From Patrick Giagnocavo: http://billburnham.blogs.com/burnhamsbeat/2008/07/fannie-maes-gol.html
This is a explanation of the Fannie Mae debacle that makes sense. It is very similar to the recent posting here in this blog: what happens when you pick a number for management bonuses and then let management work that number.
The Burnham article does not dwell on the role of management bonuses too much, only says that the managers were trying to increase book profit. Fannie Mae has had well-publicized problems in the past ten years stemming from accounting fraud. These led to substantial restatements of earnings. (reference) The incentive to engage in fraud was higher pay for managers (reference).
This maybe true, however the problems for Fannie stem from the manner in which they are structured. Since they dominate, along with Freddie, the secondary securitization market, all by design, the entire mortgage industry is dependent on them. In other words, they can’t fail and that is by design of the government which created them. Since they can’t fail, they take on more risk. The fact that they shot for a certain earning number with reckless abandon is entirely due to the fact that the government made them that way. Here is how I explained it…
http://theeprovocateur.blogspot.com/2008/07/fannie-maefreddie-mac-socialistic.html
Nice piece, Patrick!
Once again, I say that if your company requires a federal bailout because it was poorly run, blacklist the bastards! None of the Bearns Stearns people should ever be allowed to work in finance again. They had their chance, and they chose to take the money and run. Fine, but we won’t let you do it again. After all, the SEC won’t let convicted felons work as brokers–is it that much of a stretch to blacklist others too?
I’m not sure where you’d draw the line–probably don’t want to blacklist secrataries, but certainly the traders and management go on the list. Anything less is just encouraging more moral hazard in my opinion.
It’s frustrating because it seems as though the feedback loop is broken–run a company into the ground, take the golden parachute, and wait for the next big offer.
I think it’s always tempting to look at incentives, say they reward bad behavior, and then focus thereafter on the incentives as the problem. But aren’t there ALWAYS incentives for bad behavior? Isn’t that the whole point of cheating, because if it works it pays off?
These days everybody seems to get on about moral hazards, as if the only thing keeping us from turning into complete savages and pillaging our neighbors, is that we are otherwised properly “incentivized” to not do so. It’s a conceit of economists, I think, who hate the idea that there are aspects of a good society that might not make sense outside of an equation.
The problem here is pretty simple, even if the finances aren’t: some bad people did some bad things. There are ways to fight that, but not ways to guarantee it never happens. There is no system in the world that will eliminate every reward for bad behavior. The FNM managers broke laws and violated their fiduciary responsibility, but we’re to believe that the real problem was the moral hazard of their implicit government backing? The world is rife with moral hazard: we are almost never held accountable for our actions, and most of us work in situations where we are on the hook for very little of what is at stake. What keeps people from taking all manner of advantage of the myriad safety nets in our world (the GSEs are just an extreme example) is something that is not at all fashionable to discuss: morality. Not the religious pious type, but the social-minded morality that compells one to do the “right thing” even if we haven’t been direcly incentivized to do so by some board of managers. And until people start talking about that, and exerting social pressure, I’m afraid things will only get worse. Because cheating really does work out quite well for the individual who does the cheating.
These crooks should be detested as pariahs, not seen as the inevitable victims of a poorly designed reward system.
– This insuring of debt actually works for all large banks – so maybe they should all be rated like treasuries. Would Citi or Wachovia be allowed to default? No the US gov’t would step in. That is clear after Bear Stearns.
– There has always been a strange relationship between the US gov’t and these banks. Check out a historical list of board members.