Category: Gersh on Washington

The cornerstone of our financial regulatory system is disclosure. The argument makes some sense: If investors have all the facts they need to make a decision, the government should let them make the decision they feel is in their best interests.

Securities regulations require companies to tell investors about how much the business is making. Managers must also discuss the risks facing the company.

Housing regulations require lenders to disclose key details of a home loan. Borrowers must be given a detailed settlement sheet spelling out fees and terms.

Clearly, there is lots of disclosure out there. The question is, why doesn’t it seem to be working?

Innovation is the great strength of the American financial system. Innovation is the great weakness of the American financial system. There you have the regulatory challenge arising from the Great Unwind playing out on Wall Street.

Financial innovation taken too far got us into this mess. At first it was a good idea to pool together mortgages, slice and dice the income streams and create vast markets of new securitized products. It was an important innovation that built on the traditional mortgage market, a market that was well-understood, with a long history on which to base statistical risk models.

The Tech Bubble, the S&L crisis, the Asian Financial Crisis, the Mexican Peso Crisis, the Russian Debt Default – to all of these debacles, a name has been fixed.

Not so with the mess we are in now. We are clearly in a crisis, but the situation is fluid, the extent unknown, and the terminology in flux. In short, it’s a perfect time to try to define what’s going on and to attach an appropriate name.

The Contestants?

Cataclysmic events most often take their names from the storm that fed the flood. So the front runner here is clearly “the subprime crisis.” It was the unexpected surge in subprime defaults that set off a global wave of write downs and credit jitters. “Fed Shrugged as Subprime Crisis Spread” was the headline over Ed Andrews' piece in the Times on 12/18/2007. Floyd Norris took on the “subprime crisis” and answered his own question in a column dated December 13, 2007 and titled “Can Things Get Worse?”

In the 1950s and 60s, all you needed to know to run a Savings and Loan was 3-6-3. Take in deposits at 3%. Make loans at 6%, and make it to the golf course by 3pm.

Times have changed a bit. Not only are financial institutions more complicated to run, everyday financial life is more complex. In fact, I am beginning to wonder whether it's really possible for an average person to be financially literate nowadays.

Consider the mortgage market. I had heard about LIBOR (London Interbank Offered Rate, for those interested) before the credit crunch hit. I also knew that it was used as a benchmark for setting mortgage rates. (For more on benchmarks, try this link: Bankrate.com - LIBOR and other interst rate indexes.) But I must confess, I never really thought about the implications of having a mortgage tied to LIBOR. I shied away from LIBOR because I didn’t think it made sense to have my mortgage tied to the European economy. It never crossed my mind that credit card rates and student loans might be tied to LIBOR.

The Onion, my favorite source for satire, offered the most trenchant analysis of the presidential race that I’ve seen this year: "Americans Announce They’re Dropping Out of Presidential Race.” The Onion goes on to cite “intense media coverage of seemingly trivial issues” as one reason the public gave up its White House dream.

Just after reading the Onion, I opened an email from the Clinton campaign touting “'Her Most Commanding Performance,' 'Knocked Obama and Edwards Back'” The campaign goes on to cite David Gergen: “Hillary Clinton showed she is passionate about wanting to be President.” NBC Chuck Todd: “This debate was about Clinton effectively fighting back.” The American Propect’s Garance Franke-Ruta chimed in: “Clinton is back in business, and she’s feeling fine.”

On Monday, October 15, 2007, the nation will mark a major milestone when the first baby boomer applies for Social Security benefits. In true boomer fashion, Ms. Kathleen Casey-Kirschling, born 12:00:01 on January 1, 1946, will not wait a moment to get what’s due her. With Social Security officials standing by, she will enter her application online at a news conference.

Ms. Casey-Kirschling will be the first of some 80 million boomers to apply for Social Security, and most will do so early, not waiting until the full retirement age of 66.

While Ms Casey-Kirschling will receive reduced initial benefits at 62, over her lifetime she will get about the same, if not more than she would have gotten had she waited to receive full benefits at her normal retirement age of 66. That is, assuming she lives to be older than 76. Not a bad bet given that seniors today are healthier and living longer than their parents.

On Wall Street, a trader who shades his opinions to bolster his investments is said to be “talking his book.” The “book” refers to the old ledger where traders tracked their inventory of stock positions. The “talking” part is self explanatory. “Somebody who is sitting on a ton of Acme Unlimited Inc. who tells you that Acme Unlimited is going to the moon is talking his book,” emails Lou Crandall, Chief Economist at Wrightson ICAP.

Lou adds that talking your book is “considered more deceptive in a trader (who might just be in and out of the position) than an investor (who ought to believe that Acme is going to the moon.)”

There’s a whiff of the old-style, cigar-chomping floor trader in the phrase “talking his book.” In today’s world of electronic trading and global markets, a more sophisticated way to imply bias is to accuse someone of “arguing his portfolio.”

Early on in my career, I developed the following rule: If someone told me about a story or trend that rested on the proposition that most Americans are doing something stupid, that story or trend was almost certainly wrong.

My experience traveling the country and talking to people about money, markets, and our economy confirms this. Americans are very savvy about the economic forces shaping their lives. After all, money is our true national pastime, and we’re passionate about it.

So it was not that great of a surprise to me to learn that high school students have a fairly firm grasp on the economic fundamentals. The first ever National Assessment of Educational Progress focused on economics found 79% of 12th graders had a basic understanding or better of our market economy.

Most could answer questions like: “How will an increase in real interest rates affect the amount of money that people will borrow?” They understood the trade offs between staying in a job and leaving it to get a better education. And 60% could identify what happens to the federal budget when tax revenues fall and spending rises.

When I was traveling in China a few years back, many people expounded on the sorry state of Chinese corporate governance. Analysts lamented, "You have to understand, most businesses in China are family businesses." This was not considered a good thing. Advancement in Chinese businesses was limited by family connections and family politics. Professional managers need not apply.

Now I realize family businesses are the norm in the United States. Consider Sumner Redstone, the billionaire who controls Viacom. Redstone is engaged in a very public and very messy fight with his daughter Shari, once considered his heir apparent. The Bancroft family, which has controlled Dow Jones and the Wall Street Journal for almost a century, has sold out to Rupert Murdoch's News Corporation, another family-controlled business.

Harvard Business Professor John Davis, who specializes in studying family businesses, tells me that 35% of Fortune 500 companies are family-controlled. Well over half of the 1000 largest business companies are also family-controlled. Lots of people turn out to work for Mom and Dad.

I’m sure you’ve seen many of the same stories I have about call centers in India. They talk about call centers creating new opportunities for Indian women. We hear about young, educated call center workers in India flush with cash, eager to spend, creating a new consumer culture. There are quotes from analysts describing how call centers are powering growth in India’s world-class services sector.

That’s what I had read about call centers; that’s what I had seen on TV. But the reality I found in India was different. “Don’t call us a call center,” said a worried PR rep at a company known as, well, a call center. “We’re a BPO,” admonished another worried corporate media type. BPO is short for Business Process Outsourcing, which includes call center work and also business tasks ranging from processing payroll to customer tech support.

Call centers, I quickly learned, are considered the factories of the developing world’s service economy. They’re home to repetitive, dead-end jobs that offer a decent income by Indian standards, but no chance for advancement and little prestige. Turns out, most Indians don’t like interrupting American families at dinnertime to read a script pushing a new credit card offer.