Business Culture & CDOs/MBS’s in the Financial Crisis

I’m feeling rather enlightened so here we go.

A lot of people today lament businesses or corporate culture and view managers as ruthless, only caring about profit and numbers etc.  This view can (sometimes) be justified in my opinion, at least in certain countries.  While profit obviously does matter, it seems that most larger corporations repeatedly are attempting to shed social responsibility that they have (had) to society in general and/or their employees.
The question then is, why?

The maximization of shareholder value is the central purpose of the advice that financial advisory firms or financial intermediaries give to equity investors, and is therefore the ultimate task of the financial institutions that provide advice to investment clients. This finality effectively makes shareholder value one of the core products of the financial institutions. Clearly, it was only a small step from this finality of shareholder value in the investment advisory business to the finality of shareholder value as the ultimate purpose of every firm. Shareholder value became so central to corporate governance partly because it filtered through from the financial advice sector, of which it is properly the purpose, into industrial firms.

 

The producing divisions of the firm become the object of its own holding firm and of its financial investments, which view the firm’s producing divisions primarily as a financial investment. One example of this tendency, until 2009, was the firm Porsche, the management of which showed ever-increasing signs of understanding its role as that of managing a financial holding company which had invested in a production firm.

 

Many industrial firms underwent this transformation into firms with a financial holding company, and in the process, the firm’s normal logic of means and ends was turned on its head: the “end” of production became a “means” of maximizing the financial “end” pursued by the holding company.

In my opinion that sums it up.  Too much focus on immediate shareholder ‘value’ creation.  There needs to be a refocusing on the company’s long-term health (not its quarterly results) and trying to make sure that all employees are reasonably well cared for.  An employee generates value(or at least that’s the idea).

When you have crops in a field, you water them.  You do not starve them of as much water as you possibly can before they die.  Why?  Because the total crop yield will then often be smaller and weaker.  Larger margins are not something to be emphasized if your firm is already profitable.  Making sure your employees are well taken care of, is.
I want to be clear I am not advocating ‘pay-increase for everybody!!” if margins are large.  What I am saying, is that employee’s well-being needs to be a focused target of the firm.  If an employee is generating a certain value for a company but is receiving about 10% of the value created in their yearly pay, and the employee is not able to afford a repair on his car because he/she is paid too little, there is a serious problem in respect to focus on employee well-being.  Yes there’s always the argument, “well he/she isn’t responsible with their money so that’s why they can’t afford it!”  Perhaps this is true.  But when they are receiving a very low (yes; 10% is low) compensation relative to the total value they generate, the idea that they don’t spend their money ‘responsibly’ is not a relevant argument.

The purpose of the firm is the production of optimal goods under the condition that the goals of paying appropriate wages, appropriate dividends, and appropriate prices to suppliers are fulfilled at the same time as the purpose of producing optimal goods.

Of course if employees are well-cared for, going for larger profit margins is naturally not a bad thing.  It’s just that larger margins shouldn’t come at the expense of people(employees) which is supposed to be what generates value in the first place.
The caveat though to all of this is negative margins, which I do believe justifies either a general reduction in employee benefits/salary (including top-level management’s salary/benefits) or a reduction in total employees if certain positions  are providing no value.

 

Onto the financial crisis, Mortgage Backed Securities and that whole mess.   I’ll keep it short with a small quote concerning one of the largest contributions towards the creation of the whole crisis; it shouldn’t be something which comes as a surprise to anyone who has just a little bit of sub-surface knowledge of the crisis.

The (hybrid/synthetic) CDO creates incentives for its originator to pay more attention to the volume than to the quality of loans. The market for securitized loans suffers from the structural flaw that it prioritizes loan volumes over loan quality, and therefore neglects debtor monitoring.

 

Sourced from: Peter Koslowski (VU University Amsterdam) – The Ethics of Banking Conclusions from the Financial Crisis

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.