Category Archives: Artículos

What Managers Really Do

Managers, to Henry Mintzberg’s way of thinking, don’t get enough respect.

While plenty is written about leadership these days, Dr. Mintzberg, who is the Cleghorn professor of management studies at McGill University and a well-known management scholar, finds that there is surprisingly little serious study of managers and the essential work they do in organizations.
Dr. Mintzberg is out to change that. Back in 1973, he published a book called “The Nature of Managerial Work,” based on his doctoral dissertation at MIT’s Sloan School of Management. In that research, Dr. Mintzberg studied what managers actually do — by following five executives through a workweek.

16Aug09 – Wall Street Journal


Business Insight Report: What Managers Really Do

By Andrew W. Lo

Mintzberg has now returned to the subject with a new book called “Managing,” due out in September. For his latest book, Dr. Mintzberg again studied managers in action. This time he observed how 29 of them — from a CEO of a major bank to a manager of refugee camps — each spent a day. What he found were jobs filled with interruptions and activity, and varying widely by the type of organization.

Dr. Mintzberg spoke with MIT Sloan Management Review senior editor Martha E. Mangelsdorf for Business Insight. Here are edited excerpts of the interview.

BUSINESS INSIGHT: In your new book, you say there are a number of misconceptions about management. Can you talk about what some of those are, and what the reality is?

DR. MINTZBERG: The great myth is the manager as orchestra conductor. It’s this idea of standing on a pedestal and you wave your baton and accounting comes in, and you wave it somewhere else and marketing chimes in with accounting, and they all sound very glorious. But management is more like orchestra conducting during rehearsals, when everything is going wrong.
Peter Drucker said the manager is both composer and conductor. It’s very grand and glorious, but I think it’s a myth.
Then there are all these lists of the qualities of the effective manager. So I said, well, for the sake of a better world, here’s a comprehensive list of the qualities of an effective manager, combined from all the lists — and there are 50 or so items on it! Put kryptonite on the list, and even Superman wouldn’t succeed as a manager.
So I talk about what I call “the inevitably flawed manager.” We’re all flawed, but basically, effective managers are people whose flaws are not fatal under the circumstances. Maybe the best managers are simply ordinary, healthy people who aren’t too screwed up.

BUSINESS INSIGHT: Another aspect of management that your research, and apparently other research, reveals is the high degree of interruptions that managers face.

DR. MINTZBERG: Yes, that comes out of my original doctoral thesis, but it’s held up throughout the years: Management is largely about interruption. But email — and especially BlackBerries in the pocket and all that — really makes it much worse.

BUSINESS INSIGHT: Suppose you were meeting with a group of new managers who were just about to start their first day on their managerial jobs, and you had a few minutes to share some ideas with them, things they should know about the jobs they’re about to start. What would you tell them?

DR. MINTZBERG: Be prepared. It’s going to be a lot of interruption, a lot of pressures. And I’d go through the three kinds of planes — that you have a choice of managing through information, or through people, or through action. You’re going to manage through all of them, but understand the difference and understand the choices.

BUSINESS INSIGHT: You talk about the three planes. Tell me a bit more about that.

DR. MINTZBERG: Basically, managing is about influencing action. Managing is about helping organizations and units to get things done, which means action.

Sometimes managers manage actions directly. They fight fires. They manage projects. They negotiate contracts.

One step removed, they manage people. Managers deal with people who take the action, so they motivate them and they build teams and they enhance the culture and train them and do things to get people to take more effective actions.

And two steps removed from that, managers manage information to drive people to take action — through budgets and objectives and delegating tasks and designing organization structure and all those sorts of things. Today I think we have much too much managing through information — what I call “deeming.” People sit in their offices and think they’re very clever because they deem that you will increase sales by 10%, or out the door you go. Well, I can do that. My granddaughter could do that; she’s four. It doesn’t take genius to say: Increase sales or out you go. That’s the worst of managing through information.

BUSINESS INSIGHT: What’s the alternative?

DR. MINTZBERG: The alternative is to give more attention to the people plane and the action plane. Even when you’re managing information, you can manage in a much more nuanced way than just shooting a bunch of figures around.

For Further Reading of related articles from MIT Sloan Management Review can be accessed online at

Socially Profitable

By David Alvarez Rivas.

“The fall of Wall Street is for market fundamentalism what the fall of the Berlin Wall was for communism. We are drowning. If we look at inequality in the world, which is the most we have seen since the Great Depression, we have a very big problem”. These are the reflection of Joseph Stiglitz, Columbia Professor of Economics and Winner of the Nobel Prize in Economics in 2001.


Stiglitz was also the Senior Vice President and Chief Economist at the World Bank for a number of years, so his criticism of the International Financial System is legitimate, coming from inside the system.

The origin of the “Crisis of all Crises” is in the unmeasured avarice of banking institutions, offering mortgages to families knowing that it was impossible to guarantee payments, the so-called Sub Prime Lending System.

In the current context of globalization, financial institutions including international institutions such as the International Monetary Fund and the World Bank, play a key role in channeling money according to international policy, which is too often overlooked by citizens scrutiny.

The trail of money often damages both our natural environment and social equity; both financial institutions don’t accept responsibility for the social and environmental damage caused by their transactions. Like companies, they are concentrated on maximizing their stock value, and like financial professionals they are looking to maximize their earnings.

As the main actors in the global economy, financial institutions should accept a compromise with sustainability practices. They most also recognize that voluntary social responsibility measures are currently not sufficient.

The question that arises is: Are there other ways of acting in banking and finances, which create positive societal impact with their investments? The answer is yes, and though it might seem like an oxymoron, the answer is: Ethical Banking.

There are services and products that not only create economic gain, but also offer transparency in investments, social and environmental benefits, and labor rights.

The origins of Ethical Financing can be traced back to the 1960′s and 1970′s in the center and north of Europe and the US, encouraged by environmental and peace groups.

There are various banks and organizations in the World that practice Ethical Banking, whose objective is a more just and responsible use of money. It is a system that values socially consciousness initiatives and projects that benefit our social and environmental surroundings, which normally don’t receive financing from any other source.


Alvarez, D. (2009, November 12). “Socially Profitable”. The News, p. 8.

A Morgan Stanley star falls in China

By George Chen and Steve Eder

SHANGHAI/NEW YORK (Reuters) – In the end, Garth Peterson, a rising star at Morgan Stanley in China, was undone by his pursuit of “guanxi.”

A central concept in Chinese society, guanxi loosely translates as “connections” and relationships.” But to Chinese people, it means much more than that: Guanxi equals power.

“Sometimes, money cannot buy you guanxi. But if you have guanxi, you will definitely have money,” according to a Chinese saying.


When Peterson, an American then in his early 30s, joined Morgan Stanley’s  real estate investment operation in China about eight years ago, he had not yet accumulated much guanxi. But he would soon possess a surplus, fueling his rapid ascent at the bank.

With his blond hair and blue eyes, he spoke fluent Mandarin and the Shanghai dialect, and was described by his Morgan Stanley colleagues as a serial networker, making friends with the sons and daughters of powerful Beijing and Shanghai leaders and charming the Chinese executives of multinational corporations.

His downfall, however, was just as precipitous. Morgan Stanley fired Peterson in December amid suspicions that he had violated the U.S. Foreign Corrupt Practices Act, a law meant to crack down on bribes being paid to public officials overseas.

Morgan Stanley, which voluntarily reported the case to the U.S. authorities, declined to comment on its specifics.

After a nine-month internal investigation, the bank has turned its findings over to the U.S. Department of Justice and U.S. Securities and Exchange Commission, which have opened their own probes, according to an investor letter obtained by Reuters.

“Based on the investigation to date, it is believed the possible violations were centered on the conduct of a single former employee in the Shanghai real estate office,” according to the letter dated October 29 to Morgan Stanley real estate investors.

At a time when the U.S. and Chinese economies have become increasingly intertwined, the Peterson case illustrates the potential peril of doing business in China, where more and more foreign companies are hoping to take advantage of the world’s most dynamic economy.

In early 2008, Morgan Stanley Real Estate sent Peterson to a Foreign Corrupt Practices Act workshop, where he was briefed by lawyers who advise on how to avoid conflicts, bribery, and related fraud, according to a source with direct knowledge of the matter.

The firm’s concerns about corruption are well-founded. U.S. companies often cite China as a nation where there are significant risks and challenges of complying with the Foreign Corrupt Practices Act. A study by Deloitte in May said more than nine in 10 U.S. businesses are worried about the potential for FCPA violations while doing business in China. And the Department of Justice is ramping up its prosecution of FCPA cases globally.

An October report by law firm Shearman & Sterling showed that at least two dozen U.S. companies have had recent FCPA issues involving China, and at least nine have ongoing investigations. Recent and ongoing investigations have touched such companies as Siemens AG, Avon Products, and Avery Dennison Corp.

Peterson, who according to his former Morgan Stanley colleagues now lives in Singapore, could not be reached for comment. Interviews with those who know and have worked with him say his story is one of an ambitious and hard-working expatriate who appears to have crossed the line in his zeal to get ahead in the Chinese business world.


Peterson joined Morgan Stanley Real Estate’s Hong Kong Office in mid-2002. A University of Chicago MBA graduate and a former associate of JPMorgan Chase & Co, he was hired as an associate to focus on China properties. But his natural networking ability and language skills helped him gain a quick promotion.

Beginning in early 2003, he traveled frequently to Shanghai, often spending entire months in China’s booming financial hub to help Morgan Stanley Real Estate accelerate its expansion. It was Peterson’s job to identify and complete real estate deals in China.

Peterson was promoted to vice president in 2003, and then executive director two years later; in early 2006, he relocated to Shanghai. Once there, he taught himself the local dialect, which helped him get even closer to local officials and businesspeople.

After a series of hugely profitable investments, Morgan Stanley appointed Peterson a managing director in December 2007, making him responsible for property investments across the nation.

That year he married a woman from Singapore and bought a luxury apartment in downtown Shanghai for his family. Friends say he would often escort his daughter in person to her historic kindergarten in Shanghai named after the wife of Sun Yat-sen, the revolutionary and political leader referred to as the father of modern China.

The school is known for attracting the sons and daughters of the influential. Getting in requires guanxi.


At around this time, Peterson developed what sources describe as a swagger that rubbed some colleagues the wrong way.

“I can understand why he is cocky,” said one former colleague of Peterson. “Blame his fast promotion and high pressure.”

The source added, “In Peterson’s role, you have to appear tough, strong and even sometimes arrogant. That’s the nature of the job. It’s a rich job but it can also be very distressing.”

In the property investment industry, the two most important roles are buyer and operator.

Peterson’s role was always the buyer while Robert Naso, a Morgan Stanley Real Estate executive director in Shanghai, was the operator. Naso would improve the projects or properties acquired by Peterson, and then help market them to a new buyer for a higher price. The two worked closely, according to one former colleague.

In May 2008, Naso was transferred to Singapore with a new title — Asia head of asset management for Morgan Stanley Real Estate. Five months later, Peterson’s boss, Zain Fancy, a Pakistani who was based in Hong Kong, announced he was leaving.

His departure was followed by three others. Sonny Kalsi, Morgan Stanley’s global head of real estate, was dispatched to the Shanghai office to pick up the pieces.

From Singapore, the firm’s Asia management team launched a region-wide review in mid-2008 of all major Morgan Stanley Real Estate projects in Asia. The review was initially intended as a reassessment of investment strategies, giving Asia project managers like Naso a full picture of Morgan Stanley’s regional portfolio.


During the review, some projects handled by Peterson were reported internally by Morgan Stanley compliance officers for “suspected problems”.

Peterson was fired in December 2008. In February, the firm announced in a regulatory filing that it had uncovered actions by an employee in China that “appear to have violated the Foreign Corrupt Practices Act.”

Sources identified that employee as Peterson.

As a result of the disclosure, the firm put Kalsi and Andrew Yoon, the chief financial officer for the Asian real estate business, on administrative leave. Kalsi recently resigned from Morgan Stanley, but Yoon is planning to return to the firm.

A spokeswoman for Kalsi said “Morgan Stanley’s internal investigation found no evidence that Kalsi caused or authorized the alleged misuse of assets.” She added that he played “a key role in initiating Morgan Stanley’s internal investigation.”

Morgan Stanley lawyers interviewed employees and reviewed more than 7.4 million pages of e-mail and related documents, all at Morgan Stanley’s expense, according to the investor letter.

The investigation found that in a “discrete number of instances, investment assets were used for improper purposes not authorized by senior management,” the letter said.


Cultural differences make China an especially tough place when it comes to corruption.

What might be seen as a bribe in other countries too often is seen as “just business” in China, said Philip Urofsky, a former U.S. Department of Justice attorney who holds the distinction of trying more Foreign Corrupt Practices Act cases than any other DOJ attorney.

“It’s a gift-giving culture,” said Michael Pace, a senior managing director for FTI Consulting in Chicago and a former federal prosecutor. “When the government or a government-owned entity is your customer, there can become serious FCPA question by even giving modest gifs.”

Blake Coppotelli, a senior managing director in the New York office of the risk consultant Kroll, said he is seeing an increase in clients with concerns about doing business in China.

“It is just accepted practice that government officials at the local level or higher might have some expectation of benefits being provided,” Coppotelli said. “The problem is that it has been endemic and breaking that endemic cycle and breaking the cultural acceptance of it takes time.”


There was nothing subtle about Peterson’s pursuit of guanxi — and riches.

In July 2003, Morgan Stanley Real Estate and Shanghai Yongye Group announced their first partnership — a roughly $90 million investment in a real estate project to build a top-end apartment building in the Xintiandi area, a famous bar and nightlife area in downtown Shanghai.

As a result of that deal, Peterson became more influential in Shanghai’s property and government circles.

Shanghai Yongye was backed by Shanghai’s local Luwan district government. Luwan is to Shanghai as midtown is to New York city. Shanghai Mayor Han Zheng is a former Luwan district chief.

Wu Yonghua, former chairman of Shanghai Yongye Group, was a friend of Peterson’s who introduced him other Chinese officials, expanding the American banker’s guanxi network.

Wu’s daughter, Linda Wu, was hired by Peterson to join Morgan Stanley Real Estate’s Shanghai office as an associate after she finished her studies in the United States. She resigned around the same time Peterson was fired in late 2008.

A source with direct knowledge of the situation told Reuters that U.S. and Chinese investigators were interested to know more about the connections between Wu Yonghua, Wu’s daughter and Peterson and wanted to investigate if her hiring was part of a quid pro quo.


About one year after the first Shanghai Yongye project, Morgan Stanley Real Estate announced an alliance with Shanghai Dragon Investment Co, a low-profile but highly important investment arm of the city government.

The purpose of the partnership was to seek investment opportunities in Shanghai’s real estate deals, according to Chinese media reports at that time.

The deal came complete with guanxi opportunities. Shanghai Dragon was led by a government entity. Chen Liangyu, Shanghai’s then-Communist Party Chief and effectively the city’s top boss, often oversaw Shanghai Dragon directly.

Shanghai Dragon rents a villa in the Xingguo Hotel as its office. The Xingguo Hotel, a state guest house near the U.S. Consulate-General in Shanghai, was one place where Mao Zedong, the founder of the People’s Republic of China, and his third wife, Jiang Qing, often stayed.


In late 2006, Chen was detained by investigators from the central Chinese government amid a snowballing corruption probe, which cost dozens of senior Shanghai and Beijing officials’ jobs or even lives.

Between 2007 and 2008, the city’s state asset supervision commission, which was in charge of Shanghai Dragon, was shaken up as most senior officials at the commission were arrested, sentenced or fired.

Shanghai Yongye’s Wu, a government official-turned businessman, resigned in mid-2007 amid a widening investigation into senior Shanghai officials, including a long-time strong government ally of Wu.

When Beijing sent dozens of investigators to Shanghai for the Chen Liangyu case, some officials suspected connections between Peterson and Shanghai officials, but evidence was scant, according to one government source familiar with the situation.

At the time Peterson was fired by Morgan Stanley in 2008, Beijing investigators were alerted and monitored the Peterson case closely, the government source added.

The investigation by the Shanghai city government targeting local officials related to the Peterson case is still ongoing, according to the government source.


Once the investigations conclude, Peterson plans a second act in the real estate investment industry, a friend said.

He is unlikely to be jailed as he and the firm are expected to pay damages and fees, possibly through a deferred prosecution agreement, said industry sources who were not directly involved in the Peterson case but familiar with similar FCPA cases.

Peterson, meanwhile, is now living in Singapore. He told a friend that he is unlikely to return to China, but would explore other emerging markets in Southeast Asia.

Wherever he ends up, he won’t be able to count on his guanxi.

(Reporting by Steve Eder in New York and George Chen in Shanghai; Editing by Jim Impoco)

El BID y el sistema financiero latinoamericano

Artículo creado por Carolina Villalba.

El sector bancario está cambiando en todo el mundo por la transnacionalización de las finanzas, los cambios en las tecnologías de la información y la creciente flexibilidad en las normas de regulación. La competencia entre los bancos aumenta; en algunos casos, los márgenes de ganancia se reducen, y en otros, crece la fusión entre las empresas. América Latina no escapa a esos cambios.


La importancia del sector bancario se mantiene. Puede constituir tanto una opción para fortalecer la inversión doméstica como una vía para la fuga de capitales; puede servir para apoyar actividades como el acceso a la vivienda o la reconversión industrial, pero también pueden ser meros agentes de especulación financiera. En este contexto, un reciente informe anual del Banco Interamericano de Desarrollo (BID), Desencadenar el Crédito. Cómo ampliar y estabilizar la banca, presenta el sector bancario como elemento central y aborda cuestiones como el costo, la estabilidad del crédito bancario y sus determinantes así como los riesgos subyacentes característicos de la actividad bancaria. Por lo tanto es importante revisar la situación de los bancos y abordar algunas cuestiones clave que el BID ha olvidado.
El sector bancario de América Latina continúa concentrándose, la presencia de los bancos estatales se reduce y aumenta la de empresas privadas, en especial de origen extranjero. Esta última ha aumentado sustancialmente, especialmente debido a que las reformas económicas llevadas a cabo en América Latina permitieron la apertura de la economía y sobre todo del sector financiero.

Por ejemplo, entre los diez primeros puestos de la lista de los 250 bancos más grandes de América Latina se observa que tan sólo dos son estatales; en cambio, ocho son privados, de los cuales cuatro son de origen nacional y cuatro de origen extranjeros. Según datos del BID, el 65% de los préstamos totales en moneda nacional son otorgados por filiales de bancos extranjeros.

A pesar de ello, la banca estatal sigue teniendo una presencia destacada en Latinoamérica, aunque su importancia se haya visto reducida. Los bancos públicos desarrollan en muchos casos una actividad de mayor compromiso social, ya que participan en proyectos públicos de financiamiento de sectores prioritarios de la economía -como el agro, la vivienda y el comercio exterior- en los que la banca privada se muestra más reacia a otorgar créditos. Pero desde la perspectiva ortodoxa empresarial, el eje de las evaluaciones está en las tasas de retorno y los intereses devengados, y variables como la generación del empleo pueden ser irrelevantes o incluso negativas si aumentan los costos de producción. Este problema justificaría intervenciones contrarias a las actuales, ya que se debería potenciar el crédito hacia proyectos que pueden resultar restringidos en el mercado.

A pesar de estos y otros aspectos positivos de los bancos estatales, el informe del BID ofrece una evaluación crítica. Según su análisis, los bancos estatales no desempeñan un papel útil en la expansión del crédito ni en su canalización hacia empresas pequeñas o sectores más necesitados. El BID llega a afirmar que no existen pruebas sólidas que indiquen que la presencia de los bancos estatales aumenta el crédito, a pesar de que su propio informe muestra datos de que las tasas de interés de los bancos públicos son más bajas que las de los bancos privados nacionales. Es más, luego de las crisis que han asolado a la región, se observa que la banca pública logró recomponer sus depósitos más rápidamente que los bancos privados, con lo cual se convirtió en un factor clave de recuperación. En muchos casos la gente se ha visto defraudada en esas situaciones cuando el sector bancario extranjero no respondió tal como se esperaba, sino que, la mayoría de las veces, simplemente abandonó un país cerrando sus oficinas.

Otra paradoja reveladora en el informe del BID es su crítica a medidas que ahora considera deficientes para el sector bancario, pero que antes había apoyado. Entre las medidas ahora criticadas se encuentran la dolarización financiera, la alta inflación, la excesiva toma de riesgos y las políticas comerciales restrictivas.
En la medida en que los bancos tienen las llaves de los créditos que se otorgan para los más diversos proyectos, sus decisiones tienen enormes efectos potenciales en el terreno social y ambiental. Por ejemplo, un banco puede otorgar préstamos para un emprendimiento de alto impacto ambiental si le asegura una buena rentabilidad, o puede negar fondos para una iniciativa social por el temor a que el retorno no sea el adecuado. En América Latina se han sucedido muchos ejemplos de financiamiento de emprendimientos de alto impacto social y ambiental donde los bancos que otorgaban los fondos no incorporaron ningún análisis de esos efectos. Las posturas más modernas reconocen que las evaluaciones ambientales y sociales deben ser incorporadas al estudiar un posible préstamo. La experiencia indica, incluso, que un impacto ambiental genera costos económicos que pueden poner en riesgo los emprendimientos y por lo tanto la recuperación del préstamo en sí mismo.

Varias iniciativas promueven compromisos ambientales y sociales entre los bancos, buscando determinar cuales son los “mejores proyectos” para proveer préstamos. Un ejemplo de ello son los “Principios Ecuador”, la declaración de instituciones financieras acerca del ambiente y desarrollo sostenible del PNUMA (Programa de las Naciones Unidas para el Medio Ambiente), y la “Declaración de Collevecchio” que refleja la posición de organizaciones de la sociedad civil. Poco a poco esta visión aparece en la región; por ejemplo, los “Principios Ecuador” han sido incorporados voluntariamente por 31 bancos en todo el mundo, de los cuales 14 se desempeñan en Latinoamérica. Pero el BID no considera en su informe ninguno de estos aspectos.

Aparentemente el BID no ha estimado necesario dedicar un espacio a cuestiones como la evaluación social y ambiental de los proyectos. Tampoco apunta a establecer compromisos o códigos de conducta similares a los ya existentes, y ni siquiera manifiesta su apoyo a ninguna de las iniciativas actualmente en marcha. Por estas razones, el informe del BID no refleja adecuadamente ni la importancia ni las opciones de reforma del sector bancario para América Latina.

The Gray Swan

By Leo Melamed

Peking University
Final edition
Beijing, China
April, 12, 2009

Some people in the financial world claim that the global meltdown that has occurred in financial markets is an example of a “Black Swan” event-random and unexpected. In other words, it was an occurrence that so deviated beyond what is normally expected that it was extremely difficult to predict.


The black swan, of course, is a large waterbird, Cygnus astratus, and is common in the wetlands of south western and eastern Australia. It is the official state emblem of Western Australia and is depicted on its flag. But the history of this rare bird is steeped in myth. It was first described in 82 AD by the Roman satirist Juvenal who used the term “black swan,” to depict a creature that did not exist. Aristotle used examples of white and black swans to distinguish reality with the improbable. Thus, for most of history the black swan lived as an allegory for something that did not exist. That myth was exploded in 1790 when the black swan was discovered by English naturalist John Latham. It suddenly proved the existence of the improbable. That revelation gave rise to some deep philosophical discourse. As Nassim Nicholas Taleb explained in his brilliant best selling 2007 book, “The Black Swan,” the belief “all swans are white,” is based on the limits of our experience. In other words, some occurrences are unpredictable because they deviate so far beyond what we can expect.

Was this the case with the causes of the current financial crisis? Was it a black swan event? I have my doubts. Sad to say, in my opinion, much of it was predictable. To put it another way, I will argue that the financial meltdown was a “Gray Swan” event.

Let’s begin by stating that the primary underlying factor for the boom and bust that occurred was easy money. During the past decade central bankers allowed the financial world to became awash with liquidity. This was true for Europe, Asia, and certainly for the U.S. The American Federal Reserve held its target interest rate, especially, from June 2003 to June 2004 at one percent, well below historical levels and guidelines. Easy money led to global excesses and a pyramid of debt. In my opinion, it was the root cause of most of the problems.

Second, because easy money means low interest rate structures, there was a global pursuit by investors-businesses, banks, financial firms and individuals-to find means to enhance their returns. That is a predictable consequence. It is also no secret that by definition higher returns means higher risk. One modern-day approach to achieve a higher return was through over-the-counter (OTC) derivatives. Beginning in about 1988, investment banks found ways to repackage trillions of dollars in loans, selling them off in slivers to investors around the world. It began with the introduction of a financial derivative known as a Collateralized Debt Obligation, (CDO), or Structured Investment vehicle (SIV). The value and payments of these asset backed securities were derived from a portfolio of underlying assets that were packed into the instrument: e.g., corporate bonds, emerging market bonds, asset backed securities, subprime and other mortgage backed securities, REITs, bank loans, and student loans. There was little regulatory oversight. During the next decade and a half, CDOs and SIVs became the fastest growing sector of the asset-backed synthetic securities market and were sold to investors over-the-counter. The greater the risk pieces of a CDO or SIV, the greater returns to their investors. Rating agencies would rate the tranches being sold without fully understanding the totality of the risks involved. It was a recipe for disaster.

Here, I must digress. When talking about the derivatives markets it is imperative to understand the difference between OTC traded derivatives and exchange traded futures which are sometimes also referred to as derivatives. The two instruments of finance are galaxies apart and must not be confused.

First and foremost, OTC markets do not have the protective components of the futures exchanges, namely: daily mark-to-the-market value adjustments, margin deposits, price and position limits;
In the OTC markets it is up to the banks to set the reserves for their open positions while at futures exchanges margin requirements are set by an independent entity-the clearinghouse;
OTC markets do not have the guaranty of a central counterparty clearing system (CCP);
The hallmarks of exchange traded instruments are their disclosure and transparency procedures;
In the OTC market the original contract remains in place, sometimes for many years, increasing the total size of the market even where an economically offsetting transaction is in place. Not so in futures where an offsetting position eliminates the original contracts and the obligation they represent;
The OTC market greatly overshadows the exchange traded market, something on the order of five times as large;
The OTC markets generally lacked the regulatory control of federal authorities to which futures and options exchanges are subject under the Commodity Futures Trading Commission (CFTC).
These differences are dramatic. While nothing is perfect and no one can foresee all eventualities, the structure and procedures at regulated futures exchanges represent a time-tested mechanism-the very essence of their default-free success. On regulated exchanges, not only are there daily clearing mechanisms, there can be no doubt about the integrity of their daily settlement procedures. On the other hand, in the OTC derivatives market, values are often measured on the basis of the original model when the instrument was created. Rating agencies make a value determination at that time. Over time, without some form of an updating mechanism, these valuations can become stale or meaningless.

Consider: In stark contrast to the turmoil of recent events, the CME clearinghouse has operated for more than 100 years without failure. Consider, during the current unprecedented financial crisis, as marquee names of finance such as Bear Stearns, Lehman Brothers, Merrill Lynch, and Bank of America failed or trembled, the CME performed its operational functions without a disruption. No failures, no federal bailouts. As I stated, OTC derivatives and exchange traded financial futures are galaxies apart.

That is not to say, that OTC derivatives are to be banned or feared. That would be unthinkable. For the vast majority of financial managers, whether OTC or exchange traded, these risk management tools work exceptionally well. It is estimated that over 90% of the world’s 500 largest companies-domestic and international banks, public and private pension funds, investment companies, mutual funds, hedge funds, energy providers, asset and liability managers, mortgage companies, swap dealers, and insurance companies-use OTC derivatives to help manage their business exposure. Nor could it be different in today’s complex and interdependent financial world. Indeed, if OTC derivatives application were suddenly not available in business today, they would have to be invented. Without them, it would be like going back to the Stone Age. Still, the lessons learned must be applied. It is imperative that OTC derivatives have a measure of regulation, transparency, and disclosure of attendant risks.

The third consequence stemming from easy money was unconscionable leverage that occurred throughout the world within some financial enterprises, mainly investment banks and hedge funds. In the U.S., the government played a central role. In 2004 the Securities Exchange Commission (SEC) removed the historical ratio limit between debt to assets of about 12 to 1 and allowed it to go over 40 to 1. I don’t think I need explain the nature of risk and debt created by this eventuality. Again it was predictable.

Fourth, mortgage refinancing combined with subprime lending. Low rates and adjustable rate mortgages (ARM) created a huge refinancing industry. It spread like wildfire and resulted in a housing bubble. Subprime mortgages were like gasoline to the eventual housing fire. Such lending practices were based on the philosophy that everyone should own a home. A worthy goal, but highly unrealistic. In other words, not everyone can afford the mortgage payments. While residential values kept rising, as they did until they peaked in mid 2006, it didn’t seem to matter whether the new owner could afford the home or not. The owner was always able to re-finance at a higher home evaluation. It substantially reduced the equity in home ownership, raising the risk to the overall housing market. When the boom ended home prices fell and mortgage payments could not be met by thousands upon thousands of homeowners, we experienced a rash of defaults and foreclosures. The crashing housing market became a primary cause of the recession we presently are enduring. Again, this was predictable.

Fifth, an adjunct to the subprime lending were the Federal National Mortgage Association, (Fannie Mae) and the Federal Home Mortgage Corporation, (Freddie Mac). The government mission of these U.S. government sponsored enterprises (GES) created in 1968, was to keep mortgage interest rates low in order to increase their support for affordable housing. Again a worthy goal. In the past several years, these two GESs were sometimes encouraged by the U.S. Congress to continue to buy the subprime mortgage

Sixth, the doctrine of “Too Big to Fail,” was in my opinion mishandled. In theory of course, in a free market system, failure by any enterprise is an acceptable part of the bargain. Government should never intervene to save a failing company. Let the investor lose his investment when he has invested poorly or negligently. Bankruptcy is the solution in “normal” circumstances. A special methodology should be available for failure in unusual circumstances. But as we know, what is acceptable policy in theory is not always acceptable in practice. When government concludes that there exists the danger of systemic risk, in other words-when the entire economic system could unravel as a result of failure of one giant enterprise-then government may feel beholden to intervene. This has happened throughout world history. A word of caution, however: When government concludes there is a need for intervention, it better be quite certain that a) there is in fact the danger of systemic failure, and b) the rules for intervention are clearly defined.

In the case of Bear Stearns, the American government judged that the company was too big to fail. However, a few months later, in the case of Lehman Brothers, it judged the opposite. Then, in the case of the American International Group (AIG), it reversed direction again. I was never convinced that Bear Stearns was too big to fail, nor was I ever convinced that Lehman Brothers was not. I became convinced, however, that there was never a bright line for the rules under which government will or will not intervene. The market cannot handle uncertainty. Our undefined policy caused the stock market to lose faith. That too was predictable.

And finally, seventh, greed. Some commercial banks, investment banks, hedge funds and other financial institutions took advantage of the lack of regulation, and lax rules. In a rush for better returns they abandoned good business practices and allowed risk to become excessively underpriced. There was a breakdown of proper risk management controls as greed replaced common sense. Thus, although most of the causes of the financial failure were government inspired, greed in the private sector was a cause factor as well. But greed is a human frailty and predictable.

There you have it. Clearly, there was no single culprit. While there are other causes, the foregoing seven sins, in my opinion, were primary. Yes, there was lack of regulation; yes, there was failure of regulation; yes, there was greed in the private sector; and yes there were misjudgments made by a host of government officials throughout the world. But surely the blame is not with the free market system. It represents the best economic model ever devised by mankind. These same or similar failures and many more have occurred under every economic model and under every type of government regime. Indeed, while the free market system is not free from failings, in the history of civilization no other system has produced so much good for mankind nor resulted in a higher standard of living for world populations. It represents the only answer in the globalized world of today, the only system that will encourage innovation and guarantee individual freedom.

Still, there are lessons we have learned. I will simply enumerate the most telling: First and foremost, capital requirements for financial institutions must be raised. Second, leverage must be contained so that enterprises cannot become too big to fail. Third, there must be regulatory oversight in OTC transactions. Finally, on a voluntary basis, central counterparty clearing for credit and OTC derivatives must be encouraged. A CCP clearing model, in my opinion would substantially reduce the probability that the failure of a significant participant in the markets would lead to a systemic failure or require government bail-out.

But, of course, that is not the point of these remarks. My sole purpose here today was to examine the cause and effect of the actions which produced the current global crisis, and to suggest that in my opinion they were all pretty well predictable. In other words, they were not black swan events. Probably they were more like gray swans-and avoidable.

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