THE FINANCIAL AND MORAL DEBACLE FROM 2008

First of all, I would like to define the “financial debacle” as the situation when no more money could be extracted from the market with a positive profit and nobody really understands where the money came from.Both pieces have interesting approaches to analyze the situation named as “the financial debacle”, but they differ in the way the analysis has been conducted. 

As the macroeconomic phenomena are the result of the microeconomic interactions. We wouldn´t assume that people are informed about past situations. This is something we can´t assume, because the knowledge of past situations is only available when we had studied the past.  Therefore, the proposals about honoring the shareholders, keep it simple, use less leverage, standardize financial instruments (derivatives or any other), keep things in the balance sheet and publicize it could be a right approach, not only to deliver products to the market, but also, to prevent the deleterious actions against the consumer.

We can infer from the NYT various articles that has been published around the main topic, that the abuse of privileges by the financial institutions, the Government through entities as FannieMae and FreddieMac, and mortgage brokers, at the end conduct to the construction of really complicated instruments and methods just to be able to get a good rating from risk management tycoons as Moody´s. As the consumer has been trained over years to trust on the ratings, the scenario was perfect to develop the most advanced and complicated methods and risky and intentionally make-up tools just to fix the numbers and reach the consumer mind as a good product regardless of whether or not they understood what was behind.
Three root causes could be easily identified at this moment: 1) Lack of knowledge, 2) lack of transparency, and 3) Incomprehensible tools. 

The scenario was perfect, the institutions were able to develop tools that nobody could understand, and even Alan Greenspan recognizes in public that he didn´t. So, the knowledge is a strong tool when we want to improve people´s lives but is the most dangerous tool when we want to abuse of the one who doesn´t have it. 

The transparency was absent because nobody was paying attention to the signals even when they knew that a serious trouble has being built, and instead of it a crazy run to uncover the signals with smoke before the problem arises was the common behavior. And finally the intentional development of tools that the market really didn´t understand was the point of no return for this debacle. It was just to sell and put money on the market no matter what was behind of the method.  

Of course, if we take a deeper look into the economic theories, all was perfect, more money on the market as a false higher consumer income, rising prices that never goes down as false expectancy on the consumer mindset, more buyers (market) just because the risk analysis was undermined and of course the historic data of sales increasing to the sky.

All these were just perfect in terms of demand estimation and forecasting from the point of view of the economic theory. Just to add up, the promoted low interest rates by the government to control the inflation were against the profits for the banks from the mortgages revenue streams. And of course, it was needed another instrument to compensate the decrease in profit, and here the finance geniuses came up with a bunch of new derivatives that nobody couldn´t understand but a lot of people want to buy, with the promise of high returns.

Maybe this situation will never be solved, maybe the problem could be, but in the future another situation like this will appear if we don´t treat the roots and causes that promote situations like these.  We can work for example with educational tools at different levels as a treatment for the 3 roots. For the consumer of financial instruments, manuals in plain English could be developed in order they understand not only the basis but the risk analysis they will be exposed with the use of these instruments. If the consumer is able to understand the basis, so will be more difficult to the institutions to build models that nobody understands and the complexity will be reduced in relative terms.  

According to Michel Porter´s five forces model, if we increase the buyer power, the rivalry of the firms will increase and we could construct a competitive environment where the consumer has the power and even ask for substitute products.

I think we are far away for a sustainable solution to the problem, nowadays we are facing too much regulation in the wrong side (corporate) and too little in the consumer (personal) side. At the end all kind of regulation in the actual model is developed by people involved in the business with a lot of conflict of interests looking for perverse compensation without a real risk to be punished by the mistakes or negligent decisions, or just take a look on how many people has been convicted by this debacle.

We need to put more power in the consumer´s hands as the way to self-regulate the market from the buyer perspective and no from the seller perspective. Aforementioned “people don´t forget today what they didn´t know yesterday”, and in the same way people do not avoid what they don´t know is risky.