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Markets and Mayhem: An Entrepreneurial Response
By Bill Schweke on 10/29/2010 @ 01:59 PM
By: William Schweke
There is nothing like a financial crisis to spur the publishing world to generate new books, both good and bad, on the subject. Some tomes stick close to the causes and consequences, while others explore a variety of related topics. Indeed, a number of writers use today’s Great Recession as an opportunity to raise fundamental concerns about the theory, policy, methods, validity, and truth of mainstream neo-classical economics.
Many of these new works are all-too-predictable. This is not the case with the newest edition, which could be called both an “insider” and an “outsider” book. The author, Amar Bhide, possesses a hands-on knowledge of the subject matter, without losing his dissenting point of view. He wants transformational change, but is very concerned that many of the reform proposals head in either the wrong direction or make small changes that will be absorbed and neutralized by the very powerful financial services industry.
Amar Bhide’s A Call for Judgment: Sensible Finance for a Dynamic Economy, is, in some respects, a continuation of the author’s last work, The Venturesome Economy, a very illuminating study of innovation and entrepreneurial initiative among large and small firms, new and old. In this new book, though, he looks in detail at a major constraint on these dynamic factors in growth – contemporary Wall Street finance.
The author is a former management consultant at McKinsey and company, a specialized stock broker at E. F. Hutton, and a professor of business at Columbia University. Currently, he is based at the Fletcher School at Tuft’s University. Known as a major contributor to studies of innovation and new product development, Bhide is much more focused on modern global and domestic finance, per se, than most experts on the entrepreneurial field.
Moreover, he is neither a single-note market beater nor a fanatic for laissez faire economics. He likes capitalism, and he worries that the wrong sort of reforms could harm startups, sap entrepreneurial energy, and hinder small business growth by making the system of deal appraisal even more rigid, centralized, and impersonal than it already is. Bhide argues that the regulatory system of the past few decades regulated commercial banks too laxly and the securities industry in too procrustean of a fashion. He believes that the Frank-Dodd law continues this habit: it still goes too far in some respects and not far enough in others. There is a danger that some elements of the new law might further magnify an already existing, disturbing trend, such as believing that better risk management can be almost eliminated by feeding more data into a computer.
Like economist and historian Joseph Schumpeter, he is anxious about the possibility that further bureaucratization could kill the essential engine of capitalism – the entrepreneur. The financial services industry made so much money through arm’s length securitization, that he fears, given their power, they will do it again. He proposes that we “restore real finance.” Or, to be more specific, the author terms it – “traditional relationship-based banking.” This concept makes the author sound like a “small is beautiful” fan or a Luddite, but this is far from the case. He wants bankers to have the ability to do big deals and small deals, and he does not think this can be done very well through traditional anti-trust means that draw often arbitrary lines of allowable firm size.
His analysis, historical account, critique and proposals seek to find the right set of rules and structure that does not demand heroic efforts by regulatory staff; the regulator need not be omniscient.
The author elaborates this perspective by presenting his ideal capitalism, then discussing the forces and changes that have made this ideal less likely. A few quotes will clarify these points.
Our prosperity requires the enterprise of innumerable individuals and businesses that exercise their imagination and judgment—and bear responsibility for the outcomes.
Well functioning capitalism creates widespread prosperity through a widely inclusive system of innovation in which many contribute to – and benefit from – the development and use of new products and technologies. Inclusiveness is achieved through decentralized judgment tied to responsibility: individuals and businesses exercise their imagination and wit to undertake uncertain initiatives, but also bear the responsibility for outcomes – good or bad.
A financial system that supports the real economy, {Bhide} argued, will have identical features: decentralized judgment tied to responsibility, with prices, dialogue , relationships, and organizations that strike the right balance between control and autonomy – all sustained by good laws and regulations.
This balance has been lacking for more than two decades. The result is a much more centralized, mechanistic, and arm’s length finance. The rewards have been massive for upper management and the financial services sector, but with little personal downside risk. These features hinder dynamism in the real economy, undermine the legitimacy of capitalism, and make the financial system more prone to crisis.
According to Bhide, US banks and other deposit-taking institutions (credit unions, money market mutual funds, etc.) must be limited to basic lending and nothing else. He adds that depositors in money market mutual funds should not be able to withdraw their funds for less than 30 days. Temporarily idle government funds, pension funds, and endowment funds that seek places to deposit in guaranteed accounts should be regulated regarding their behavior. At the same time, he contends, this separation of commercial and investment banking has to be accomplished in a manner that does not impede a return to relationship-based, case-by-case judgment and due diligence. Evaluating a proposition for finance will not solely rely on quantitative credit scoring techniques that are deceptively objective and all too rote.
There is nothing mechanical or routine about financing new business prospects. Finance theory went wrong, when it tried to use mainly past events and probabilities to overcome genuine uncertainty and convert the deal into a simplified problem in risk management. To paraphrase Donald Rumsfeld – there are many things that you know you don’t know, as well as those that you don’t know that you don’t know. And these surprises may turn out to bite you when you least expect it! You cannot anticipate most of these sorts of events, but you are better off using intuition and a broad understanding of the way the world works as additional inputs into your decision making. Thus, loan officers should also draw upon their knowledge of the owner’s character and overall competence, the firm’s management strategy, quality of financial “books,” trends in specific industries and regions, particular market conditions, and so forth.
Lastly, the book also provides a clear introduction to modern financial theory and action, a history of government regulation of finance, a good treatment of the events that led to market mayhem, a thoughtful critique of President Obama reforms, and Bhide’s own proposals.
These are just a few of the highlights in this intelligent, business savvy book.
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