21 July 2009

The origin of the financial crisis: an iconoclastic view (2)

2. Competence, governance and ethics

On this favorable background, the lack of competence, governance and ethics have exacerbated this dangerous policy.
  • Competence
I do not feel sorry for all the institutions and investors who bought all these ABS, CDOs and others derivative's acronyms without analysing these products, understanding the risk, relying purely on credit rating agencies and interest rates received.

I however feel sorry for the investors that entrusted their savings in fixed income and money market investment funds that were invested in these toxic-non-performing-whatever-name-you-give: they did not know and could not know; they were ripped off by at best incompetent professionals / organisations and at worst dishonest (they are always good clients of law firms to make sure they do not have to indemnify clients!).

This was coupled to a remuneration system that encouraged short termism vis a dual asymmetry:
  • Timewise: the bonus paid is never withdrew if after X years profits turn out to be losses
  • Riskwise: the risk is entirely supported by the organisation
Regarding investments via feeders (either institutions or independent advisors), the Madoff affair just exemplified what happens when professionalism and ethics disappear to the benefit of quick profits and easy money: a huge scandal and tremendous losses for investors. In this case, both regulators (the SEC, but frankly other regulators did not do better) and feeders share the responsibility for the lack of supervision and due diligence respectively.

Derivatives were pointed out as being the origin of the crisis: I disagree! Derivatives magnified the crisis but did not originate it. Incompetence and greed are the culprits.
  • Governance
Governance is a word that has been very fashionable with politicians and CEOs of large organisations for the past 10 years or so. Talking is not acting.

Most of the time, boards of directors are not independent and just there to agree to whatever the Chairman/CEO decides (golden parachutes, remuneration out of reality, platinum pensions, no takeover but if there is a fat check attached to it - remember Mannesmann/Vodafone Air Touch in 1999/2000-, etc.) : no questioning please! But why should questions arise when these boards work like a club of friends that distribute directorships regardless of the competence and of course independence whilst getting juicy indemnities...

Shareholders rigths are rarely exercised by individual investors that either do not fill in the proxy forms, or when they are filled, leave it to the board to vote. True, institutional investors are becoming more vocal as well as small groups of militant shareholders; they however are the tree before the forest.

And could carry on discussing about conflicts of interest lying with rating agencies or auditing firms.

To change this culture, it has to come from the top of organisations. What we witnessed is a problem of ethic at the highest level.

Boards of directors have largely failed in their role of control. The independence, accountability and competence of boards is THE prerequisite for governance, ethics and competence again take command of corporations and spread within.

The third part will discuss Regulation and control.