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History has a funny way of humbling men. So do markets. Perhaps the most disturbing aspect of Lehman Brothers' fall is that it comes almost seven years to the day after 9-11. That day was supposed to teach us humility, and the fall of Lehman, coming six months after the collapse of Bear Stearns and coupled with Merrill Lynch's disappearance as an independent company, are the result of a complete lack of humility on the part of those executives charged with leading the world's most important purveyors of capital in the post-9-11 world. For all the talk of pulling together in the wake of the terrorist attacks that shook America to the core and that supposedly set our priorities straight, Wall Street rushed headlong back to its mindless pursuit of profits and speculation without consideration for the consequences of its actions. Now the chickens have come home to roost.
In April 2008, HCM published a controversial essay entitled "How To Fix It," in which we outlined our (unsolicited) recommendations for how to correct the excesses that led to the credit crisis that began in mid-2007 and brought us to this historic day. We are republishing that issue of the market letter by attachment for those who did not read it the first time. Our key recommendations, which seemed much more radical in April than they do today, were the following:
Improve financial industry regulation and replace substance over form in the regulation we have.
Place absolute leverage limitations on financial institutions at much lower levels than the 30:1 levels that led to this crisis.
Place an absolute limitation on hedge fund leverage.
Regulate Wall Street compensation by basing it on multiple years' performance, add clawbacks and high water marks, and limit cash compensation that is paid out and weakens these firms' balance sheets.
Tax private equity firms' carried interests at ordinary interest rates rather than capital gains rates and restrict private equity firms' ability to go public.
Outlaw off-balance sheet entities.
Reinstitute the uptick rule with respect to short selling.
Finally, we made the point that too much economic activity in the United States was aimed at speculation rather than production. For example, the equity markets are increasingly dominated by quantitative investment strategies that are driven by considerations that are totally divorced from considerations of fundamental value. At the same time, the credit markets are increasingly utilized to finance change-of-control transactions for private equity firms that are done simply because low cost financing is available, not because a project is going to add to the productive capacity or capital account of the nation. As we wrote in that April issue, "[a]t some point, society has to figure out that the way an investor earns his money is even more important than the amount of money he makes. This is why human beings were vested with moral sentiments, so they could distinguish the quality of human conduct from the quantity of its results."
