From Medicine to McKinsey to Main Street: Transferring risk to shareholders: Quarterly greed with no skin in the game

Wednesday, November 26, 2008

Transferring risk to shareholders: Quarterly greed with no skin in the game

Michael Lewis has a great expose on Wall St (both culture and incentives) this month, titled The End of Wall St's Boom.

While the whole piece highlights the train wreck that is current Wall St culture, there's great insight at the end as to why this happened so badly now. And, as with all things, it comes down to what you do when you play with other people's money.

When as a public firm, that means raking in profits when risk is taken, while not personally accountable for any (the public shareholders become a backstop, where partners' own wealth was once at stake), then the long-term equity values begin to recede in importance to the quarterly/ annual bonuses.

What this highlights is the lie of Wall St finance, that bankers created vast amounts of wealth and needed to be paid to do it well. Instead, it highlights that in banks, it makes sense to take the winnings out and distribute them to the shareholders in good times. As a partnership, that used to happen. As public entities, the shareholders were fleeced and left holding the bag. I sense we'll need to see public entities with less-well paid bankers and private entities whose shareholders will again create and share in the gains (and losses).

What we've also seen is that diversification is a farce in a world where derivatives tie all publically available assets together...the strategies to control risk should return to underwriting of individual investments. As with all things, assumptions break he most complicated models, so its common sense, vision, and leadership--not spreadsheets--that will show us the way forward and make the world a place better than today. As Thanksgiving nears, let us give thanks that we can gather our loved ones around and as the night gets darkest, it always gives rise to a brighter tomorrow.