The Sales Solution: E=mc²

 

 The Sales Solution: E=mc²


In the wake of the 2008 financial crisis, we were confronted with an entire generation of people who had been out of work for so long that they simply gave up on finding a job. With no prospects and no plans, these Americans found themselves looking for alternative ways to survive. This blog is dedicated to discussing how some companies attempted to address the problem by encouraging their employees to embrace entrepreneurship as a means for creative problem solving and economic growth.

The best way forward is not clear yet, but there are many things that still need to be done if we hope get out of this mess in the fastest possible time. We will try to discuss them in this blog, starting with the main culprit of our current problem: lack of innovation.


We all know what happened. Banks and other financial institutions grew at an almost exponential rate, and then on a night of October 3rd 2008, everything collapsed. The bailout effort was hastily put together, building upon the old $700 billion Troubled Asset Relief Program (TARP). A new administration took place in 2009, led by President Barack Obama who promised to change the way business is conducted in America. This blog will discuss how this turned out.

For today though, let us speak about the companies that we all know are responsible for our problems today: banks.

To really understand what happened, one also has to understand what caused the crisis. A simple but incomplete explanation would be that banks made bad loans and then defaulted on them. Or they bought too many houses or car loans and didn't sell them fast enough, leading to negative equity and then a loss of trust in the banking system.

This is how the topic is normally explained. But in fact there is more going on. Banks were indeed making bad loans, but they are not the main culprits of our current situation. Banks themselves are regulated by the Federal Reserve Bank, a federal agency that is supposed to ensure that banks don't make bad loans. So we find ourselves in a situation where banks made bad loans, but they also borrowed money from the Fed in order to keep moving forward and make even more risky decisions.

As a result, it is clear that there was another cause at play here. In fact, there were two causes: financial innovation and a faulty monetary policy approach — or E=mc² .

Financial innovation was the concept of bundling assets together and selling them as fast as possible in order to attract investors. People often find it funny how in the past everyone wanted to buy individual stocks, but now the same people are buying bundles of different assets together and selling them as fast as possible. The World certainly is a strange place we have adventured too far into…

When bundled together, these assets are called financial derivatives. But these bundles were sold to a public that was unprepared for what it was going to be getting: an avalanche of risks. In fact, these financial derivatives were really nothing more than a game of chess with a lot more pieces on the board.

Banks kept on making bad loans even until late 2008 when they could no longer afford the interest payments that were coming from their growing derivative portfolios. This is because financial derivatives are essentially bets on future movements of the underlying assets. To give you an example: if Microsoft stock goes up, then the person who has bought a call option will make money, but this doesn't mean that the bank holding this derivative position is going to make money. In fact, they might be losing money. The same goes for other types of derivative contracts and most of them were designed by the large banks in order to show a lot more value on their balance sheets than they actually got.

The worst aspect about these contracts was that they didn't reveal their risks upfront to investors and instead hid them in small print or just avoided mentioning them altogether.

The result of this financial innovation is that most investors were not aware of the risks they were taking and the big banks could continue to make bad loans. In fact, financial innovation actually worked in only one way: it helped to hide the debt that banks had on their balance sheets instead of showing their complete financial health.

The central bank also contributed to this failure as they chose a monetary policy approach that was too loose and made it possible for so-called "casino capitalists" to take enormous amounts of risk without any consequences. The fact that central banks kept on lowering interest rates until they reached nearly zero also made it possible for large banks to borrow a lot more money.

I should also mention that there is a theory held by some economists, most notably Nassim Taleb, which states that the banking sector was never meant to be as big as it became in the first place. According to this theory, our current financial system is unsustainable and built on no real principles. This has led to yet another problem: economists are looking at the past and applying old models in order to find solutions for our problems.

This is what Nassim Taleb stated in an interview with Charlie Rose:

The world we live in is not one where you have a discovery and then the technology rolls out gradually. We live in a world where you have the discovery, and then it becomes a big business, and only after that does the technology die. And that's what happened to derivatives, which are not a financial phenomenon — they are a technological phenomenon. They were born as an option pricing tool; they didn't exist before 1950 or so. But over time, as people are making money from them and getting rich from this kind of business of selling options, it became an economic force in its own right.

Basically what he is saying is that the system we have now is unsustainable and will most likely collapse.

While derivatives are blamed for most of our current issues, I feel that it is only one of many causes. The financial crisis was not a single event, but instead a whole complex network of events linked together to create what we've seen today. Financial innovation also enabled a huge shadow banking sector to develop which was unregulated and mostly unregulated by the Federal Reserve Bank. The Fed couldn't regulate them because they were not considered banks, even though they behaved like banks and performed very similar functions as traditional banks did.

If the shadow banking sector was regulated, then perhaps the financial crisis would have never happened.

I also blame the Fed for being too lax with monetary policy and allowing these casinos to develop under their very own noses. This also let many banks take enormous risks that they otherwise would not have taken, which resulted in bad loans and sub-prime mortgages that were sold to people who could not afford them. All of this was made possible because of a lack of regulation and supervision by the Federal Reserve Bank.

Conclusion

The financial crisis has been a long, painful process that continues to affect us today. From the housing bubble bursting in 2007 to the current collapse happening in Greece and other countries, we see that our economic system is still far from being fixed.

Many people were hurt by this process and many are still suffering from its aftermath. Unfortunately, I don't have all the answers for how we can fix this system or prevent another one from destroying it again. All I know is that if we don't change our current monetary policy and early warning systems, then another crisis will come to pass sooner than we think.

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