Be wary of the man who urges an action in which he himself incurs no risk.
-Joaquin Setanti
Last week I had the privilege of speaking at a local college on the subject of business ethics. We spent some time talking about the need for "moral hazard" in order for capitalism to work. Moral Hazard generally refers to a party being insulated from risk. In other words, they get to participate in the rewards, and suffer little if any pain when things go astray. The risk-reward balance is thrown asunder. CEO's who are paid annual salaries north of $1 million, and are able to cash out with $5 to $10 million if they are fired, are a good example of the lack of moral hazard.
Below is an article by Barry Ritholtz, of The Big Picture, that addresses this topic on a national level. I couldn't agree more with his thesis that we need to "take the loss" in order to bring risk-reward back into balance. What Barry doesn't mention is that we the taxpayers get stuck paying for this unwillingness to "take the loss". Make the risk takers (CEO's, stock and bondholders) take the loss, and they will think twice about who they invest money with.
Take The Loss
Here is something that you may not think about often enough: Taking losses.
Its something that every rookie trader must learn to do — and all of the TBTF banks refuse to do. Even sovereign nations seem unwilling to accept this simple fact of financial life.
There will be losses. How you handle them determines your fortune, your fate and your future.
Seeing how people handle losses is revealing of their character and integrity. Hiding losses is what rogue traders do. Its also what rogue banks do, and apparently, rogue nations.
$2.3 Billion in losses hidden from UBS sights by a rogue trader is chicken feed. But ponder how many $100s of billions of dollars in mortgage losses are hidden from view? The real rogues are America’s largest banks, and their enablers in Congress. .
When the TBTF banks (via their purchased Congressman) forced the Financial Accounting Standards Board to pass a rule allowing them to hide their mortgage losses — FASB 157 — it showed the dishonest nature of these entities. It was revealing of the lack of integrity of all of the institutions involved — from Congress to the banks to FASB.
When Bear Stearns first began to wobble in 2007, the initial error in this era of bailouts was in rescuing their bondholders. Instead, in 2008, they should have been forced to take the loss.
Its the same for creditors of Citi, Bank of America et. al. — instead of rescue packages, their creditors should have had to take the loss.
Mortgage delinquencies growing? More and more defaults in the pipeline? We can extend & pretend, or we can take the loss.
Note that via the FDIC, some bank lenders did take the loss. Washington Mutual’s collapse led it to being bought by JPM. Wells Fargo picked up Wachovia. Other examples abound, In each case where losses were forced to be realized, we ended up with a healthier few banks, and no moral hazard.
Zombie banks get created when they do not take the loss.
Now we have the European crisis, wherein all of the parties involved refuse to (say it with me) take the loss.
Greek debt piling up? You can restructure, renegotiate, reneg, or you can take the loss. Portugal’s balance sheet a problem? Well, the ECB can kick the can down the road, or they can force lenders to take the loss.
The model for not taking the loss has to be Japan. Look at their stock market since 1989 and you will see the net result of not taking the loss. The Japanese have suffered through lost decades as a result of their refusal to take any write-downs, propping up their Keiretsu.
Until we purge the bad debt from the financial system, we will be stuck with a long and painful de-leveraging.
Please, won’t someone in Washington or Brussels or Tokyo understand the importance of this simple trading rule? Take The Loss already!
Its something that every rookie trader must learn to do — and all of the TBTF banks refuse to do. Even sovereign nations seem unwilling to accept this simple fact of financial life.
There will be losses. How you handle them determines your fortune, your fate and your future.
Seeing how people handle losses is revealing of their character and integrity. Hiding losses is what rogue traders do. Its also what rogue banks do, and apparently, rogue nations.
$2.3 Billion in losses hidden from UBS sights by a rogue trader is chicken feed. But ponder how many $100s of billions of dollars in mortgage losses are hidden from view? The real rogues are America’s largest banks, and their enablers in Congress. .
When the TBTF banks (via their purchased Congressman) forced the Financial Accounting Standards Board to pass a rule allowing them to hide their mortgage losses — FASB 157 — it showed the dishonest nature of these entities. It was revealing of the lack of integrity of all of the institutions involved — from Congress to the banks to FASB.
When Bear Stearns first began to wobble in 2007, the initial error in this era of bailouts was in rescuing their bondholders. Instead, in 2008, they should have been forced to take the loss.
Its the same for creditors of Citi, Bank of America et. al. — instead of rescue packages, their creditors should have had to take the loss.
Mortgage delinquencies growing? More and more defaults in the pipeline? We can extend & pretend, or we can take the loss.
Note that via the FDIC, some bank lenders did take the loss. Washington Mutual’s collapse led it to being bought by JPM. Wells Fargo picked up Wachovia. Other examples abound, In each case where losses were forced to be realized, we ended up with a healthier few banks, and no moral hazard.
Zombie banks get created when they do not take the loss.
Now we have the European crisis, wherein all of the parties involved refuse to (say it with me) take the loss.
Greek debt piling up? You can restructure, renegotiate, reneg, or you can take the loss. Portugal’s balance sheet a problem? Well, the ECB can kick the can down the road, or they can force lenders to take the loss.
The model for not taking the loss has to be Japan. Look at their stock market since 1989 and you will see the net result of not taking the loss. The Japanese have suffered through lost decades as a result of their refusal to take any write-downs, propping up their Keiretsu.
Until we purge the bad debt from the financial system, we will be stuck with a long and painful de-leveraging.
Please, won’t someone in Washington or Brussels or Tokyo understand the importance of this simple trading rule? Take The Loss already!
Highlights from Dallas Fed President Richard Fisher:
Dallas Fed President Richard Fisher is, in my opinion, not only one of the most outspoken Fed presidents, he is certainly one of the most enlightening.
Yesterday, Fisher stepped to the podium again, and began his speech with the following analogy, and a photo of desolate Jan Mayen Artic Weather Station.
- Jan Mayen is a desolate volcanic island located about 600 miles west of Norway’s North Cape. It is the home of a meteorological and communications station manned in the harshest of winters by 17 hearty members of the Norwegian Armed Forces. If you read Tom Clancy’s Hunt for Red October, you would know it as “Loran-C,” a NATO tracking and transmissions station. In the video game Tomb Raider: Underworld, Lara Croft visits Jan Mayen in search of Thor’s Hammer, considered the most awesome of weapons in Norse mythology, capable of leveling mountains and performing the most heroic feats.
- My brother Mike recently visited this station on Jan Mayen. This is the sign that greeted him.
- In norsk, it reads as follows:
- “Theory is when you understand everything, but nothing works.”
- “Practice is when everything works, but nobody understands why.”
- “At this station, theory and practice are united, so nothing works and nobody understands why.”
- My wry brother implied that this about summed it up for monetary policy. Drawing on theory and practice, the 17 members of the Federal Open Market Committee (FOMC) have been working in the harshest economic environment to harness monetary theory and lessons learned from practice to revive the economy and job creation without forsaking our commitment to maintaining price stability. But the committee’s policy has yet to show evidence of working and nobody seems to quite understand why.
Let’s repeat that last sentence one more time for emphasis. “But the committee’s policy has yet to show evidence of working and nobody seems to quite understand why.”