Posted tagged ‘Wall Street’

The Financial Crisis — One Leading Economist’s Perspective

May 12, 2009

Earlier this week, I had the opportunity to hear nationally acclaimed economic expert Joel L. Naroff, Ph.D. Naroff is a well decorated economist.  He was selected for having the most accurate economic forecast among the Blue Chip Economics Indicators survey participants for the years 2004 to 2007. Bloomberg Business News also named Naroff Top Forecaster in America for 2008 and he has been quoted in most of the major business publications and appeared on many of the major business news networks.

I was therefore very interested in what he had to say about the economy. Because I found his perspective unique, I thought to share my understanding of what he said with you.

Generally speaking, he presented an optimistic view of the immediate economic future, although he had some concerns about the long term picture.

Naroff first explained that the most important responsibility of an economist is to tell when things change. In fact, this is the same major role of a business leader. S/he too must know when conditions change. He views his job as looking at turning points.

So here was his take on what got us into this mess…

Naroff believes the villain in all of this is the dot coms. (The dot coms? Yes, that was what he said…read on) The dot coms taught us all a very valuable lesson and that was not to invest in vapor. Companies needed to have value and be tangible.

Learning this lesson paved the way for what we are experiencing today.

The byproduct of this lesson is that our next investment choice would be something that is the antithesis of vapor and something that always appreciates. And so we targeted real estate.

As you may recall, in order to get a mortgage, one needed to place 20% down, have a credit rating of 720 and show several years of meaningful income as evidenced by your tax returns. This was a good way of determining who was willing to put “skin in the game” (the downpayment part) and who could afford to make payments on a mortgage.

So the real estate market gets hot, and the finance industry sells to this target segment that has these credentials to purchase real estate.

Eventually, though they exhaust this target segment, and therefore a new target segment is needed. The financial community then lowers the standards by which one could be deemed worthy of receiving a loan in order to increase the size of the segment. In 2003, the standards are lowered and then, they are lowered again in 2004.

Before long, the requirement of putting money down disappears, people with less than stellar credit ratings are considered appropriate and all one had to do was spell the word “j-o-b.”

People began to flip houses because it is easy to do. Real estate prices increase 40% in one year and then 30% in the next.

And so, we experience a dot com boom all over again. People are “investing” in real estate without placing any money down. As Naroff explained, when you place no money down on a house, it is not a mortgage – it is a lease.

This bubble had to burst.

Construction starts to collapse and its collapse ripples to all supporting businesses including electrical, woodworking and manufacturing.

Meanwhile, Wall Street discovers that it can bundle all of these distressed mortgages and have them rated as securities. And with no money down, these bundles get AAA ratings.

Housing starts to devalue and once the mortgage exceeds the value of the property, people decide not to pay their mortgage. With no money down, it is easy to walk away.

The problem began to mushroom when many of the banks keep these securities on their books. This was a huge mistake. When people walk away from their obligations,  the housing values plummet and when they plummet, so do the values of these securities.

The decelerating cycle was now underway.

In September, Lehman Bros goes under. A bank actually sends several million marks to Lehman twelve minutes before Lehman marched into Federal Court. When a bank learns it can’t lend to another bank and, because everything in our economy operates on credit, this is tantamount to a kiss of death.

A crisis of confidence emerges as we listen each weekend for news that another major financial institution is about to go bankrupt.

In October, we get TARP, the first financial bailout program. It is partly designed to mask the problem before the national election – and even though we wasted money, the financial system was stabilized.

So in 2005 – 2006 – everyone got credit

And in 2007 – 2008, no one gets credit.

In our next post, we’ll share what Joel Naroff explains about how and when he thinks we will get out from this crisis.


The Financial Crisis, Early Warning Systems and the Leader’s Role

September 18, 2008

Crises just don’t happen.

As with any difficult time, the challenge is always how to learn from the experience to assure that it doesn’t happen again. Clearly, there will be some very provocative analysis. Some will attribute the root cause to greed. Others will state that the lack of regulatory oversight contributed to this problem. However, I feel that the very root cause may be elsewhere.

Every business leader must install four components by which they can operate their company.

The first is, of course, a strategy and operation plan. Strategy, as we already know, provides the corporate direction and the operational plan provides that tactics that we are to follow that will get is to the strategic destination. Together, they tell our organization what we must do.

If the strategy and operational plan detail the “what,” then it is the management philosophy that details the “how.” Every business begins and ends with people and their behaviors. A company must recognize the mutual opportunities and responsibilities with its customers, employees, stockholders, suppliers, communities and the public.

This recognition leads us to believe that it is desirable to have a common philosophy. The company’s philosophy should be the basis for actions by managers at all levels of the organization.

An effective management philosophy details

  • What the company is and what it will become
  • How the business will be managed
  • The basic responsibility for each employee
  • The human values that we will live by
  • The company image

The third pillar that must be in place is the compensation program. It should motivate people to properly deliver on corporate tactics consistent with the management philosophy. It serves as a means by which employees will wish to stay within the organization.

Finally, a set of steering mechanisms must be in place. Think of it as more than key performance indicators. It is the dashboard that illustrates how the business is “flying” in all areas and allows for early recognition of difficulties so that course corrections may be easily made and made as early as possible.

So , from a management and leadership perspective, what likely went wrong that caused this crisis?

It is likely that the failures that triggered this crisis are a result of deficiencies in all of the above areas.

  • The strategic and tactical plan may have been flawed in that it took on too much inappropriate risk.
  • The management philosophy may have either ignored or encouraged the achievement of short-term profits at the expense of long-term growth and therefore encouraged irresponsible behaviors and actions.
  • The compensation program may have rewarded results that were produced without consideration to proper behaviors.
  • The steering mechanisms may have been ignored at the earliest stages and therefore corrective actions could not be taken soon enough

The management lesson for all of us then is to place and actively reinforce these elements within our business. It is surest way to avoid catastrophe and the friendliest path to growth and success.

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