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Friday, 9 October 2009

John Thain's 10 Lessons of the Credit Crunch

I would summarise the recent remarks of former Merrill Lynch CEO, John Thain, at Wharton Business School in the 10 points below (my adds in italics). But two general observations. First, John says he doesn't believe there could be another bubble as damaging as this particular one, whereas we can't possible know that. It seems a lot safer to assume there will be a more damaging bubble, so we can at least consider what it might be and have some chance of acting to minimise or avoid the consequences. And, second, John is pessimistic that we'll heed these lessons of the credit crunch. So, logically, he would have to concede we're in for a repeat.
  1. Loan/mortgage brokers should be incentivised based on loan performance, not just volume;

  2. Loan owners who securitise must retain a significant proportion of the equity;

  3. Government sponsored entities should be not-for-profit (i.e. they can run at a profit, but can't distribute profits, with an exception here in favour of the Treasury, surely);

  4. The issuers of securities need to explain not just the risk in the security, but also what residual risk remains with the issuer and how it plans to cover those risks (this would demonstrate more clearly the inter-relationship between markets for credit and insurance, the use of shadow banks, and related assumptions);

  5. Banks must reserve more capital as a proportion of total assets in a rising market, so they can afford to reserve less in a falling market;

  6. Private equity firms should not be free of leverage controls (which suggests they need to make the same risk explanation in 4 above to their investors as issuers of other securities, regardless of whether those investors are 'sophisticated' or market counterparties);

  7. Financial regulatory structures need to be more logical, less duplicative, less expensive, with no gaps;

  8. Compensation should be variable, reflect how earnings are generated, tied to longer-term performance, aligned with shareholders' interests and ultimate financial results;

  9. Credit risk management needs to be improved - but the crisis has demonstrated that once toxic assets are on the balance sheet it's tough to get rid of them, so there has to be some recognition that a government guarantee is ultimately necessary to remove them;

  10. Financial institutions must pay for their implicit government guarantee, over and above existing FDIC or other financial compensation schemes.
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