Mortimer B. Zuckerman's editorial "How to Fix a Market Failure" [May 19] suggests seven reforms that will neither fix the current market failure nor correct the system from this type of event happening again.
All of the suggestions together fail to get at the root cause of the current debacle. The problem is that he and others fail to recognize that one type of risk should not be allowed to be transferred. The main components of risk faced by these lenders are interest rate risk, inflation risk and default risk. Interest rate risk and inflation risk cannot be controlled by the lenders and thus can be hedged properly. Default risk can be controlled, modified and manipulated and this is where the source of the problem arises. Lenders knowing that loans will be repackaged and sold understand that they will not be subject to default risk and therefore fail to price and underwrite loans properly while passing this risk, as well as the other risks on while stripping the origination fees allowing them to start the process all over again. This is called moral hazard, the intentional failure of proper underwriting. Zuckerman fails to point out that it is proper to transfer or hedge against interest rate risk and inflation risk but default risk needs to be maintained by the original lender. To do anything less provides the incentive for this debacle to continue and to allow the market to fail all over again.
Saul W. Adelman
Zuckerman is correct as far as he goes regarding the multifaceted collapse of our financial markets. But he stops short of identifying the core cause: corporate executive and board compensation and privilege. We need only look at the recent (and others of the last decade) parade of executives, having failed miserably, often exercising clear negligence and lack of oversight, who have walked away with massive severance benefits leaving severely damaged companies, employees and owners behind. Or try to justify last year's bonuses ($39 billion) for the top management of five major financial companies, an amount equal to 50% of the losses ($80 billion) these "brilliant" employees generated so far. Our corporate structure and rules are broken. The executives and board members are swimming in the same money pool, focusing their attentions on stuffing their pockets instead of on their company duties. These personal distractions of greed leave the welfare of the owners—the stockholders—and the "lesser" employees as a distant afterthought. We have evolved into a system whereby obscene benefits accrue to top management for very short-term successes with no cost to them if the gains prove to be imaginary or temporary. It is this reward structure that has led directly to the leverage/risk follies of the innumerable convoluted and incomprehensible financial "products" whose value increasingly lies in their ability to avoid regulation and to obfuscate reality. Even more telling of the criminal-minded ethics that have evolved are the recent actions by several corporate boards to immunize the compensation packages of their CEOs from their failures. Today's corporate power balance between management, owners and the other employees is severely out of balance and totally irrational and in need of a major structural overhaul. The corporation is a creation of law and it is past time that the laws be revised to bring a return of responsibility, leadership accountability and healthy economic incentives to our business world.