Monday, October 13, 2008

Karl and Groucho Do Wall Street

It seems ironic that the failure of Marxism has turned in recent days to resemble the, hopefully, temporary failure of free market capitalism. For all the wailing about the impending socialism of effectively nationalizing banks and investment firm with public money if we scratch a bit deeper we find the profession of the free market to be less pure than we ever imagined.

The failure of Marxism was a failure of human character. The mortgage debacle which is at the foundation of the current financial crisis is an agent/principal conflict, a model made for character failure. The risk has been divorced from the risk creator. Even within the investment banks themselves, the complexity of the financial engineering masked risk.

In business transactions there are principals and there are agents. Principals are those who ultimately bear the responsibility as owners for either the loss or the profit. Agents, are like a real estate or stockbroker. Incentivized by the transaction, not the result. Much like the chicken and the pig at breakfast. The chicken is involved, the pig is committed. The current financial collapse was to a large result the result of too many chickens, not enough pigs.

The financial allure of transaction based compensation for so many participants in the real estate bubble created the moral hazard that one's behaviour had no consequence. The mortgage broker needed merely to sign another borrower up and send the mortgage to Countrywide for his commission. The property appraiser needed only to bump up the valuation a little to help grease the skids to move the process along. The easier the valuation, the more business would come from the happy mortgage broker. All along the line, quality was replaced by quantity. Who knew such a simple matter was the seed of such chaos?

An irresponsible freemarket sowed the seed of it's own demise. No is the time for responsible intent to right it again.

John Barnyak