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Short-Termism

Speaking of financial regulation, here's Steve Pearlstein on the rise of "short-termism":

The roots of this short-termism go back to the 1980s, with the advent of hostile takeovers mounted by activist investors. This newly competitive "market for corporate control" promised to reinvigorate corporate America by replacing entrenched, mediocre managers with those who could boost profits and share prices. In theory, the focus was on increasing shareholder value; in practice, it turned out to mean delivering quarterly results that predictably rose by double digits to satisfy increasingly demanding institutional investors. Executives who delivered on those expectations were rewarded with increasingly generous pay-for-performance schemes.

As fund managers grew more demanding of the short-term performance of corporate executives, investors became more demanding of the short-term performance of fund managers. To deliver better returns, managers responded by moving money from bonds and blue-chip stocks to alternative investments -- real estate, commodities, hedge funds and private equity funds -- where there was more risk, higher leverage and bigger fees. In time, the managers of these alternative investment vehicles began looking for new strategies to improve their results, and Wall Street was only too willing to accommodate with a dizzying new array of products.

At times, it seemed to work spectacularly. During the late '80s, the late '90s, and again during the recent boom, investors earned record returns and corporate executives and money managers earned record pay packages. But after the bubble burst in each cycle, the gains to investors turned out largely to have been a mirage, while the gains of the executives and the money managers remained largely intact.

But this isn't mere carping. The Aspen Institute has a new paper on rolling back short-termism across corporate America. And this isn't just any new paper. This one's cosigned by "billionaire investors Lester Crown and Warren Buffett; mutual fund pioneer John Bogle; Richard Trumka, the soon-to-be new president of the AFL-CIO; present and former corporate chief executives Jim Rogers of Duke Energy, Lou Gerstner of IBM and Henry Schacht of Cummins; retired Wall Street hands John Whitehead of Goldman Sachs, Pete Peterson of the Blackstone Group and Felix Rohatyn of Lazard Freres; Marty Lipton, Ira Millstein and John Olson, the deans of the corporate bar; and respected academics such as Bill George of Harvard and Lynn Stout of UCLA."

Worth a read, I'd say.

By Ezra Klein  |  September 11, 2009; 4:23 PM ET
Categories:  Solutions  
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Comments

The cited paper underscores another correctable defect in ERISA, stating that "While a legal standard exists, nevertheless, there is no mechanism to impose or incent the fiduciary obligation on a plan's investment decisions from the perspective of the plan's beneficiary interests. Furthermore, the Pension Benefit Guaranty Corporation (PBGC) does not have a mechanism or the mission to do so, despite being the agency that partially bears the failure of private pensions." The paper then makes the suggestion to "Modify ERISA allowable investment practices through rule changes to promote long-term investing by those investors holding equity in tax-advantaged accounts."

ERISA is a huge block of legislation, largely unenforceable: Justice Rehnquist had specific, rather snarky, thoughts on the matter. The President has already suggested some revisions to ERISA and the suggestions made in the cited paper would be useful as well.

Posted by: rmgregory | September 11, 2009 4:17 PM | Report abuse

Haven't read the paper, but it strikes me that a transaction tax of .025% on transactions of financial instruments (that's a mere 25 cents per $1000 or $2.50 per $10,000) would be an appropriate move. A long-term investor (which niow means holding investments a month or more) wouldn't notice it but the insititutional daytraders could contribute a little to the government's coffers and probably pay for both health care reform and financial industry oversight.

Posted by: Mimikatz | September 11, 2009 4:24 PM | Report abuse

we should be clear about this: by and large, a lot of people pocketed a lot of money through fraud.

as a result, they and their family are set for life, and their offsprings will have a tremendous head start.

but we are never to discuss class in america.

Posted by: howard16 | September 11, 2009 4:59 PM | Report abuse

Massive salaries to managers based on quarterly profits encourage people to strip-mine companies rather than grow them slowly over time. This should be perfectly obvious to any rational individual.

The only reason it's not perfectly obvious to the people on Wall Street and their minders is because they believe in the insane ideology that economic systems are "self-regulating." They actually believe that because it makes no sense to kill the goose that lays the golden eggs, we would never create a system that encourages us to do precisely that--in spite of the fact that throughout human history, we have done exactly this sort of thing on a pretty regular basis.

And, of course, now that we have bailed them all out, they believe they can be as short-sighted as they want, and nothing bad will happen. They'll stay rich, and reporters will occasionally mention foreclosures in California, and it's all no biggie.

All these specific recommendations need to happen--but we also have to recognize that the natural state of an unregulated economy is not harmony. It is spectacular wealth inequities as well as booms/manias in useless goods, followed by nation-destroying crashes.

Posted by: theorajones1 | September 11, 2009 8:07 PM | Report abuse

Dear Ezra,

I believe this post is subject to false nostalgia.

Short-termism is not a recent phenomenon that started in the 1980s with the rise of LBO/private equity titans and the like. The same occurred in the 1970s with Nixon Shock, which focused on short-term price controls, opposing all sane economic reason. It occurred in the go-go 1960s with the rise of conglomerates that beefed up EPS (earnings per share) via the faulty accounting of small, fast-growing acquisitions (even despite overpaying for them)--a fact that they would soon rue in the coming market bust.

The same short-termism has plagued man-kind since time-immemorial. Remember the rash decision of Spartan youths to forsake the sage advice of Archidamus to wait and be patient in Thucydides' Peloponnesian War?

It is more likely that we are a rash species--part and parcel of that crooked timber of mankind. To fight against this tendency to see only what is in front of us at the cost of our long-term survival and gain, we have created laws, education, structures, and institutions to help mediate this impulse.

I agree that we need to refine and perhaps revolutionize these laws and structures, but please do not fall into this false nostalgia for the past. We often see the same rhetorical device used by the Republican party (ex. "small town America", "old-fashioned American values", etc.). Such sophistry helps to evade the issues at stake.

Kindly,
A reader.

Posted by: shelata | September 12, 2009 4:45 AM | Report abuse

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