BlogWatch: Yves Smith at "Naked Capitalism" adopts generational model of financial crisis - 7-Jun-2009 - Generational Dynamics

She says that middle-level (Gen-X) managers extorted executive (Boomer) management.

I've been relentlessly critical, on this web site, of economists, analysts, journalists, politicians and bloggers who cannot seem to grasp even the simplest, most obvious generational interpretation of what's going on.

I'm still baffled how economists can be so totally dense about the cause of the dot-com bubble of the late 1990s, almost as if they have a brain defect. The dot-com bubble began at precisely the time that the risk-averse survivors of the Great Depression all disappeared (retired or died), all at once, leaving incompetent Boomers in charge as senior managers of financial firms. (See "System Dynamics and the Failure of Macroeconomics Theory" and "Markets fall as investors are increasingly unsettled by bad economic news" for detailed discussions.)

After the dot-com bubble collapsed in the early 2000s, the Generation-Xers began entering middle-management, and the massive credit bubble was launched by means of the creation of fraudulent "toxic assets" that were sold by the trillions of dollars worth to innocent investors. This was possible, as I've written many times, because of the lethal combination of greedy, nihilistic Gen-Xers, combined with greedy, incompetent Boomer bosses. (See yesterday's article, "SEC charges former Countrywide CEO Angelo Mozilo with fraud," for a discussion and illustration.)

Mainstream journalists, economists, analysts, politicians and bloggers are all totally oblivious to such generational explanations, no matter how utterly obvious they are.

Yves Smith, of the highly popular Naked Capitalism blog, has written an article that closely adopts the generational model that I described above.

Smith does not refer to the Gen-X and Boomer generations, but it's clear that she's referring to the generational split when she says that "middle level (meaning MD but not executive level) employees were effectively able to extort management." I've written about the power that Gen-Xers have been able to exert over Boomers (and, particularly, that Gen-X women have found Boomer men particularly easy to manipulate), but Smith adds to this model by referring to it as "extortion."

"What I believe happened is this (very crude story line, but I am highly confident, to use that old Drexel chestnut, that his pans out):

Wall Street firms got big, both as banks started invading their turf (and banks big to begin with). This meant greater spans of control. In the old days, anyone who was running a meaningful profit center was a partner, and there were few enough partners that the management committees could keep on top of them. But as firms got bigger, you had important profit sources that did not have an expert at a higher level running them. They might have some general knowledge of a business, but not specific knowledge.

Trading became more important as a profit center relative to other activities due to (gradual) erosion of profits in other areas thanks to deregulation.

Rising popularity of hedge funds gave top traders (proprietary traders) a ready exit, plus set a new high pay bar

Other boats in trading land rose pay-wise due to 3. Other big producers could always exit to another firm, if not set up own firm.

Even if non-prop traders who are "producers" in theory can be replaced, in practice having top guy disappear, taking key people with him, is a bad position to be in. You do lose momentum, you even risk control failures on the desk. If the book is big and active, they do have management hostage. Particularly in new, specialized areas, it would take time to poach someone from another house to fill the gap. (A big issue here is I am not sure how to define who might be able to hold the firm hostage. The head of any major trading desk might fit the bill; not sure who else ought to be included).

As a result of 1-5, middle level (meaning MD but not executive level) employees were effectively able to extort management. Think of what would happen in a nuclear reactor if the staff who knew how to run it could go on strike. So collectively they were able to get themselves overpaid, often in the form of getting to run bigger risks than they should have (ie, the payout norms may on the surface not have change, in terms of ratio of pay relative to apparent production/profitability, but if you are running much bigger risks, you've increased your personal top line to the detriment of the enterprise).

And the top level guys had reason not to question it because:

Fighting it would risk having the firm appear less profitable, talent would exit

Firms were now public, incentives and pay badly skewed towards short term incentives.

Competition in many markets based on league tables, meaning market share

I have spoken to some experts who believe this fact pattern to be true, but as of 2-3 years ago could not prove it.

I believe that this probably cannot be established in a rock-solid fashion without having access to internal data (and policies), but I wonder whether readers can point to any anecdotes or case examples (in the public domain, say in Institutional Investor, The Deal, other industry publications) supporting the logic chain above."

It's worth repeating a couple of paragraphs from my recent article on the SEC charges against Countrywide's Angelo Mozilo:

Mozilo's crime, according to the allegations, is that, having discovered the fraudulent activities were going on, he attempted to conceal these activities, and he didn't direct his employees to stop them; and that, having discovered the activities, he engaged in insider trading to benefit from them.

If we now apply Smith's "logic chain" to the SEC's indictment, then we can suggest that Mozilo didn't simply neglect to stop his employees from defrauding investors. The implication is that he couldn't stop the fraud because he was being extorted by his employees. What I call a "culture of complicity" can now be called a "culture of extortion."

As I've written before, I've often heard the following from Gen-Xers: "We were working for Boomers, and we did what they told us to do, because we had to, or we would have been fired." This is a modern version of the Nuremberg defense.

I usually answer, "If your Boomer boss asked you to kill his wife, would you do that too?"

But now, with Smith's insight, we have a kind of "reverse Nuremberg defense": the executive management of these financial firms can start to claim that they went along with the the massive fraud by their employees because of extortion.

To which I might ask, "If your employees were committing murder, would you go along with that too?"

Any employee whose job involves committing crimes always has the choice of leaving his job. A person making a six and seven digit salary by defrauding thousands of investors can certainly find a job making a five digit salary doing an honest day's work.

Instead, what we have had are huge numbers of nihilistic Gen-X financial engineers and middle managers, combined with incompetent Boomer executive managers, people with no moral and ethical bearings at all, who knowingly defrauded investors for their own financial gain, and destroyed the global financial system along the way.

Generational Dynamics Web Log for 7-Jun-2009
BlogWatch: Yves Smith at "Naked Capitalism" adopts generational model of financial crisis

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Generational Dynamics Web Log for 7-Jun-2009 BlogWatch: Yves Smith at "Naked Capitalism" adopts generational model of financial crisis

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Generational Dynamics Web Log for 7-Jun-2009
BlogWatch: Yves Smith at "Naked Capitalism" adopts generational model of financial crisis