Wednesday 17 September 2008

A Capitalist's view of the crisis

I've invited Nick Drew, who posts some interesting stuff on the rather good right-of-centre business blog Capitalists@Work, to give his take on what is going on...

How bad do you think the current crisis is?

Until recently I would have said much worse than most people think (see my posts for the past 15 months passim) but now I’d say: as bad as can be realistically imagined. Fighting-in-the-streets bad.

As you’ve gathered, I’m not one of those capitalists for whom blind optimism is a moral imperative.

Is it confined to the financial markets or is it affecting the 'real' economy?

Don’t be daft, there’s only one economy. No man is an island …it tolls for thee !

What impact do you think the crisis will have on a) financial regulation b) financial innovation?

I hope that financial regulators will take an unbendingly rigorous interpretation of their existing mandates. Had they done this over the last 10 years we would not be where we are now. It is politicians who set the climate on these things and regulators have been told to lay off. Brown (for example) is highly and personally culpable in this regard - an absolute outrage (I shall be posting on this soon).

Nothing inexplicable has happened. Due to these ‘light-touch’ and non-interventionist interpretations of the mandate, basic risk-management and risk-measurement precepts have not been followed: so financial institutions have been allowed to get away with being grossly under-capitalised. Oldest story in the world. Capital adequacy is the key (followed closely by diversification).

You can’t stop innovation. Like atomic physics, the genie is out of the bottle – people (some people !) understand how to think about finance more clearly than ever before. They will go to their graves thinking the same ideas, wherever and whenever application of them is possible.

Is the private equity boom over or just taking a breather? Was it just debt driven?

PE means many things – the first big PE funds were just divisions of investment banks and we may not be hearing much from them for a while. Some PE’s have done clever, potentially enduring things and will be around to keep playing the game. Others have just pissed their clients’ money up the wall. It was – or became – debt-driven, but then again, so did almost all investment when borrowing was so ridiculously cheap ! Even Sovereign Wealth has become accustomed to leverage.

Quite a few serious commentators have said pay in the financial sector has been part of the problem. Is this right, and if so what can be done about it?

Absolutely. Dysfunctional bonus schemes are a cancer. Because so few people bother to learn in detail what’s going on (see your final question), for those who see clearly it’s been like taking candy from a blind child. A couple of horrible similes there, and I meant them that way.

Ideally, shareholders (see below) in their own interests would carefully structure schemes that served the company’s long-term interest – it’s not difficult! As a back-stop, as I said the other day, I like the idea of the comp scheme being an input to capital adequacy calculations – that would get attention, believe me.

Is shorting a problem or not?

Intellectually, no – indeed, in theory it’s a vital mechanism (it was shorting that revealed Enron for the house of cards it had become). However, in (current) practice, it has proved too easy to play market-manipulating games using short strategies – tricks that if done on the long side would be illegal.

Clever players will generally find ways to short things. So it’s best that it is made available to all investors, put on a transparent footing, and manipulative practices clamped down on hard (back to regulation again).

Shareholder groups appear noticeable by their absence from the debates about pay, shorting etc. Does it matter, and any thoughts on why that might be?

Of course it matters: as you have endlessly and correctly pointed out yourself, it undermines what ought to be a key plank in the economic theory of the corporation.

But you can take a horse to water … let’s face it, voters in political systems don’t exactly pull their weight ! - but there should be some structural improvements made. One would be to resolve the conflict of interest where non-execs cheerfully propose crazy comp schemes because back at their own ranch they know they’ll be getting just such a scheme from their own non-execs in turn. Institutional shareholders often have parallel conflicts (as well as useless performance criteria, see Taleb passim).

Lemme tell you that in privately-held companies, shareholders don’t laze around scratching themselves. In public co’s we need the concept of the Hero Activist Institutional Shareholder - a concept that is basically lacking. He’s the one I want managing my pension-fund.

A financial crisis ought to provide opportunities for the Left to advance a critique of free market capitalism. Where do us lefties get it wrong, and do you think we have a role to play?

It should indeed be that opportunity. Lefties are fundamentally disadvantaged because (a) you are all so hooked on big, sluggish World-View ideologies with ethical pretensions (apparently it’s actually virtuous to believe the crap you people catechise so painstakingly), whereas we are empiricists, and nippy with it; (b) the world rumbled this 20 years ago and now everyone ignores you; (c) lots of you (present company excepted !) are idle buggers and some of this stuff needs heavy-duty thinking, hard sums, and hands-on, real-world working experience in finance.

Result: it’s like a bunch of medieval schoolmen trying to understand string theory using Aristotle. Of course no-one listens.

But of course you have a role to play ! Contrarian viewpoints are the stuff of capitalism. Let’s have a bit of compelling anti-thesis - get stuck in, guys !

Closing anecdote: a very dear uncle of mine, a lefty cleric, towards the end of his life said that if he had one regret it was that for 60 years he skipped the financial pages, and only then realised that they are the important ones.


Unknown said...

Good stuff Tommo, good questions, straight answers!
The scarlet pimpernell

Tom Powdrill said...

cheers. Nick is quite a smart chap, innit.

Nick Drew said...


actually, ahem, I made a small error (*blushes again*): for Sovereign Debt, read Sovereign Wealth

Tom Powdrill said...

no probs, I've given it the Trotsky treatment!

Nick Drew said...

thanks, Joe !

BTW I noticed the Grauniad's leader today also used the Donne quote .. you don't think ... ?!

Tom Powdrill said...

You never know. I'm 95% certain a columnist for The Scotsman ripped off something I wrote on here about executive pay. It used the same arguments and quoted the same book I did!

Nick Drew said...

as you say, one never knows

I did a humorous series of posts (well, I thought so anyway) a year ago and bloody Tim Dowling of the Graun used something remarkably similar a day or so later