Follow the Risk

Follow the Money Risk

In the past when we tried to sort out causes and motivations, a good rule was follow the money. But in our present circumstances it works better to follow the risk. A fundamental notion of capitalism is that profit is the reward for accepting the risk of entrepreneurship.

My late father-in-law, Ed Chandler, grew up in the Great Depression, and after finishing college he was jobless. His dad had quite literally lost the farm when the margin loans he had taken to speculate on stock were called. Ed ended up riding the rails as a hobo looking for work. It's a long and interesting story, but Ed went from being a hobo with only seventy five cents in his pocket to being the respected owner of several businesses and a multi-millionaire.

What distinguished him and made him successful was luck, an uncanny ability to see business opportunities, and a willingness to take big risks. On several occasions he literally bet everything he owned on his next venture. Often he had no detailed plan; he just forged ahead with unswerving confidence that whatever challenges came up, he would be able to work things out as he went forward. Business plans, pro-forma projections of income and expense, were bean-counter concepts he never bothered with unless some conservative banker forced him to. 

Not every enterprise Ed launched was successful, and some cost him dearly, but he persisted and ultimately he was rewarded with enough success to leave a business legacy that continues to prosper today.

Sadly this is not the model of the corporate executive of the 21st century. Golden parachutes, huge retention bonuses, and bloated compensation packages completely insulate and buffer today's captains of industry from the business risks they pilot their enterprises through. There is no real downside for them. If the company goes bust, they take a vacation secure in the knowledge that most of their personal wealth is safe.  Sure, some of those stock options aren't worth what they hoped, but at no point is their lifestyle at risk. (My father-in-law bet home and hearth on his business judgment. The grocery money was sometimes at risk.)

The infamous Credit Default Swaps (CDSs) were, of course, a tragic example of ill-advised shifting of risk away from profit. And the underlying sub-prime loans created financial risks that far exceed the borrower's ability to cover. Yes, many of those borrowers have now lost everything to bankruptcy, but a substantial share of the risk was assumed by lenders who should have anticipated that these loans had more risk than the borrower could hope to make good on when the real estate bubble burst.

Actually, most of them probably knew of that risk, but it wasn't their money they were gambling. Those lenders were large institutions, the actual people who made the loans, employees of the institutions, lost only their jobs.  Or did they?