Thursday, March 1, 2007

Fiduciary Responsibility, RIP

Financial firms and professionals are by law required to practice what is known as "fiduciary responsibility". The term comes from the Latin "fides" meaning loyalty - you may be familiar with "Semper Fidelis" from the US Marine Corps.

Simply put, such firms and individuals are expected to work for and protect the best interests of their clients. As professionals, they are held to a higher standard of performance, simply because they are expected to know better - their position of authority gives them great power of influence over their customers.

Banking is - or was - based on counterbalancing fidelities: depositors provided professional bankers with their savings and expected to be protected ("saved") from the vagaries of fortune and bad judgment. Bankers gave out loans only after carefully examining credit and character: they had to, in order to protect both their depositors and their institutions from defaults, since the loans rarely left their books. Loyalty to the customer and loyalty to the bank were interlocked - a virtuous cycle that benefited everyone. Borrowers sometimes grumbled about heartless bankers who took away umbrellas when it started to rain, but overall the system worked out pretty well.

Therefore, banking used to be a rather mundane and boring business. Borrow at X, lend at Y after saying no repeatedly and collect (Y-X) as a small, but regular profit. Who do you think created the three martini lunch? "No, no, no, no"... Dow Chemical calls: "yes"...martini, martini, lunch, pie, coffee, liquer...."no, no, no". Go home. Collect modest salary at month-end and repeat until gold watch and pension. This post, however, is not intended to provide a full history of US banking. Suffice it to say that after the 1970's, inflation, high interest rates, dis-intermediation, the supremacy of capital markets and financial "innovation" have all resulted in the complete transformation of banking.

Today's banker acts as a disinterested merchant hawking his wares as cheaply as possible to any and all comers - marketing to the masses is everything (just look at the ads). Banks now make money on volume, not quality. Loans are originated elsewhere and gathered by the bank as an industrial meat-packer buys cows from hundreds of cattle-ranchers. They come in the front door as whole loans and are dis-assembled, sliced, diced, ground and shrink-wrapped into tranches and immediately sold out the back door as ABS/MBS hamburger in a myriad of sizes, qualities and prices. The bank-processors keep little or none of the loans on their books, depending instead on the slice & dice fees for their profits. Under this system, volume is not everything - it's the only thing.

The result has been an institutionalized collapse of lending standards. Banks don't even bother doing their own credit analysis any more, depending exclusively on independent credit bureau scores. And why not? They are just industrial scale merchandising operations concerned with "efficiency", "productivity" and "turnaround speed": Loans approved while-u-wait, Make-your-own-loan, Loan in yen for whatever you yearn, No money - No problem.

The astonishing amount of debt accumulated by the US and other western nations has come not just from low interest rates but, also, from a complete and total evaporation of traditional, sound banking practices. Fiduciary responsibility was summarily executed and buried years ago - RIP. But will it rest in peace? - or will the Financial Frankenstein Creatures slapped together by the so-called financial engineers, using nothing but starch glue and rubber bands, come apart at the first recession rainstorm?

What's more, another set of apprentice-sorcerer bankers got the transmutational idea of covering the patchwork Creatures with yet another layer of financial skein named "credit derivatives". What exactly is - literally - a derivative of credit? Do you boil a potential deadbeat in goose fat to distill and release his essential AAA-rating, one that was somehow locked up and hidden inside his worthless credit? How do you separate "credit" from "worthy"? In the end, "fides" has been reduced to "feed-us" (fees) - as many and as frequently as possible.

Today's Brave New Banking Corps is marching to the tune of "Semper Fee" right off the Debt Mountain cliff. No one would lament the crash and ruin of fee-fed fools, except that banks have the ugly propensity to take down whole economies with them.

Before it's too late, someone please bring back the Real Bankers (tm).

1 comment:

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