Wednesday, November 2, 2011

It takes disclosure to hold bankers' worst instincts in check

In his Bloomberg column, William Cohan laments that our financial system is not set up to hold individuals like Jon Corzine in check so that they do not recklessly bet their firms.

Mr. Cohan, since before the financial crisis began on August 9, 2007, I have been saying that the only way to stop this behavior is disclosure.  Detailed disclosure.  Disclosure that is updated every day.

Regular readers know that it is only with this disclosure that market participants have the information necessary to assess the risk of the firm.  It is only with this risk assessment that investors can accurately adjust both the amount and pricing of their exposure to the firm.

As a firm's risk increases so does its cost of funds.  As a result, with net income essentially flat, the stock price of the firm gets hammered as future earnings need to be discounted at a higher rate to reflect the increased riskiness of the firm.

This is what is meant by market discipline.

Until we have this type of disclosure, we are going to let bankers' worst instincts run wild.
In the end, Jon Corzine was little more than an unsupervised rogue trader.... 
In any case, it’s incredible how little Corzine and his associates learned from the collapses of Bear Stearns Cos., Merrill Lynch, Lehman Brothers Holdings Inc. and American International Group Inc. three years ago.... 
It didn’t have to be this way. The tragic element of Corzine’s MF Global is that Monday’s bankruptcy filing could have easily been avoided if Corzine’s ego and ambition had been held in check by someone -- anyone -- willing to stand up to the former New Jersey governor, senator and senior partner at Goldman Sachs Group Inc. (GS) 
Where, for example, was J. Christopher Flowers, the billionaire founder of J.C. Flowers & Co.? According to MF Global’s most recentproxy statement, Flowers’s firm owned 6.8 percent of MF. But then Flowers had reasons to have blind faith in Corzine: It was Flowers who recruited the former governor to MF in 2010, and also made Corzine a partner in his private- equity fund.... 
Where were MF Global’s other institutional shareholders, such as Fidelity Investments (which held a 14.8 percent stake, according to the proxy), Guardian Life Insurance Co. (7.4 percent), TIAA-CREF Investment Management LLC (6.6 percent) and Piper Jaffray Cos. (PJC)(6.3 percent)? Were they too dazzled by Corzine’s resume to take a serious look at how he intended to transform MF Global from a backwater to a major player on Wall Street? 
Where was MF Global’s auditor, PriceWaterhouseCoopers LLP, which managed to pocket almost $25 million in fees from the company over the past two years? 
And where, for heaven’s sake, was MF Global’s eight-member board of directors -- a ragtag collection of mostly unknown Wall Street types who had the fiduciary responsibility on behalf of creditors, shareholders, counterparties and employees to make sure Corzine wasn’t taking irresponsible risks? Is it too much to ask a board of directors to take this responsibility seriously? Apparently it was at MF Global....
The collapse of MF Global points once again, in the strongest possible terms, to the importance of having a substantive, teeth-bearing regulatory regime charged with overseeing the kind of asynchronous risk-taking that gives people like Corzine the incentive to gamble with other people’s money in hopes of reaping financial windfalls. 
And yet, more than three years after the collapse of Lehman Brothers and the onset of the financial crisis, we don’t have in place anything close to necessary regulations to try to prevent companies like MF Global from exploding. 
There is little question that from the outset of his tenure at MF Global, Corzine was swinging for the fences. He told me at the time that he saw MF Global as sleepy and risk-averse; he was determined to ratchet up exponentially the amount of risk the firm took using its creditors and shareholder money. Corzine himself had only a tiny fraction of his fortune invested in MF Global. His option-oriented compensation package encouraged him to take outsize risks in order to move MF Global’s stock price into “in-the-money” territory.... 
While the denouement of MF Global is still being written, one thing is crystalline: Behind Jon Corzine’s bearded, avuncular facade lies the soul of a stubborn, ambitious and aggressive risk-taking trader who in the end drove MF Global into the financial abyss. If only someone had had the guts to stop him.

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