Sounds Boring - but it's not
I know what people who read this title think (LegerdeWHAAAT???). This is going to be another story of the financial system and how corrupt it is. It is going to be boring. Corruption, yes; boring, no - and here's why:
I stumbled across this post by Omer Rosen. This, in a nutshell, explains how banks were cheating clients on something called treasury-rate locks. Now, I am not going to go into how all this works (Omer explains it so much better than I ever could), but I wanted to give folks my reaction to this (please read the post before continuing).
This was something corporate wizards bought into! This was hedge fund managers and the people running retirement accounts buying these investments! The banks were duping the financial services industry! How could any normal person stand a chance against them?!?! This thought process lead me to another one: what happened to the days when companies bought their customer's loyalty - giving up short-term gains for a lifetime of profits? Are there any of those companies still around (and no - I am not going to tell you a list of companies that are good)? How can we get those days back?
Wizards and dried up wells
Well, let's start with the problem. From my understanding of the situation*, in the 1990's, incentive structures really began to get more and more huge. Incentives that were designed to cause top-level management to do what is in the best interest of the company (stock-options, profit sharing, etc.) ended up making management only do what was good for the company short-term (cooking books to inflate shares, taking on long-term high risks for short-term high profits, etc). This, at least for the short-term, made the company look ridiculously profitable, and made the shareholders and the executives very rich. It also made for some serious problems later on. Execs were coming up with all kinds of schemes to make the company barrels of short-term money. From shifting losses around to other departments (or even companies), giving out insanely risky loans, or insuring things that should never be insured (gambling and those insanely risky loans are just two examples), corporations were doing everything they could to grab as much money as they could while it was still out there to grab. Eventually, though, everyone on the inside of this knew the well had to dry up. Then September of 2008 hit.
In that month, all the credit markets froze. What that means is, the well dried up. There were massive withdrawals from money market mutual funds (from which most credit flows), and loan defaults were at an all-time high. Everything financial was put to a halt, and the banks went into panic mode. All the money grabbing was done. There was a massive reset hit, and billions of dollars vanished in the blink of an eye. Obviously there were other factors to this that I will probably discuss in a later post.
You would think that kind of thing would cause corporations to realize their mistakes, adjust their incentive plans, and start doing business differently. You would think. But that doesn't seem to be the case. So, companies are back at business as usual. Which brings me back around to the original intent of the post: to explore and understand why companies don't value customers and ignore long-term profit potentials. They do it because their executives get paid better when they do it. So, how do we fix this?
Education, education, and change
Again, I am not an expert at any of this. This blog has many topics that have been and have yet to be covered, and I am no where near smart enough (nor do I have the time) to be able to become an expert on all of them. But, here, again, are some of my thoughts and possible suggestions on this:
1. Education - I know, I already covered this subject, right? Well, I mean we need to educate shareholders and owners and boards of executives on how to properly structure incentives to achieve long-term goals. We need to make sure that well-planned, long-term incentives are part of every corporate game-plan to make a fortune - over a long period of time.
2. Education - Wait, what?!?! You just said that! This time, we need to educate the public on the math principles behind financial markets, and then how to apply those principles to new situations. Us, at the lowest levels, could have stopped what was happening if we had understood the principles behind it and said, "I'm not going to buy". The banks didn't hide how they calculated all of this, they just didn't say that it wasn't an ethical way to calculate these things.
3. Accountability - We need to start holding corporations accountable when they do under-handed stuff like this. This, for me, is just like stealing. You would arrest me and throw me in jail if I just came in and took money out of your vault, so why should we let you get away with taking money out of our pockets?
4. Incentives other than money - This is a society change that I never really liked. We have moved away from doing things because they are the right thing to do and because they need to get done. We now do things because they make us a lot of money and because they "feel good" (Those things usually cost a lot of money). People need to realize there are other things than money that we should be worried about. It used to be your banker was a trusted advisor, a friend, and a pillar of the local community. They would work hand-in-hand with you to make your money work as hard for you as possible. They focused on your long-term goals. They took care of you, and you had no problem paying them for that. On the big picture side of things, job creation, the country's stability, and infrastructure improvement should all be incentives to corporations as well.
5. People - We need to have the courage to stand up and say there is something wrong when we see something wrong. We need to be able to tell corporations that act this way that we won't give them our money. Until that happens, I don't foresee any changes to the current system. I think businesses will always follow the money (even if it is just short-term).
When we decide to work together, build businesses that don't act like this, educate our people, and take a stand; we could make great things happen. I hope that someday that will be possible. Keep reading, folks, and I look forward to hearing from you soon. Thanks.
*For those that want more reading, check here, here, and here (these are very lengthy and very technical posts).
