Lessons Learned?

Government officials are now signaling that the economy has stopped its decline and recovery is just around the corner. The critical question before the house is whether we will learn anything from the economy’s steep decline and will we take action to prevent or minimize the chances of its return.

First we must recognize that those who point to the “housing bubble” as the culprit, are pointing at the wrong target. We should expect bubbles like this will reoccur regularly as the normal actions of the free market work. It is normal to over build houses in times of growth (read optimism). This tendency is fueled by greed (profit motive) and frankly the inability to know when is too much. The natural cure, of course, is to stop building houses (directly following the consumer’s decision to stop buying them). Given a little time, supply versus demand will come back into balance and house building will resume.

Second, we should look more carefully at the near collapse of the investment and banking industry’s to find the real roots of the economy’s sickness. Consider that in 1997, the financial services sector produced the highest amount of earnings of all the business sectors in the US.    Since banks and investment firms do not inherently create any value, how was it possible? The flip side of the banks/investment firms’ earnings is that other business that actually create something were less attractive to investors than banks and investment firms.

There are two lessons staring everyone in the eyes.

• The self management and governance functions of most large banks and investment firms (and some insurance companies) was broken and did not function as designed. The steady creation of new investment vehicles fueled a race amongst firms to earn the most and therefore attack more demand for their stock. This enabled top executives to earn unconscionable remunerations and at the same time allow their companies to go bankrupt or very close to it.
• The question of how America is to once again create value has been laid before us. Fast food, certificates of deposit, and real estate exchange are not avenues that create value regardless of how we might appreciate these services. We must find new industries such as solar energy, biosynthesis, and light weight, long life batteries as well as bringing back historic industries such as machine tools, furniture, and textiles.

Lastly, the lesson of size is sitting out there waiting to be assessed. Did the size of these banking, insurance, and investment firms play an adverse role in the collapse? While it seems a tenet of capitalism and free markets that companies should be allowed to grow and acquire as their means allow, I think we would do well to look at whether there is a practical size above which the necessary governance capability is either missing or too expensive. Banking, investment, and insurance seem to me three businesses that do not belong together in any combination and like Citigroup, when combined are a disaster waiting to happen.

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Tags: banking, business, economic crisis, economic recovery, free markets, insurance industry, investment firms

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