Overconfidence or Incompetence...assigning blame for the financial crisis

"The financial crisis was not caused by incompetence, but rather experts who were blinded by their overconfidence." I just returned from a financial industry conference in Washington DC and one of my favorite book writers, Malcolm Gladwell (loved "Blink" and "Outliers") spoke about his observation of the crisis with the typical nuanced and human behavior twists he is known for. He explained that mistakes of incompetence are usually no big deal as they seldom rise to the level of influence of an expert (we could argue this point about our elected officials!). It's when experts with supposedly all the information and knowledge possible develop a can't lose mentality. When this happens, the world can change around them, but the expert will never see it. Case in point, Jimmy Cayne, former CEO of Bear Stearns. He was found at a bridge players tournament without access to communication while his firm was crashing and burning. His world was being destroyed around him and he just didn't see it. Then, after the crash is assessed, he denies doing anything wrong, typical of an overconfident expert. You'd never say you crashed your car because you're a good driver would you? Same with Dick Fuld at Lehman and others who crashed and burned. It wasn't their expertise, but their human nature that allowed for their respective firms' demise.

I watched parts of the Senate hearings with Goldman Sachs and not only was it evident that Goldman cannot admit they were wrong (they're the experts...right?), but the Senators made it obvious they have no idea what's going on. So you have both Goldman expert overconfidence sparring with Senatorial incompetence, very entertaining...but not very productive. Politicians always seem to be focused on their rear view mirror looking for a villain to blame while the opportunity to effect positive change passes them by. Like Gladwell, I really don't think there is any singular entity or person to point the finger at for this crisis. Frankly, people at all levels had their hand in this deal. It was one big casino and Goldman was simply one of the more visible bookies among others who were placing bets on behalf of those for and against the deal while making some bucks on the vig. They even placed some of their own bets on the deal. The finger pointing, blaming and vilifying has run its course and is becoming destructive. But the government continues to look for the perpetrators (blaming Bush for everything has run its course) like a dog chasing its tail and looking very foolish in the process.

I'm not saying that Goldman is pristine as they would like us to believe. Similar to the other bookies in the business, they were simply doing what the system allowed them to do; make money for their clients and themselves even if it meant taking advantage of the system. But clearly, they weren't alone. Earlier in the decade, I knew a couple mortgage brokers in Southern California who were not only making money...but obscene money. I'm talking private jets, multiple high end vacation homes, etc. These were relatively unsophisticated folks who were basically just So Cal surfer dudes liv'in the life. I always thought it strange that guys like this could be knocking down the big bucks. Now I know. They were part of a chain of people from the high school drop-outs with no income flipping homes in So Cal all the way up (including the Government) to AIG's unregulated financial products division. They all believed they couldn't lose and after they did, each denies that they had a hand in it. They were all overconfident experts who couldn't see the world changing around them.

So as I'm prone to do, I'll end with a couple quotes:
" Two things are infinite: the universe and human stupidity; and I'm not sure about the universe"
         -Albert Einstein

"Nearly all men can stand adversity, but if you want to test a man's character, give him power"
          -Abraham Lincoln


Combine stupidity and power, and you have a prescription for disaster. If only those up and down the chain would fess up to their part in the crisis so we could get past these silly hearings and get on to the business of fixing our economy. But as much as we each intellectually know this, human nature trumps it all. Again, entertaining, but not terribly productive.

“Do or do not... there is no try.” -Yoda

"It is what you learn after you know it all that counts"


-John Wooden

 

I had the privilege of hiring John Wooden to speak at a conference I was heading a few years back. He'll be 100 years old in October and when he was with us, he was well into his 90's. He sat as he spoke and the audience was hanging on every word as he delivered his wisdom in Yoda-like fashion. The quotes above and below are some of my favorite lines that he spoke.

"Things turn out best for the people who make the best of the way things turn out."

As I've written before, this past year has been a unique and rewarding experience for me. After taking my little sabbatical http://johnleffertsblog.blogspot.com/2010/01/new-and-improved.html , I've come to see myself, the industry in which I've spent a quarter century, and it's participants in a whole different light. With my new found time I've taken the opportunity to attend multiple industry conferences, speak to many CEO's and leaders in the financial services business, and study the trends that are shaping the future. Clearly the business has evolved somewhat over the past several decades, but one thing that everyone seems to agree on is that change in the coming years will be in multiples of what we've seen before. The key dynamics driving it are new regulations, the boomer segment retirements and transfers of wealth and the new economics of the business forced by the "great recession" with the expected changes in tax law to pay for it all.

Yes, we all acknowledge that change is happening, but few are changing their business models to survive much less take advantage of the opportunity change invariably presents. It's business as usual as if the industry participants are closing their ears, shutting their eyes and covering their mouths hoping the threats all go away if they just wish them away. Every segment in the business wants the others to change fitting their desire not to...similar to the definition of insanity. Fee only advisors want everyone held to their fiduciary standard. B/D reps want everyone to answer to FINRA like they must. Insurance folks are fighting both. And the politicians who are deciding the fate of this issue could care less about any of them preoccupied with playing to the public opinion in demonizing bankers, their compensation and their "too big to fail" employers.


Think about it...If 12b-1 fees go away, the vast majority of already thinly margined Independent B/D's become totally unprofitable and unsustainable. Further, if the Indy brokers lose their independent employee status with their B/D's as is being discussed in Washington now, it pretty much implodes the Indy B/D model as we know it. Wirehouses keep bleeding brokers now that we're down to 4 majors with momentum to keep shrinking. It seems the allure of brand and glue of culture no longer apply while the only thing that keeps their brokers in the system are the unsustainable musical chairs game of upfront bonus money. Then you have the insurance based distribution models whose only economic reason for being is to sell proprietary manufactured products. When (not if) the fiduciary standard is applied and all products must be supported and compensated on the same basis, you guessed it, this one also economically implodes (unless they chose to view their sales force as loss leaders...and some do). Next you have independent RIA's who have seen their revenues pounded by market losses while they are facing increased regulatory burdens and costs never seen before. All this while every channel is pushing an average age of 60 with too few successors to keep each respective enterprise going much longer. Pretty much bad news for everyone, right?


Well, not really. Do I think all those things listed above are going to happen? Some will, but then, some won't. I've learned to never underestimate the inertia and human desire to keep the status quo. Additionally, the story line of this business has never been brighter for the future. It's a simple story of supply and demand. The demand for financial advice has never been greater than it is now and will only increase as demographics evolve. Add to that the declining supply of advisors to meet that increasing demand and econ 101 points to this being about the best business to be getting into bar none. The greatest challenge the industry faces is creating a distribution model that will survive the new economics. One that seems to be gaining traction is Hightower Advisors http://www.hightoweradvisors.com/ out of Chicago picking off high end wirehouse teams using a hybrid platform while maintaining a semblance of belonging to something unlike the typical Indy B/D. A model like this that diversifies past the wirehouse broker and can further attract the high end insurance professional and Independent RIA seems to me to be the one that is positioned to flourish. It doesn't exist today in a scalable form, but I suspect you may be seeing something like this soon.

I'll leave you with a couple more quotes from Wooden; "Failure is not fatal, but failure to change might be." Those choosing to stay the course and do business as usual are at risk now more than ever before. Another is "The most important key to achieving great success is to decide upon your goal and launch, get started, take action, move." This one speaks to me personally. I've taken enough time to survey the landscape, build a business plan and prepare for the future. I may not know it all, but I can tell you that I've learned a great deal over the past year. It's almost time to launch. Stay tuned...

Groundhog Day or April Fools?

As I write this, it's 4/1/10...April Fool's Day. So when I saw the IPO for Primerica roll out of Citi today and close up over 31%, naturally, I thought it was an April Fool's joke. How could the least sophisticated, multi-level marketing, slightest educated and lowest in the food chain of financial product distribution forces hit the street with such resounding success? It must be a joke...right?...Nope, it actually happened. Who knows where the stock goes from here and now that it's out from under the umbrella at Citi, whether the warts will begin to show. But today, it's no joke....they hit the street running.

The phrase often used for product and commission driven distribution folks like Primerica goes like this; " To a hammer, everything looks like a nail". Primerica grew to 100,000 reps by hiring auto mechanics, teachers, butchers and anyone who would sign on to find whole life insurance policies and replace them with term insurance so they could "invest the difference". A compelling idea, except that human behavior being what it is, few ever invested the difference. But to Primerica, every person was a nail and the only tool in the box was the hammer of term insurance and a highly loaded mutual fund. Sounds horrible, except it's happening in too many facets of the business even in the more so called sophisticated of markets.

If you're an insurance agent focused on the retiree market selling 12% commission equity indexed annuities, you'll be pulling that hammer out of your tool box every chance you get. Many B/D advisors seem to focus single mindedly on the rollovers where the only hammer they have is a variable annuity. The same could be said about the fee only segment of the business. If all they have in their tool box is asset management for a fee, that tool will be the only thing coming out of their box as well. As a participant and observer of the financial services business, particularly the retail segment, I've been hopeful that the long anticipated financial services reform would bring clarity and closure on the future direction so we could march forward accordingly with positive, lasting change for the better. With the advances made in our society over the past several generations, a day like today is a reminder that our financial services business hasn't really advanced much at all. It's the movie "Groundhog Day" all over again, and again...and again.

But change will come. It's probably going to be more of the evolutionary type than wake up one day and find regulations completely revolutionizing the entire industry as we may have thought would happen a year ago. The fact that Primerica is still standing today with the regulatory and legal issues being what they are is really amazing. It tells me that the appetite for retail financial services is unlimited and if a firm like Primerica can have any semblance of success, then for firms that really know what they're doing, the sky is the limit. But then again, maybe it will prove to be an April Fool's joke after all. We'll see....