Mismanagement

"It's not the lack of money that kills our economy, it's the mismanagement of it." - TJ Anderson

In a follow on to the previous two blogs I had a very interesting infusion of thought from some of my readers and one in particular caught my attention.  The discussion was in terms of the size of companies and governments and how this impacts not only returns and ultimately causes the failure of the institution.  The question was is it really the size or is it mismanagement of the assets and in all honesty I believe that one is a factor of the other.  The larger the business or government becomes the larger the influence of political posturing and by default the larger the mismanagement of the assets.  There is less concern over shareholders or tax payers and more and more concern over personal payments and power, which ultimately leads to the company's or government's demise.

As an example investment and large banking institutions are so big that they are perceived as too big to fail.  This brings into account morale hazard - the hazard associated with the management's lack of accountability.  Should the bank fail then there is no impact to the management team other than a loss of their reputation and potentially their jobs (although in modern times it seems that losing the job is the best financial decision as there is usually a multi-million dollar payout to fire the person), but until then taking inordinate risks in order to maximize profits and their pay checks is the norm.  This bubble is protected by the central bankers of the world as they step in to sort out the problem should they cause an economic shock wave.  They are essentially playing with tax payer money so their personal risk is limited to the job loss while their upside is almost unlimited.  In this kind of environment the main focus is on developing new products that will maximize returns without a concern for the risks imposed.

The authorities are expected to monitor these risks and impose laws to regulate these enterprises but they are always behind the market for the simple reason that they cannot keep up with the new financial developments and derivatives that are dreamed up daily by the wizards of the financial markets.  While in the Bible the 12 apostles may have been enough to spread the word, there is no way that the 12 Federal Reserve Districts can keep ahead of the army of international bankers that test the limits and find holes in the system daily.  Furthermore, regulations take time to be implemented and by the time these are in place the market normally has moved on having anticipated the crack down.

The side effect is small business.  These companies have to operate under intense scrutiny, they do not have the resources to comply with all the new regulations that are supposed to keep large institutions under control but cripple their ability to operate, have limited access to investment dollars and are required to repay every dollar borrowed (unlike governments and large banks who just print more).  For this reason they are masters at working on a shoe string budget and remain lean and efficient.  Money lent to these companies is relatively risk free for the simple reason that the loan requirement is so small that if one business is lost the impact on the bank is small.  As Donald Trump explained once that if you borrow $1 million then the bank owns you, but if you borrow $1 billion then you own the bank.  Much the same with small business, while it is perceived that the risk to investing in them is high (and it is as many do not make it to year two, largely due to a lack of funding) the overall risk to the economy is low due to their small size.

The current system is therefore flawed in that not only is size the problem but there is no accountability for the actions of the large institutions.  One way to solve this problem would be to adjust the method of pay.  Instead of receiving a massive payment at the end of a good year it could be withheld for 5 or 10 years.  If during this time period the bank ran into financial problems caused by the risk taking at the time of the bonus award the deferred payment would be used to offset the losses.  In this way management might think twice about a risky bet to make a quick buck and may rather look out for the longstanding of the bank and its shareholders, not to mention the lowly tax payer!