Other People’s Money 3 – The Credit Crisis

The real point of this thread is to discuss how, at the heart of the current economic crisis, is our habituation to other people’s money.

What is credit, of course, but other people’s money? Would you really buy the 52-inch flatscreen and the Quatrroporte with your own money? Sure, first  Hyundai, and now GM, are offering to take some of the risk out of buying a new car. But what was the choice to finance these items to begin with, but a way of sharing the risk of the purchase with a bank or finance company? If you knew for certain that you could afford it, shouldn’t you have just bought it?

That’s the crux of the banking and credit crisis as well. Incentives and rewards for top executives at financial service firms have not aligned with the long-term institutional interests of those firms for decades now, undercutting the very philosophical basis of arguments in favor of outsize executive compensation. Alan Greenspan, as we all now know, was “shocked”:

As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.

Really, dude? You didn’t see this one coming? That the executive overlords in the too-big-to-fail tranche weren’t accountable to anyone but their great-grandchildren? That on the basis of some Ayn Rand-ian fantasy you set a bunch of free radicals loose with trillions of other people’s money and somehow, by the laws of the universe — under some universal law of the origins of specie — it was all gonna’ work out for the best?

At least in the days when financial institutions were held, either by law or by custom, to some size where they couldn’t single-handedly risk trillions of dollars, they were accountable to each other. They’d have to build syndicates, and Bear Stearns wasn’t going to let Salomon Brothers drag them into a deal that smelled. No one on Wall Street wants to change someone else’s diapers.

Likewise the Clintonian and beyond “Fair Isaac Deal” that’s been foisted on the American middle class: In the end, American workers really didn’t need better credit scores, although their entire financial lives were overdetermined by this calculation; what they needed were better wages and a health care system that properly insures against financial calamity in the face of long-term or catastrophic illness. But we too fell sway to the lure of other people’s money.

So, in the coming months, as we slowly unwind this horrible mess, let’s look to these benchmarks:

  • Financial firms need to get smaller, not larger. They need the participation and countervailing force of multiple-firm involvement in deals large enough to threaten, or that might even remotely threaten, the overall stability of financial and credit markets.
  • We need more shareholder reform and activism. Executives at financial firms need to be held to account, every day, for how they handle the corporate assets with which they have been entrusted. This very much includes how much they pay themselves and each other.

Lastly, let’s all wean ourselves off our habt of living off other people’s money. Start a savings account. Pay with cash. You’ll be a better person for it.

P.S., while I’m on a rant, why does this guy (see video) have to be a cyclist? Just as the cycling community started to recover from the negative impressions created by John Kerry?

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