This blog post originally appeared on RealMoney Silver on Sept. 15 at 7:44 a.m. EDT.
At the core of financial system's current breakdown is the fact that there remains too little, not too much, financial industry regulation. Too many regulations serve little or no purpose (similar to the pages of silly and lengthy disclosures in Wall Street research reports that few read and even fewer rely on). Regulatory enforcement is arbitrary and, at times, unpredictable -- a system that values form over substance.
Over the past decade Wall Street's compensation was no longer calculated on multiple years of contribution/performance but rather became a short-term (meritocracy) calculation based on a one-year profit and loss statement. The extraordinary compensation at hedge funds, private equity, and in the investment and commercial banks became a "heads I win, tails I win" proposition as a star system emerged that was based on contributions calculated within reduced time frames rather than an assessment of the value-added contributions over lengthy periods of time (subject to high water marks and claw backs).
Importantly, supporting my view of a "heads I win, tails I win" structure, outsized annual compensations were typically not retained but rather were allowed to exit Wall Street every year -- in part, helping to explain the appreciation in home prices between 1995 and 2005 on the East and West Coasts.
A general lack of regulatory scrutiny and enforcement, the absence of risk controls and a continuum of reckless management decisions at the world's leading financial institutions (banks, brokers, hedge funds, private equity, etc.) have combined to create a
, which has resulted in a credit market gone amok and a shadow banking system often under the radar of regulators.
Stated simply, allowing investment banks to be levered over 30-1, private equity deals to be levered at 20-1 and hedge funds to be levered over 5-1 is, as a friend mentioned to me over the weekend, "the financial equivalent of playing Russian roulette with five of the six chambers of a loaded gun."
Laissez faire policy has failed. And since the markets have grossly failed to impose the type of discipline that was necessary to protect the system from the accumulated buildup in credit (and the current contraction), regulators will now step in. Unfortunately, it is now too late as once again the regulators will prove to be reactive, not proactive.
For now, the rescue packages will dominate the day.
But for tomorrow, the effect of a credit market running amok will be felt hard by the real economy.
I have long written that the impact of deleveraging was the equivalent of a broad monetary tightening, and with the
American International Group
news over the weekend, the extent of the economic damage to the real economy, though still unknown, will be widely felt.
Memo to investment strategists/economists and their economic and corporate profit forecasts: Get real.
Memo to investors/traders: Continue to err on the side of conservatism.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.