report this Comment On November 09, 2011, at 1:20 PM, whereaminow wrote:

    dctodd27,

    This part.

    ---->It's all still there

    In the wake of the catastrophic financial crisis of 2008 and 2009, there are those that want to us to believe that the answer lies with the market.

    "Regulations?" they cry. "Bah! Executives will be sufficiently chastened by seeing what happens when they screw up. What we need are fewer regulations and more trust in the market."<----

    Acting as if regulations were not already in place to deal with these institutions (they were, and covered every single action they engaged in), while acting is if the market has no solutions (when the market chose a solution - bankruptcy - that they rejected), is the logical leap that confounds me.

    David

  • Report this Comment On November 09, 2011, at 1:21 PM, TMFBent wrote:

    Who'd have thought that a guy who didn't wear his seatbelt and asked his driver to speed him along at 90 mph could be the kind of person who didn't really manage risk well.

    Corzine was luck at GS, and he's lucky to be alive. He was lucky at MF, for a while. Clearly, he has never learned the difference between lucky and smart.

    No doubt, he'll find future suckers who believe the story that this kind of meltdown wasn't his fault, wasn't forseeable, and he'll convince them to shove money his way, hoping he doesn't go flying of the Garden State Parkway again.

  • Report this Comment On November 09, 2011, at 1:43 PM, dctodd27 wrote:

    David -

    I still don't see how that anything in that quote blames the market for what happened. All that quote is saying is that there are those out there who think that if the market was allowed to operate freely, those who take excessive risks would be punished accordingly (by the market). Sadly, government intervention has propped up institutions that would have otherwise failed, in order to protect the interests of the bondholders of those firms at the expense of the taxpayers. And because of that intervention, these same institutions never learned the lssons they should have and now take the same risks. The implication is that the the misguided bailouts are to blame, not the market.

  • Report this Comment On November 09, 2011, at 2:03 PM, whereaminow wrote:

    dctodd27,

    I'm glad that you agree on the big picture issue here, but I know what that comment means because I read these authors often. It's part of being around here too long ;)

    David

  • Report this Comment On November 09, 2011, at 2:07 PM, cattywampus wrote:

    I wish, I could count on the guilt or the shame of comparing these guys to a boiler room operation, but it won't slow them down for a microsecond. These guys see themselves as the financial warrior elite, with their weapons of mass destruction, derivatives and credit-default swaps, bringing down companies, corporations, governments and whole countries. The smartest guys on the planet.

  • Report this Comment On November 09, 2011, at 2:09 PM, HKendrick wrote:

    David,

    The "market" was responsible for poor assessment of risk and, consequently, terrible allocation of capital on a massive scale. The best solution is to forbid (through regulation) firms from engaging in the type of behavior that led to it (such as massively leveraging other people's capital). We had two choices, bail them out, which has costs (yes, some in the form of moral hazard) or let them fail, which probably would have had greater costs. So, "all market, all the time" proponents don't see the solution, because to them, the market is never wrong - even in the face of the overwhelming evidence of the last few years.

  • Report this Comment On November 09, 2011, at 2:11 PM, Darwood11 wrote:

    @ WhereamInow;

    I agree with you.

    @ TMFBrent;

    "Corzine....never learned the difference between lucky and smart." I suspect one of the reasons he, and many others have taken all of those risks with a "who cares" attitude is the nature of the compensation and bailouts. The government backs these people implicitly and explicitly. That promotes risk taking, because there is seldom a consequence and large financial rewards.

    As the authors stated "Ken Lewis, retired on a cushion of dynastic wealth....Morgan Stanley's John Mack... was handed total compensation north of $37 million."

    The government has facilitated the risks these people take. So have the boards of the various companies. But it is the government that has used taxpayer money to bail them out, seldom extracting anywhere near the financial "pound of flesh" required as a reward for the taxpayers taking on these unwelcome responsibilities.

    Today, it was announced that Fannie May needs another $7.8 billion. The National Board of Realtors wants the limits on FHA loans increased to $729,750. Some are now saying that FHA is the "new subprime."

    This will never end, until it ends very badly. I am becoming concerned that 2008 was simply a "foreshock."

  • Report this Comment On November 09, 2011, at 2:17 PM, HKendrick wrote:

    "The government has facilitated the risks these people take. "

    Yes. Not least by failing to regulate these people effectively. And yet free market fundamentalists cry "Less regulation!"

  • Report this Comment On November 09, 2011, at 2:57 PM, DividendsBoom wrote:

    Regulation should be further specified, us free marketers aren't against regulation, just crappy regulation, which most of it is. So why layer on more and more crappy regulation? How about a few direct, effective ideas on regulation. I have a few. I like the owner-operator culture mentioned above, regulate that execs in financial firms must have their personal wealth at stake in the company. Another one, SEC action should be levied against individuals either in addition to, or instead of companies. Why has just about every financial firm been prosecuted by the SEC but not individuals? Is it illegal for a company to do certain things, but not employees of a company? These are regulations I can get behind and even argue increase market efficiency.

  • Report this Comment On November 09, 2011, at 3:14 PM, HKendrick wrote:

    DB,

    Was Glass-Steagall crappy regulation?

  • Report this Comment On November 09, 2011, at 3:30 PM, whereaminow wrote:

    I'd give any liberal $20 if they actually knew what Glass-Steagall did, but how would we follow up?

    Tom Woods takes down the Glass myth here.

    http://www.tomwoods.com/blog/repeal-of-glass-steagall-had-no...

    David

  • Report this Comment On November 09, 2011, at 3:43 PM, HKendrick wrote:

    A "take down" that's long on opinion and short on analysis from a senior fellow of the Ludwig von Mises Institute. That's surprising.

  • Report this Comment On November 09, 2011, at 3:57 PM, HKendrick wrote:

    And just so I'm clear, David, you think that the presence of regulation led to massive misallocation of capital by the market? Which regulations? Please read more about the Community Reinvestment Act before you mention it. Which regulations contributed to rating agency "mistakes"? Or to terrible CDS bets?

    I know, I know, the "too big to fail doctrine" was on all these guys' (and gals') minds while they were making these mistakes, right? Don't get me wrong; I'm no fan of bailing them out. But the best way to do that is to limit their size. Makes the market more competitive too, so any efficiency losses (of which I'm dubious in any event) should be outweighed by more competitive markets. You see, it's not just moral hazard that makes markets less efficient (and moral hazards come in market-engendered varieties as well, by the way); it's barriers to entry of all kinds, monopolies, ...

  • Report this Comment On November 09, 2011, at 3:59 PM, Darwood11 wrote:

    The problem is, there is a huge difference between regulation and proper penalties.

    I'd suggest that things would change if there were proper penalties, which means laws enacted, which punished for certain bad behaviors or outcomes.

    I don't really see the difference between some of the chicanery in the board rooms and on the highway. On the highway, take a risk, speed recklessly, and there are civil penalties if people get hurt.

    However, in the board room, or the President's or CEO's seat, take a risk, and as long as no on dies, even if many lose their pensions, or companies go under and the shareholders are burned, there is no penalty. Meanwhile, the decision makers are well paid for those mistakes.

    So we reward reckless financial behavior because there is no punishment for "legal" behavior which many would call "irresponsible." Deep financial losses? Failure to fund pensions? Investing in losing businesses or business schemes which jeopardize shareholders? None of it illegal. However, if at the same time there are large salaries, bonuses, options given, etc. I must ask, why isn't this type of behavior considered to be reckless and therefore "illegal?" And why aren't the risk takers then stripped of their wealth, which could be argued was "ill gotten?"

    It's interesting that there is, in financial circles, this conversation about "rewarding risk." However, it seems that really what is too often occurring is "bad behavior " is being rewarded. Those who are putting out their capital, buying stock, etc. Those shareholders are the ones who are really taking the risk, and for, it seems, little reward. I'm not surprised the past 10 years is sometimes called "the lost decade." Nor am I also, at the same time, surprised to see that the wealthiest are now even wealthier. I do think there is a correlation.

  • Report this Comment On November 09, 2011, at 4:27 PM, ejclason2 wrote:

    My understanding, from reading many articles, a few books, and watching some documentaries. Things were slightly negative, but not horrible, when Lehman got in trouble. The decision was made not to save Lehman and thats when things went to hell. I can't prove it wasn't a coincidence, but I doubt it. If more financial institutions had been allowed to go belly up, would things have gone better? Maybe an arguement could be made for the long run, but in the short run, things would have gotten even worse.

  • Report this Comment On November 09, 2011, at 5:08 PM, whereaminow wrote:

    HKendrick,

    The root cause of the boom/bust cycle is government intervention. In its current form, that intervention is the privilege bestowed upon the Federal Reserve to target interest rates and manipulate the money supply.

    Capital misallocatoin, classically known as malinvestment, can only occur on a broad scale when interest rates are held too low for too long, causing a mismatch between the time preference of consumers and producers.

    Deregulation is a scam. It always has been and it always will be. That's because the government's idea of deregulation is to re-write the rules to benefit a different group of people. Real deregulation is the removal(!!!!) of government interference. Hence, real deregulation would be the abolishment of the Federal Reserve, for example. No real deregulation has occured in America on a large scale in at least 100 years.

    By extension, the idea that we need more regulation is equally fallacious, since it assumes that we somehow lacked it in the first place. This is obviously untrue.

    I appreciate that you've of the Von Mises Institute. Let's keep in mind that this is the only school of economic thought that had dozens of scholars correctly predict the housing bubble and crash. Their "opinions" must be coming from somewhere interesting. Hope the readers will take a look.

    David

  • Report this Comment On November 09, 2011, at 6:08 PM, xetn wrote:

    So, where was our glorious federal regulators and the Fed, both of them have responsibility to oversee and prevent this type of "investing". Right? Where was Dodd-Frank? Having a party?

    Why wasn't this firm saved? Oh, yeah. they ain't G.S. Just breadcrumbs.

  • Report this Comment On November 09, 2011, at 6:21 PM, DJDynamicNC wrote:

    Regulation is not an all or nothing exercise.

    There are common sense regulations which have been repealed that were put in place specifically because of the problems of the market.

    There are also regulations that have been put in place because of lobbyists carving out exceptions to existing code and rent-seeking through new codes.

    There are also regulations that are, yes, just plain dumb. The de-regulation of the brewery industry was a massively successful move. I would love to see a good deal less regulation of non-essential industries like barbershops and psychics (I'm not kidding: http://www.cityofpalmdesert.org/Index.aspx?page=246 )

    Regulatory capture is endemic. When half of the SEC is made up of former "Government Sachs" employees, you're going to see exactly what we saw - improper or failed enforcement of existing laws and a resistence to new laws.

    Meanwhile, the pillaging continues apace.

  • Report this Comment On November 09, 2011, at 7:16 PM, Darwood11 wrote:

    "Regulation" as so many other things with our politicians, is an exercise in obfuscation.

    For example, our government recently passed, as part of the "Health Care Reform Bill" a requirement that businesses, such as mine, provide 1099s for everything from telephone bills to rent.

    This was repealed by a Senate by a vote of 87–12. So 12 of our esteemed politicians decided this was a good measure. Sen. Robert Menendez, D-N.J. even attempted to block the repeal and instead, pass a measure for further study.

    Yep, the "grey market" in the US is thriving, by which I mean the millions according to the IRS who underpay their taxes with such chicanery as "barter" or downright lying on their returns.

    Meanwhile, legitimate "small" businesses such as mine are required to dot every i and cross every t.

    Frankly, that's why I don't care a hoot about more regulation. I'd like to see some real penalties for breaking the rules.

  • Report this Comment On November 09, 2011, at 7:16 PM, ynotc wrote:

    At it's simplest hubris is pride or arragance that leads to death. Death of a human, company or finances.

  • Report this Comment On November 09, 2011, at 7:20 PM, Darwood11 wrote:

    Or a country.

  • Report this Comment On November 09, 2011, at 8:24 PM, CaptainWidget wrote:

    The blame on overpaid CEO's and excessive risk taking lands squarely on cheap money, depreciation, and low yields on safe investments (savings accounts, bonds, ect).

    There's one entity that can fix that....or more correctly, ABOLISHING one entity could fix that.

    Without a Fed, interest rates would rise, boards wouldn't authorize huge CEO pay (because with finite capital in the market, those funds are better utilized inside of the business) and people will run away from risk because non-risk yields would increase dramatically.

  • Report this Comment On November 09, 2011, at 11:00 PM, youngblood58 wrote:

    In 1982, the financial services industry accounted for roughly 10% of our GDP. Today, it's over 45% of our GDP.

    The problems of the banks and financial institutions will not go away anytime soon. It is part of a larger economic shift that's taken 30 years to get here.

  • Report this Comment On November 10, 2011, at 12:17 AM, joandrose wrote:

    Tiingall - you hit the button on the nose . You are absolutely correct - the introduction of a licensing system which is fully enforced is the ONLY way we will ever be able to enjoy a degree of protection from unscrupulous bankers and traders

  • Report this Comment On November 10, 2011, at 1:37 AM, seattle1115 wrote:

    @whereaminow: "The root cause of the boom/bust cycle is government intervention."

    You don't honestly believe this, do you? If you do, I would strongly suggest you read some Minsky, or simply study the history of the American economy in the 50 years after the Civil War. What you have written here is so spectacularly wrong - so utterly contrary to all available historical evidence - that I have a hard time believing it was meant to be taken seriously.

  • Report this Comment On November 10, 2011, at 3:15 AM, whereaminow wrote:

    seattle1115,

    Your homework assignment for tomorrow: Google "suspension of specie payment."

    I've studied every episode of crisis in the American economy from 1787-2012. Each severe crisis was preceded by a credit fueled boom. Each boom was a result of an increase in the money supply and credit. Each increase in the amount of credit was accompanied by some form of government bestowed privilege, that without, never would have been possible. Each boom resulted in a general bust as the grasping for resources revealed reality. Each bust caused a contraction of credit. And each bust resulted in more privilege for those who created the problem in the first place. 1819, 1837, 1857, 1873, 1893 (this one caused by a boneheaded government price fixing scheme known as bimetallism), 1907, 1920, 1929, all the way up to 2008.

    Every one the result of government intervention.

    David

  • Report this Comment On November 10, 2011, at 5:24 AM, scavanna wrote:

    It is time for the Vocker Rule! Regulation does not work

  • Report this Comment On November 10, 2011, at 7:53 AM, ravenesque wrote:
  • Report this Comment On November 10, 2011, at 8:07 AM, Fullstep wrote:

    I think the words "claw back" need to be spoken. Bernie Madoff is in jail and his assets were attached. Corzine should suffer the same fate. Civil recourse to claw back all of the assets of executives who are part of a criminal enterprise (read RICO) would chasten these people.

    There was a front page piece in the NYTimes on Tuesday that looked at the SEC's weak record of enforcement.

    As for whether "the market" or the lax regulatory framework and the permissive Federal Reserve is at fault: which came first, the chicken or the egg?

  • Report this Comment On November 10, 2011, at 8:40 AM, Fullstep wrote:

    Credit rating agencies are a creature of the free market. Left to its own, the market evolves ways to generate information that guides action.

    Angies List, feedback on eBay. Caveat emptor.

    The spectacular failure of the rating agencies with respect to mortgage backed securities makes me wonder whether the market will generate sufficient information (for a fee) to guide action.

    Milton Friedman used to argue that licensure was really a substitute for collusion by suppliers to restrict entry. Doctors, plumbers, lawyers etc. all were happy to get licences because that meant it was harder to enter their respective professions.

    Much of the logic behind Friedman's arguments depend on low or vanishing transaction costs and costs of acquiring and processing information. These costs. in reality, are big. Asymmetry of information makes signals (such as licensure) rational.

    Can we trust the FDA stamp of approval on a hot dog? Would we rather take our chances? Would we rather trust a private hot dog rating agency?

    You can buy hot dogs only from a national brand with stellar reputation. Of course, then you are putting your trust in the executives of the company, to uphold the long term reputation of the company. Sometimes executives cut corners to boost short term profits when their personal interests diverge from the long term interests of their company...

  • Report this Comment On November 10, 2011, at 9:23 AM, Tygered wrote:

    And yet the Republicans want even less regulation so these people (who own the Republican party) can steal even more of our money. I will guarantee you that we'll be seeing crises that are even worse than 2008 within the next few years, especially if the de-regulators get their way. These bankers and investment guys should be so heavily scrutinized that they should be required to raise their hands to go to the restroom. If they act like unruly kids with no care for anything and hubris, then they should be treated as such. Regulate, regulate and regulate some more and punish, punish and punish even more if they steal our money.

  • Report this Comment On November 10, 2011, at 9:39 AM, TMFBane wrote:

    Some things we know are unlikely to change. Human nature is what it is and folks will continue to take huge risks, if there is no real downside. And let's face it, our regulators have shown time and again that they aren't up to the task of overseeing these reckless institutions.So I wonder if we need to bring back the old partnership model (or something similar). If these guys had their net worth tied up in these companies, I'd bet they'd act much differently.

  • Report this Comment On November 10, 2011, at 3:30 PM, cattywampus wrote:

    Mike Mayo's book 'Exile on Wall Street' was covered in a WSJ article last Saturday, 11/5/11 in the article titled 'Why Wall Street Can't Handle the Truth' In it he talks about the, Interstate Banking Law of1994 and how it let banks operate across state lines, which resulted in easy gains from consolidation, mergers and cost cuts. Having grown through that period they turned to increased consumer loans with greater risk, spurred by executive stock options, hence the current crisis.

    He suggests a better version of capitalism, rules that are actually enforced, accountability for mistakes and more transparency. He says look at London and the U.K.'s version of our SEC (called the Financial Services Authority) higher paid more competent regulators who are not dependent on the industry they are monitoring and a reduction in the clout of the big banks. Also, watch out for the new bred of Obamavillians operating out of Obamaville, I hear they are arming themselves with Obamamite.

  • Report this Comment On November 12, 2011, at 1:45 AM, TomBooker wrote:

    (my emphasis)

    "But the hubris, ignorance, and lack of serious personal downside that fueled much of the idiocy leading up to the crisis can be seen in spades in the implosion of MF Global. ?????!!!!!Regulators have clamped down on the big financial players in the wake of the crisis, so those executives are playing it very safe right now. !!!!!!!????But make no mistake about it -- in this high-octane industry with trillions on the table, the ingredients for the next crisis are all still as prevalent as ever."

    OMG!?

    Koppenheffer. I'm blaming this one on you, you're supposed to be the Senior writer.

    You get too many things right, to get this so Peter-Pan wrong.

    Tell me... Are you trying out for the Sunday morning Beltway Bubble shows??

    David Brooks and Tom Friedman can't live forever and you're looking like a shoo-in for a spot at the Wall Street/Wash DC Public Relations tables.

    Sorry, I'm hyperventilating. That's the worst case of editorial Conclusionus Interruptus to which I have ever been subjected.

    I think I have a case of reader whiplash.

    "Regulators have clamped"????

    on What?

    There is at least $630MM of client money MISSING. Not lost on a bet, missing.

    That was "segregated" money. "Regulation" clearly states that the Managing Cesspool can't mix their clients' money with their own money for sidebets in which they are the Primary.

    It's the foundation of the commodities and swaps brokerage business.

    And the entity sure as hail can't use clients' money to meet their own collateral obligations.. which considering MF's book and the scenarios of past Financial System bellyflops... I would put at the top of the Sherlock Holmes list for first attempt at deduction.

    Meanwhile, this is how Gary Gentsler, Boss of the CFTC (and ex-Goldmanite #2 in the story) "regulated" the event... you can only find this kind of stuff in a Sorkin stenography-from-the-criminals.Best-Seller.

    Gensler in front of Congress, NYT dated 11/03..

    http://tinyurl.com/br2yave

    "This was an example of a financial institution having the freedom to fail,”(snip) ..

    ...“I don’t think there’s any taxpayer money behind this.”" (snip)

    No Gary, there wasn't. (Although I'm amazed he didn't know that for absolute positive. "think" is a wimp of a word when your main goal is veracity.)

    It was clients' money, that went missing.

    The ones you are supposed to protect, no matter who the guy is, running the Craphouse Game.

    And in what has to be a golden moment in the I-hate-Elliot-Ness Contest among regulators.... Regulator AND investigator Gensler tips-off my alleged perpetrator... NYT again..

    "Mr. Gensler first spotted a potential shortfall late last week, personally calling MF Global’s attorney to alert the firm. But it was not until around 2 a.m. Monday morning that the firm fully recognized the magnitude of the missing money. The disclosure sent bidders fleeing and the firm had no choice but to file for bankruptcy"

    hey, if you really want a job which demands weak-kneed equivocation take this guy's job..

    "potential shortfall" "late last week"????

    They had already confessed to co-mingling money which is a violation of Regulatory Law and about 20 guarantees in the MF Global Perspectus, and the money was GONE.

    Why would Gensler give THEM 4 or 5 days to find it? And not be with the DOJ at MF Global "late last week" securing the books and soon-to-be ex-employees?

    That's not "freedom to fail", it's freedom from jail.

    If that is "clamps", somebody needs to learn how they work.

    I get the point that MF Global was luckily small potatoes to systemic risk, and MF Global is a symptom of the same.

    But you can't realistically say that regulators currently have any impact on Wall Street bankers who have given themselves every reason to exhibit the epitome of psychopathic behavior, showing lack of empathy and remorse, shallow emotions, egocentricity, and deceptiveness.

    These guys are doing whatever they want.

    And part of that is a shovedown on the whole MF Global Drama... for Corzine or 'for the good of the system".

    This 3-Act play has every symptom of what is wrong with Us.

    And we're not going to get better, until we get one of these things into Act 3.

    Next time:

    Bank of America Holding Company moves $30Trillion (total notional value) in opaque derivatives from their Merrilll Lynch subsidiary, to the BoA Banking subsidiary. (that's the Mom and Pop old-fashioned bank part of the corporation). To stabilize their credit rating.

    It succeeded. Why? Because excessive derivatives need reserves. What kind of reserves? Highly liquid reserves.... like the $1.3T in customers' savings deposits and equivalents.

    It is argued that the deposits are safe through the FDIC guarantee. the depositors will get paid first and whole, if there is an event.

    But that doesn't make any sense, if the deposits were a safener for the derivatives and credit rating.

    It seems to me if the digested material hits the circulating mechanical device, the FDIC is going to get caught holding some or all of the bag.

    But they are virtually broke, and would at some point have to go to the Treasury.

    And you know who will get the bill.

    The FDIC should have said "NO!". They didn't.

    These guys are doing whatever they want, and nobody is saying anything.

    You had the building narrative, then threw it under the bus..

  • Report this Comment On November 12, 2011, at 4:54 AM, Sunny7039 wrote:

    I see the "free market" sophists are out in full force.

    Perhaps a truly "free market," without "government involvement," would work. Why don't we really try it? Of course, this would me getting rid of the corporate form of doing business. After all, the corporation itself is a creature of the state, and provides a mechanism for shielding individuals from liability for their very own actions, as long as these were undertaken to further the business of the corporation. They can't be held personally responsible, no matter how bad things may get. Well, whose big idea was this? Sounds like a massive "governmental put" to me, in favor of a refusal to stand behind and be accountable for what you do. How irresponsible is that? Let's just get rid of it, and see what happens.

    Come to think of it, the same goes for intellectual property laws. Why should anyone have access to the court system, and ultimately the sheriff, to defend things like patents? Anyone who can reverse engineer anything and make it better and cheaper should be allowed to try, with no barriers, and no one to answer to. As things stand, they can get sued, be held liable, and then the guy with the badge can come around and seize their property! How statist is that? It's practically a gulag.

    We can also get rid of the SEC. If you can't be bothered to go check up on your investments yourself, and audit their books yourself, well then you have no one to blame but youself if your stake in a partnership (remember, we just got rid of "corporations") goes south.

    This is starting to sound like a plan.

    :)

  • Report this Comment On November 12, 2011, at 5:12 AM, Sunny7039 wrote:

    Would a "free market" entail allowing anyone to print money who wants to? Because that is pretty much what we did when we allowed various arcane derivatives and swaps to be traded OTC with no accountability, no centralized clearing house or reporting, and with the institutions doing the trading also being allowed to say how much debt (as a double- or triple-digit multiple of their reserves) was "safe" for them to take on to buy these instruments. Instruments which by the way are still waiting to be "marked to market." And it has been a few years now, you know?

    Are Moody's and Standard and Poor's the "government." Or are they "private?" Because they kind-of messed up, too, I kind-of think. Not that anyone had to give back their salaries or bonuses, though. That's their property . . . that's none of our business. (Note: sarcasm alert)

    If you believe in the "free market," you must insist on a return to "mark to market" accounting. After all, only the market can determine value. And then, we have to have more competition among the auditors, too. Somehow, or other. Or, uh, might the accountant willing to sign off on the best picture of this mess be the one who gets hired? Hmm . . . this is starting to get complicated.

  • Report this Comment On November 12, 2011, at 5:18 AM, whereaminow wrote:

    We went without an SEC until the late 1930s. Read Benjamin Anderson's Economics and the Public Welfare. Before the SEC there were competitive stock exchanges, so if they didn't catch fraud among the companies they listed, the EXCHANGES went out of business. Now the exchanges have a government enforced monopoly (the only kind that can ever exist for any serious amount of time) and the exchanges go scot free even when they are obviously complicit in the fraud.

    The SEC has done nothing for the individual investor. Besides blowing every opportunity to catch criminals that were identified by the private market (See Madoff, for example) they have shielded and protected some of the biggest criminals in other cases. Now the SEC is merely an arm of GS.

    The market only goes up for years and decades on end because the Fed prints money. That's it. It has nothing to do with super duper USA awesomeness or the noble bureaucrats at the SEC. It's printed money, that's all it is. If you don't print it, the market can't go up.

    David

  • Report this Comment On November 12, 2011, at 2:07 PM, TMFKopp wrote:

    @TomBooker

    I think you misunderstand the section that you quoted from the article. That was specifically referring to the TBTF financial institutions and the propensity for them to do something massive and stupid and massively stupid again. It had nothing to do with the missing client funds at MF. That's inexcusable and something very wrong has happened there.

    Matt

  • Report this Comment On November 12, 2011, at 4:59 PM, Sunny7039 wrote:

    Before the SEC, and the federal banking regs and deposit insurance, it was an ordinary occurence to lose your entire life savings in the blink of an eye. Booms and busts were bigger. People, especially in the western states, settled scores on their own. (Are you a good shot? Didn't think so.)

    More to the point, we have major players from all over the world invested in our markets, buying our securities, and lending us and our enterprises money. (You, uh, do know that we are a debtor nation now, right? Or did you imagine that was irrelevant?) WOULD THEY CONTINUE TO DO SO if there were NO SEC? If they knew that losing everything were as easy in 2011 as it was in 1911?

    You know absolutely nothing about capital formation.

    And BTW, let's get back to my original point. The corporation itself is a creature of the state. So are the IP laws. Let's get rid of all of that, too. It's just a bunch of statist nonsense that lets people off the hook for their own actions. It lets everyone be as irresponsible as they want. They should start taking personal responsibility for their choices.

    Let's be really free. Then we can talk.

  • Report this Comment On November 13, 2011, at 11:03 AM, gkirkmf wrote:

    Posted in part as a response to this article.

    http://www.fool.com/investing/general/2011/11/11/banks-promi...

    I think it also applies here.

    The banking problem is just one aspect of a growing problem caused by LARGE corporations. Lest we take our eye off the ball, remember that GM and Chrysler arranged bailouts for themselves during the "financial" crisis!!!

    Seems to me that if we are to survive as a country 100 years from now, we have to come up with a different way of controlling bigness other than the laze fare capitalistic approach we have today. It's like lemonade stand economics. It works well in the micro, but fails at the macro level. Capitalism works great at the micro level. The rise and failure of small businesses reveal this. It allows the best of breed to survive. But, look what happens when you let this concept grow and grow. We now have gigantic groups of people who have a societal license to act as one person. There is competition in their ranks to achieve higher management levels and higher pay. Morality is nonexistent. It’s up (with more pay) or out. The drive to succeed puts heavy pressure on finding ways around the regulatory apparatus to eke out higher and higher bonuses and promotions.

    Does anyone have a solution? I would like to hear other’s approaches to solving this conundrum. At the risk of being roughed up in the MF world, I will propose mine to get the ball rolling. In my view there are two very different approaches to solving the problem.

    One solution is to equal out the playing field to use a sports metaphor. This would solve the jobs problem also by the way. We increase the number of auditors and regulators to the point where the government has a chance of controlling these large corporations. The logical conclusion of the present trend for management to either push to sell out (and take a big golden parachute with them) or acquire another company (and increase their salary accordingly) will result in one large corporation being regulated by one large government. This is not my favorite solutions by the way…

    The other possibility that I see is that we limit the size of corporations which are either incorporated in any of the 50 states, or not incorporated in the US but operate anywhere in it. I leave it to others wiser than myself to come up with an exact limiting formula. Personally, I would just limit corporate assets to a certain size based on industry. I would be especially carefully in setting the size of conglomerates. In my opinion, limiting corporation size would go a long way towards the goals of limiting the size and influence of government in our lives, not to mention enhancing the rule of law in an uncertain future.

  • Report this Comment On November 14, 2011, at 12:50 AM, TomBooker wrote:

    @TMFKopp

    No. It probably has to do with a Friday midnight word-barf by me. (h/t to Eliz Warren for that term)

    And as difficult as it is to see, I admire the writing done by Housel and you. You both get out the thesis out in a manner measured appropriately for the venue.

    I read it a bunch of times, Matt. There's no ground within it for which I can't find common purchase with you.

    It's just that I thought you might really go for it.

    You were, one at a time, eliminating any possible claims they could make to the slightest semblance of individual and social order.

    We (I'm an amateur hack, but follow how and what writers write)) keep writing that they are ignorant, arrogant, narcissistic, learning-disabled etc... Our lists get longer and more sophisticatedly preened with the insidious event of the day.

    It may be said that we, as a society, are steeping ourselves in helplessness, and demonstrations against that feeling. (#OWS?)

    My suggestion is that we somehow feel WS et al are some necessary logical conclusions for which we are responsible. As if somehow we created them, and put them where they are.

    IMHO, as whacky as Americans can seem, It is actually about these men themselves. They are without, and beyond, their own control.

    As investors, we find them afoul in their imagined precision to quantify risk.

    IMHO, they are bereft of any consideration to risk, whatsover.

    And that is not natural by any human standard..

    "That CEO Jon Corzine and other MF Global executives seemingly didn't learn anything from these recent failures is jaw-dropping."

    Well, what is left?

    They are not dumb. How 'bout "They're nuts". How 'bout they are serial psychopaths?

    They can't not do, that which they are doing. They don't see it as wrong. They see it as a necessary part of themselves.

    When one sits down and writes a list of everything Corzine did, .. He had to think he was a God, not bound by Reality.

    Don't roll your eyes, entire nations have been run by psychopaths.

    My current bent is to fan the flames of an irresistible sense of urgency to start picking off these Mad Men. They are that great of a threat to us. We do not have time to wait for Glenda, The Good Witch, to show up to confirm the extreme danger constituted by these clinical psychopaths.

    Any people who writes things which other people actually read, are welcome to join in..

    We can start Monday morning, with the goal of having at least a dozen in handcuffs by lunchtime.

    "Regulators have clamped down on the big financial players in the wake of the crisis, so those executives are playing it very safe right now."

    That was my emphasized part of the quote. IMHO, It's counterproductive, because it gives folks a false sense that these people are contained, and time is not of the essence.

    IMHO, the threat is not out there, it's right in our face. We know who they are. And we can start with MF Global's entire Sr Management.

    That is also why I reacted adversely to the reference of MF Global's dilution by the Market. Stuck on my version of stupid, I don't want it trivial on any layer, even if it is. (FoxNews is my inspiration;)

    And it looks like i may have fished my wish...

    Somebody BIG got hurt in the deal..or

    There's a lot of damage outside of the deal ..or

    Somebody is holding a gun to the CME's head, or

    The CME is stone-stupid to think they have to buy integrity for their exchange, when nobody cares about the integrity of exchanges.

    After Market, this got put out in the Friday afternoon News trash....

    "Though CME Clearing does not guarantee FCM-held assets, CME Group is willing to provide a $250 million financial guarantee to the trustee to give the trustee greater latitude to make an interim distribution of cash to customers now, given the monumental task he faces to sort through considerable data and claims in order to complete the MF Global liquidation and make distributions to creditors.”

    The only reason which can be immediately dismissed.. for an entity from the financial sector to cough up $250MM... is the one they claim.

    Write on.

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