from the executive director
Balancing the Scales
One of the greatest challenges of publishing the Investment Professional is providing content that is timely and pertinent to the current state of the investment industry, but also forward-looking and confident. In this third issue, we address the financial crisis from a variety of perspectives and recognize significant and positive changes in the profession.
In our cover story, Amy Buttell considers the form that the banking sector will take as it emerges from the meltdown stronger and leaner. She asks leading economists, historians, lawyers, and analysts to weigh in on key questions: Will the universal banking model continue to be viable, and what new models will emerge? Will the trend away from investment banking, and toward more traditional banking and brokerage services, continue? How will the regulatory framework take shape, and will regulatory agencies have enough resources and human capital to do the job?
Garnering the opinions of economists and organizational psychologists, Marlene Givant Star explores the pervasive thought processes that made the bubble possible: blind optimism, rationalization of dishonesty, overestimation of our ability to deal with negative consequences, lack of long-term perspective, extreme levels of competition, absence of ethical leadership, and what author and behavioral finance professor Hersh Shefrin calls “Lehman envy.” Shefrin notes that “[firms] wanted to be number one. The focus on immediate gratification was enormous. Like overeating, drinking, smoking—they give you pleasure today, but there may be a huge cost down the line.” By calling attention to these behaviors, organizational psychologists can help businesses restructure their management and compensation practices to mitigate abuses.
Fair-value accounting has received its share of blame for aggravating the crisis. Neil O’Hara argues that mark-to-market rules are more relevant than valuations at historical cost in conveying the value of assets, and contends that suspension of fair value does a disservice to investors, who require transparency. On the other hand, Tom Arnold, John H. Earl Jr., and Michael Weiss of the University of Richmond claim that approaches like fair value, which presuppose market liquidity, tend to fail when liquidity dries up. They maintain that the amendments to FAS 157 made shortly before this issue went to press—giving firms greater discretion in valuing mortgage-backed securities and collateralized debt obligations and allowing them to take illiquidity into account—are merely “emergency treatment of the illiquidity problem, not preventative care. Regulatory bodies … must continue to investigate the problem.”
Leon Cooperman, the founder and chairman of Omega Advisors and a former president of NYSSA, also comes out against mark-to-market accounting. In a detailed and down-to-earth interview, he explains the culpability of investment banking in the crisis, the impact of the recession on both the buy and sell sides, and how he would deal with toxic assets.
Nobel Prize-winner Harry Markowitz, considered the father of MPT (modern portfolio theory), debunks the notion that MPT is inapplicable during a downturn. Sophisticated investors, he argues, understand the risk–return trade-off: “If you want greater certainty you must give up return in the long run. MPT never promised high return with low risk.”
Following up on Charles Ellis’s historical overview, published in our last issue, Lori Pizzani conducts an executive roundtable envisioning the changes that will take place within the securities analysis profession. The participants predict that research will become more specialized and that compensation will be based on the quality, not the popularity, of research. Analysts will broaden their views and skill sets for a global economy. Credit analysts will be more insightful and go beyond the balance sheet, looking more closely at counterparty risk.
Bonnie Buchanan of Seattle University joins Tom Arnold to show how the mortgage crisis was foreshadowed by the collapse of Heilig-Meyers in 2001, and to urge rating agencies, regulators, and lenders to take to heart the lessons both events provide with regard to ruinous lending and collections arrangements.
We are pleased that readers have started writing in with responses both to our content and to events in the industry. We encourage you to send comments and questions to editor@theinvestmentprofessional.com. Don’t forget to check our website, www.theinvestmentprofessional.com, for information on upcoming issues. Content from previous issues is always available online. We look forward to learning how the Investment Professional can best serve you, our members and readers.
