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Paul R. Portney

Paul R. Portney

Paul R. Portney is Dean of the Eller College of Management at the University of Arizona, where he also holds the Halle Chair in Leadership.

The Answer Lies in Washington

It's true that the financial crisis was rooted in part by unethical behavior on the part of Wall Street's leaders. When someone creates and/or sells a financial instrument--whether a mortgage-backed security or anything else--that he knows is destined to fail simply because the eventual problem won't be his to deal with, something's wrong.

Nevertheless, we will not avoid such problems in the future by naively expecting Wall Street (or anyone else, for that matter) to simply hire more "ethically evolved" people. One ex-Lehman trader was quoted in the New York Times this past weekend as having said you cannot expect people at one firm to avoid selling financial products that their counterparts at other firms are profiting handsomely from selling. He's right.

The answer lies not on Wall Street but rather at the intersection of Pennsylvania Avenue and North Capitol Streets. Congress must strengthen our financial regulatory system so that someone is looking out for "systemic risk," so that those deemed too big to fail are not allowed to take the same chances as those whose failures will be accepted, and so that those who rake in big bonuses in good times will see them clawed back if they turn out to have been premised on a house of cards.

The perhaps uncomfortable truth is that most of us respond to the incentives we face, financial and otherwise. Wall Streeters may focus especially sharply on the paychecks they receive, but if we want them to behave differently, we have to see to it that those paychecks depend in part on behavior that is good for all of us, not just for them.

By Paul R. Portney

 |  September 14, 2009; 12:43 PM ET
Category:  Economic crisis Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati  
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I don't trust Wall Street anymore and I probably never will again. I have pulled all of my assets out of stocks and now focus on making equity investments directly into companies where I actually know the individuals who are running the operation. It's not fool-proof, but at least I know that our interests are aligned and that there is not an incentive to work against my best interests. If the investment fails, I will not feel the same kind of anger that I felt toward the individuals who mismanaged my money and took me for granted. I hope this type of direct equity investment model becomes the norm and Wall Street eventually because irrelevant.

Posted by: CNY-DC | September 15, 2009 9:32 AM
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Parcons observes and asserts:

"No company should be to big to fail. Not an industrial company, not any so called big bank or giant department store chain."

This is called "moral hazard". The problem is that there is a crucial difference between a big bank and your other examples: the bank is a key part of the entire economic systems way of managing and creating the money supply. So when the bank fails, the whole nation's money supply suffers.

That is why, once upon a time, government reached a deal with the banks: government would protect them from an unreasonably high risk of failure due to competition with Regulation K, and the banks would refrain from risky behavior. But this agreement broke down under President Reagan with his 'deregulation'.

Now we see the real ugly results of that breakdown.

Posted by: Syllogizer | September 15, 2009 5:34 AM
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No company should be to big to fail. Not an industrial company, not any so called big bank or giant department store chain. Those companies that take chances or are poorly managed should be allowed to fail. If that is too difficult to understand then break up the banks into more manageable size so that such a large deposit base is not concentrated in so few big banks. The same with department store chains. Look at Macy's, they are regionalizing their stores to account for local preferences. Big is OK , gigantic is not so good.

Posted by: Parcons | September 14, 2009 9:40 PM
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In many of these comments, I see a dangerous fallacy being repeated over and over. That fallacy is that we HAD a "free market system" or a "laissez-faire system" during the period that lead up to the collapse.

This assumption is not accurate.

Rather, as any good, relatively up-to-date economics text will point out, pure laissez-faire systems have never lasted for very long, all economic systems are MIXED economic systems. Even the old Soviet Union, though officially and predominantly a planned economy, had markets run mainly on free market principles, namely the kolkhoz and the local 'rynok'. And don't forget the black market;)

So the cause of the collapse CANNOT be "the free market" or "laissez-faire".

After all, even in a laissez-faire system, the government still participates in the market by enforcing property rights and contract law.

But aha! Neither of these was properly regulated or enforced during the period leading up to the collapse! How, for example, can we fool ourselves into believing that contract law was enforced, when both credit card companies and real estate lenders got away with such outrageous contracts all these years?

In fact, our governments failure to do even the laissez-faire duties of government was so bad, I suspect we would have been better off if we had really HAD a laissez-faire system!

The fact of the matter should be crystal clear: government needs to do at LEAST as much as the duties of government under a laissez-faire system; there are good reasons to think it must do more, since the laissez-faire duties do too little to protect the individual from the power of the corporation. Rather, the laissez-faire list of duties assume that the market will do this, an assumption that history has NOT borne out (tace libertarians).

Posted by: Syllogizer | September 14, 2009 9:01 PM
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Portney rightly observes:

Congress must strengthen our financial regulatory system so that someone is looking out for "systemic risk," so that those deemed too big to fail are not allowed to take the same chances as those whose failures will be accepted,

We had a regulation that accomplished much of that: it was called, if I recall correctly, "Regulation K".

So the real question is: why did we jettison this protection -- imperfect though it was? I see no answer to that in Portney's article.

Clearly though, the answer must have much to do with the irresponsible fad for 'deregulation' that swept the nation starting with President Reagan.

Posted by: Syllogizer | September 14, 2009 8:46 PM
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Capitalism, like all the "-isms", simply can't work in the real world.

Without a lot of propping up from a powerful arbiter (here, the US government), the artificial conditions that permit the underlying mechanisms of the free market to work vanish. This has historically been true, and for blindingly obvious reasons. All the folderol about "enlightened self-interest" can be dispensed with - because what works best in a free-market system is simply self-interest.

This is, of course, the same self-interest that is the engine behind oligarchies and "competator" collusions. It's also the engine behind shareholders squeezing companies dry for short-term gains, and companies so focused on meeting shareholder desires that they implode, taking their employees and clients/customers down with them.

I have never really understood the absolutist "laissez-faire" side of things. The ridiculous idea that by eliminating the very things that prop up true free market systems will allow them to run more efficiency has never worked. The more serious the consequences of a particular subsystem's collapse, the more carefully it needs to be monitored; inefficiency is a reasonable "insurance cost" to pay.

Posted by: iamweaver | September 14, 2009 7:30 PM
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One of the major reasons for the economic crises (which is really a crisis of liquidity) is that so many of the so-called financial products (a term which I consider an oxymoron), are unregulated. Consider such "financial products" as Special Investment Vehicles, which are really an accounting scam that allowed financial institutions to hide their toxic assets so that they wouldn't pollute their uunjustifiably optomistic asset balances.

Regulation needs to be re-established so that banks really behave like banks used to. In the good old days, banks were responsible for their own assets and liabilities, and as a result, were conservative in considering risk.

When whiz kid "quants" in financial institution can slice and dice tranches of questionable CDOs and then pass them off to other investors, much like playing the card game "Old Maid", there is no incentive to limit risk.

As Mr. Portney states, do not count on "Wall Street" policing its actions, much less exercise moral responsibility.

Posted by: MillPond2 | September 14, 2009 5:48 PM
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Quite right! If there is one thing that we have learned from the deregulation of the financial world/market is that you cannot trust people to look out for others' "best interests". Free markets do not work. You need to have some rules, to achieve a fair playing field be it among competitors or consumers.

The only tragedy, is that the little guy that was royally screwed by these irresponsible, selfish, and greedy CEOs, lenders, advisors, et al. are still paying the price for these individuals carelessness, while those who committed the crime are bailed out-- and are now getting even richer.

Posted by: jromaniello | September 14, 2009 4:10 PM
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