The world seems to have lost its ability to reason and to gain a sensible perspective in several sectors of human activity including world football tournaments. Recent events of the latter became leading indicators of what is happening in the global economy.
So, with cameras placed all around the world in their millions, on sport pitches, and in our cities, with London now placing them at every possible corner and street (bye-bye to English privacy!), we instead allow world football games to disregard simple technology (which by the way is already there) generating transnational upheaval.
Not a good risk strategy: most of the world watching, a global game worth trillions in tatters, only to satisfy a few stubborn barons? That is not about the beauty of human error. It is simply highly improper risk handling for such an important game. It is like saying, “I want to ignore reality”.
Yet, reality is going to hit sooner or later. And while football is just a game, though with so many interests involved, here goes the analogy that mirrors this World Cup events with the politics and problems of the participating countries: from their inability to handle risks, to structure remunerations effectively, to their lack of sense of urgency to resolve the current crisis.
No one seems to really make sense of what is happening nowadays. Most are just narrowly looking at little components of reality, ignoring the macro picture.
Yet, a small number of commentators seem to “see the light” and understand that to a systemic crisis, a systemic answer is needed. Among these comes an article by Dr. Mohamed El-Erian: Beyond the false growth vs austerity debate.
It is absolutely true. Reacting only to the daily emergencies, being frantically trapped in the extremes of the very short term, will only conceive ill actions, failing strategies, risk mismanagement, and bring us deeper into this crisis. Three years after its unravelling, the West is still in a “confusional” state.
Instead, we need to analyze medium and long term risks and implement necessary systemic strategies as I try to argue in: Time Horizon and Capital Flows Redirection for Growth.
Yet, to add to what El-Erian points out, the current dire circumstances require more courage and finally to answer the Big Question, from which all current analysis should begin.
Is this crisis, now in its third year, a cyclical crisis or is it instead of a fundamentally structural nature?
El-Erian rightly adds that “the world is facing deep structural challenges, yet its leaders are stuck in a short-term, cyclical mindset”.
It appears undeniable that this is an unprecedented, structural, systemic and epochal event which reveals essential and serious flaws in the financial, economic and political systems of the Western world. The news is: there is no place to hide.
Therefore, unless these flaws are systemically resolved, we are deemed to sufferings and misery with sideways anaemic trends and high risks of further catastrophic disasters.
A Need For Change: Risk Strategy As A Key To the Future
Even after what has happened, the conditions which brought about the breakdown are still in place.
We still live with the moral hazard of giant corporations “too big to fail” and so “too big to exist”, and impossible to manage. We still tolerate the conflicts of interest brought by business entities that perform a range of functions which are dangerously too wide. We still allow traders to “corner” markets; “High Frequency Trading” is still not being banned.
Ownership and management in financial services and in most industries became more and more dangerously detached and it is still the case today.
As I try to explain in Why Banks Should Clean up their House and Take on the Opportunity of Modern Times,to make matters worse, the perennial and unlimited government guarantee is still there and it allows these entities to defy the gravity of open market rules at the expense of everyone else especially the medium size firms and the general public. The “Self Regulation Time” has come but appears illusory to expect.
Where should we be going from here? Macro systemic strategy and micro risk management are needed.
“Direct Investing”, Proliferation of Players, Empowering Boards
Governments should step out of their “herd like behaviour”, stop just reacting to emergencies and instead they should promote and facilitate the following systemic risk strategy approach.
I) A long term capital redirection: “Operation Direct Growth”; II) the proliferation of market players; III) the revamping of boards and their functionality; and IV) explain all of these measures upfront in a massive information and public involvement campaign.
In order to solve matters, and for the West to re-emerge, governments should promote “direct investing”, i.e. schemes of the like of “Operation Direct Growth”, along with the creation and development of non bank lending channels to restart the economy, increase productivity, reduce the risk of losses, and insure against future financial shocks.
I am proposing what is effectively a new asset category which does not exploit the owner in terms of fees, governance, control and transparency. “Operation Direct Growth”, is a strategic and analytically formulated plan which focuses on opening a “direct reallocation of the capital use” between capital rich institutions with a medium to long term horizon and firms in sound conditions that yet need further resources, a strategic support and a better future prospect.
There will be no intermediaries in the exchange. The main actors of this plan are a consortium of institutional investors, pension funds, endowments, sovereign funds, and other long term investors.
Such a new investment method is based on analytical evidence, (“the Direct Alpha Factor: see formulations in “Operation Direct Growth”), and it is directed towards infrastructure projects and sound firms in the real economy that due to the current circumstances, are not able by themselves to fully capture business opportunities. Thus, the investment subjects are in “sound” sectors with good growth potential now held back by the general lack of trust and the absence or withdrawal of banking facilities.
The aim is not to substitute public recovery efforts, or to replace the fundamental banking functions, but to favour enterprises to restart the economy and to prevent future shocks from happening.
Such interventions will also enable the application of ethical values, best corporate governance practices and aim to sustainable growth. The recipient firms will then begin to increase their capital expenditures, to hire new employees, to develop new projects. The economy will restart again and with a renewed dynamic intervention for the west.
The Big Bank is dead, long live the SME
Secondly, a proliferation of players should be promoted in all sectors of economic activity: from financial services to corporate industries, re-establishing partnerships, breaking up banking, corporate activities, and where feasible, creating federated operating entities.
This is going to stimulate the re-growth of the pivotal medium size firms. Enterprise size matters and an oligopolistic totalitarian world will only bring distortions and misery (Time Horizon and Capital Flows Redirection for Growth). In this respect, the financial services bill now discussed in the USA is a step in the right direction but more needs to be done.
The only real slogan to be heard in the street should now be: de-mergers, break up of activities to unleash new value. All that has followed Big Bang way back in 1989 has become outmoded and a new economic world order is now required. Leveraged financial growth (often fictitious), huge consolidation, catering solely for short term takings is no longer an appropriate or desirable model.
In fact, it can easily be demonstrated that the value of the individual components of any of the top largest banks, and largest corporations, is now much higher than that of the whole. We need market players that have full incentives to gain but that can also fail without creating systemic risks and “moral hazards”.
Recreation of medium size entities deeply specialized in their area of expertise, where management and employees are owners, should now be the “line of attack”.
Governments would grant incentives and award tax breaks to direct long term investments into the real economy. Tax advantages should be open to capital to promote long term ownership, specialization, and medium size operations in recreating direct ownership and focus on specialty areas.
This would represent a huge incentive for change and the real reward in any business, reopening healthy competition and establishing a higher level of specialization now needed in the western economies in their transition from industrial to “information societies”.
Since capital and lending facilities would start flowing again to the real economy, due to the “Direct Alpha Factor”, with the growth of a multitude of players, several hundred thousands of skilled employees would be happily returning to work with much benefit to the community. This will generate a virtual cycle in terms of consumer spending and rebalancing of public finances.
How else would those huge public deficits be repaid? For further analysis on this crucial matter please see: Greek Crisis Confirms Systemic Capital Redirection Urgency
Finally, with the growth of medium size enterprises, able to take the risk and free to fail, the problem of systemic hazard will be resolved and the risk diversification achieved will then keep things under control.
Allowing long term incentives for management buyouts will bring back that fundamental “skin in the game” element, that responsibility that is so healthy in any human activity and endeavour. It will make taking calculated risks and receiving proper rewards possible again.
Thirdly, a total revamping of the board of directors and operating committees should be favoured.
Chairmen and board members should focus on their duties and should be qualified with material, relevant and specific skills to the business. Their mandates should allow them to have only a very limited number of other tasks elsewhere. Smaller entities will favour real control and more reactive management from both boards and top management.
Therefore, it will be the board of directors who deal with how to allocate and distribute profits and determine how to remunerate top management and employees – and not anyone else. The problem today is that too many boards have de facto no corporate control. Many corporations are so huge that it makes impossible to manage and steer them effectively.
Fourth measure, a clear public information campaign should be conducted to explain to the general public the ways in which the economic problems are being solved and how the community’s contribution will help society to regain ground.
This four pronged approach would be a win-win move to bring about a much needed recovery.
Conclusions: “Do You Want The Truth Or Something Beautiful?”
Currently, the risk amassed in the short term is huge and it continues to grow dangerously, the conjunct spending cuts and austerity measures in European countries, in absence of any systemic long term growth plan, could sink any hope of future growth, suffocating consumption, increasing distortions, stagnation and creating social unrest.
In this environment, rising global imbalances are likely to precipitate new crisis, most enterprises become more and more risk exposed, unprepared to face the new issues, unable to identify and manage their own risk and to implement a sensible strategy. So much so, that enterprise value suffers a real risky “compression”. (Time Horizon and Capital Flows Redirection for Growth: “Depressed Alpha”: Enterprise Value Distortion By Uncertainty)
A proper systemic risk management strategy with the implementation of macro factors outlined above could start generating a reversal. At an individual company level, the execution of an appropriate micro risk strategy now becomes a must.
Like on football pitches, technology, expertise and strategic solutions are already available. Ignoring it, being in psychological denial, or simply continuing to surrender to the forces of lobbying, or incompetence, will only further deteriorate matters.