Stephen H Baum Leadership

If you think the EPA has had a strong hand in the private sector, wait until you experience the IPA: the Investor Protection Agency — sword and shield for the small investor, non-creditworthy mortgagee and others seen as fleecees. With jurisdiction akin to the Consumer Product Safety folks and the FDA, IPA certification that products are safe and effective will be required to sell derivatives. 

Why is this no longer unthinkable?

The sub-prime mess is “deja vue all over again.” And in this round, the rating agencies failed to identify the risks, the bankers relied on the rating agencies and apparently did little due diligence and risk management themselves and a lot of people are getting hurt. 

One of my expert money managers has low expectations of the rating agencies, given what he sees as the level of expertise in the ranks of their staffs. Another of my experts sees the incentives for the bankers too powerful to expect equal attention of risk-taking and risk-mitigation. That is why some banks’ losses are a bigger piece of their net worth than a prudent investor would have put at risk. 

And when the bank sells me a product and charges an up front fee which inflates their profits now, when their and my  reserves against failure are small relative to what is at risk, and the crash on them and me comes later, well that is a prescription for disaster. Derivatives have become so complex that large banks taking large risks violate Warren Buffet’s first rule of investing: invest only in what you understand. And when the unsophisticated investor (especially in real estate related transactions) do not understand either the product or the risk, caveat emptor is not  sufficient.  

So, can the companies do the job themselves? Can the industry clean up itself? Or is this the auditing profession case before Enron, Andersen and Sarbanes Oxley? 

This sort of government intervention in capital markets usually has consequences other than those intended. To avoid it, we will need to see “Signal Acts:” institutional and industry solutions outside the comfort zone of those in senior management today.