Brain Drain

In response to questions asking about how a particular firm was able lose lots of money on any given trade, I always responded using an analogy related to baseball or the original six team NHL. Because we have inserted an image of the greatest player who ever lived, YAZ, let's use baseball in hopes that what I have been saying about the financial sector's lack of comprehension of risk might actually make more sense. BTW, this intelligence void exists in all sectors of our society at the moment ... it's just a bit more obvious in Wall Street.

So, Yaz was the last triple crown winner in baseball, 1967 the year of the "Impossible Dream" when the Sox dropped the World Series to St. Louis. The sports analogy is relevant because, the pool from which players are selected, consists of a very small sample of really talented people. As an example, a pitcher with an ERA of 4.5 is considered an ace today but 50 years ago, he would have been lucky to get three of four starts per season. Today's player earns several million dollars and not much, on a relative basis, is expected of him. Just as a greater number of teams playing today has diluted the available talent pool, so has the IQ of Wall Street dropped as the firms grew in size. That is, there is a finite number of people that have the ability to really understand the risk inherent in structured securities such as CMO's and CDS' - maybe ten people. Unfortunately, given the vastness of the the market and its complexity during the boom years, in order to execute it safely, about 200 competent risk managers were needed.

Just as the one-eyed man is king in the land of the blind and just as an average hitter can bat over 300 when pitching sucks, Wall Street will listen to inexperienced very average people lacking a fundamental understanding of risk. Team owners ask, what fills the seats? Home runs. Wall Street owners ask, what fills the coffers? High risk securities.

When we don't expect much, we get what we expect ... average.

Average people who like to take risk do more stupid things with worse consequences because they lack a fundamental understanding of the result of their actions. Remove well crafted regulations, like Glass Steagall, and well-intentioned people who do not understand risk set the stage for disaster.

I'm rambling, but you get the point. As long as we are governed by average people who really don't grasp what can go wrong, or right, things are not going to improve.

And, unemployment is not going to improve and deficits are not going to go away because the entire public sector suffers from bloat. The bureaucracy exists to perpetuate itself and is not about to commit suicide.

Here's a Really Swell Idea

LOOK! Up in the sky ... it's a new agency that will provide early warnings about the health of Wall Street firms by analyzing their balance sheets and other stuff that they provide to the SEC. BY the way, did these firms actually have all of the swaps and underlying on their books? I wonder if they will in the future? Golly, I really feel safe with the US Congress calling the shots.

What do you think?

Senators Endorse New Financial Analysis Agency

WASHINGTON — Senate Banking Committee members from both parties said Wednes- day they had agreed to include in their regulatory overhaul bill a new Office of Research and Analysis that would provide ear- ly warnings of possible systemic meltdowns.
The proposed agency, which has sometimes been referred to as the National Institute of Fi- nance, is intended to give regula- tors daily updates on the stability of individual firms as well as that of their trading partners, includ- ing hedge funds.
The agency would give regulators a broader view of the health of participants in the financial markets and the potential for problems to spread. The idea’s supporters say that kind of in- formation was lacking in recent years as the housing bubble burst and troubles spread from firm to firm.
The new agency would have no policy responsibilities but would instead collect and analyze data, building models to assess rela- tive risk levels and predict how one firm’s problems might affect others.
As proposed, the agency would be housed in the Treasury Depart- ment with a director, appointed by the president and confirmed by the Senate, who would be an ex-officio member of a systemic risk council that would be cre- ated by the bill. It would draw its budget from assessments on the largest financial firms, according
to people who are close to the ne- gotiations but who were not au- thorized to speak publicly.
The financial reform bill ap- proved last year by the House would create a systemic risk council that would collect simi- lar data without establishing an independent agency to do so, a difference that will have to be re- solved before a bill is sent to the president.
“One of the problems we ob- served in the recent crisis is that nobody knew who had what,” said Sen. Jack Reed, D-R.I., who last month introduced a separate bill to establish a National Insti- tute of Finance. “The result was a cascading effect of uncertainty and doubt.” NY Times

It begs the question, if a decent analyst can earn five times as much in the Street, why would she work for some agency that is only providing window dressing?