Business schools have been in existence for more than a century, but they have failed to articulate a meaningful explication of the concept of fiduciary duty as it applies to managers. This omission is striking because the primary duty of management is to serve shareholders. The subject of economics, specifically information economics, has developed an attenuated image of fiduciary duty as alignment of two utility functions--that of manager or agent and that of principal or stockholder. However, the practical ramifications of such alignment are not explicit and remain a sphinx-like riddle.
Do managers owe a duty of disclosure to shareholders, and if so, what competencies are required to exercise such disclosure?
Do managers owe a duty to act in good faith toward shareholders? If so, what is the ethical make up required of managers?
Must managers be capable of explaining bad news in a balanced way? If so, what competencies are required?
Are managers expected to act on behalf of shareholders? If so, to what degree does an understanding of economics, incentives and accounting serve as a pre-requisite to competent managerial action?
How far are boards expected to go in assessing personnel standards and systems?
These questions are not asked in management courses. Nor are they answered. They are not asked in business schools at all, nor are they answered.
It is not surprising that American business has become a spectacle of bad ethics, incompetence, mismanagement and waste. Corporate boards have not been required to develop standards of competence. Little is expected of boards. Managers are compensated on the basis of stock market trends that do not reflect managerial skill.
Monday, March 16, 2009
Howard S. Katz's Poem for March 8
Howard S. Katz has preceded his current newsletter with this poem:
A sadder man you’ll never see
Than Don Quixote Bernanke.
The only thing that he does know
Is how to print a lot of dough.
He’s striding all about the town
Not knowing whether up is down.
He fights “Depression” it is said.
“Depression” is all in his head.
Dear Bernanke, may I be bold?
Suggest you view the price of gold.
The thing to know, before you sup,
The price of gold is going up.
And that’s a signal, if you’re wise,
That all the prices – gonna rise.
And then the country will be poor,
No goods to buy at local store.
You’re bailing out the ultra-rich
And leaving country in the ditch.
I’ve said to you, you are a cad.
Cause printing money’s very bad.
No, this is point you do not know.
One can’t get rich by printing dough.
So turn your policy around
And give us money that is sound.
A sadder man you’ll never see
Than Don Quixote Bernanke.
The only thing that he does know
Is how to print a lot of dough.
He’s striding all about the town
Not knowing whether up is down.
He fights “Depression” it is said.
“Depression” is all in his head.
Dear Bernanke, may I be bold?
Suggest you view the price of gold.
The thing to know, before you sup,
The price of gold is going up.
And that’s a signal, if you’re wise,
That all the prices – gonna rise.
And then the country will be poor,
No goods to buy at local store.
You’re bailing out the ultra-rich
And leaving country in the ditch.
I’ve said to you, you are a cad.
Cause printing money’s very bad.
No, this is point you do not know.
One can’t get rich by printing dough.
So turn your policy around
And give us money that is sound.
Thursday, March 12, 2009
Inflation as Loss Function
Banks create money and then lend it to borrowers. The quality of projects that banks select will cause inflation, stable prices or deflation. The best quality projects would cause productivity to exceed the amount of money created, and so monetary expansion to be deflationary. If projects that banks select just equal the average quality of economic productivity then there will be neither deflation nor inflation. If banks consistently choose projects that are inferior to the average project with respect to productivity then there will be inflation.
This suggests that inflation can be viewed as a quality loss function (see discussion in Taguchi). The target loss should be negative. Economically, diminishing marginal productivity suggests that as more money is created losses will be greater. However, if banks are competently run and have adequate quality processes with respect to project selection, they can offer loans to projects and sustain zero inflation.
The management of banks becomes a critical problem to economic welfare if the banks themselves lack quality management capacity to select loans. This has been the case. It is impossible for outsiders to design quality processes that will improve loan selection because this depends on identification of borrower and project characteristics that are only known to lenders.
There is no literature on selection of entrepreneurial risk by lenders. This is not a topic that academics have treated and it is not a topic that bankers have carefully considered.
As a result of the absence of quality processes in making loans, the financial system has failed to make loans effectively. The current financial process results from quality losses, i.e., the Taguchi loss function among banks is large and so results in bad loans. Consistent inflation since the establishment of the Fed suggests that banks have failed to develop competent quality processes in lending.
Anecdotal evidence suggests that banks have consistently made loans based on incompetent criteria: to large institutions who cannot make good use of the funds; to firms with close connections to the banks and to firms engage in activities that loans other banks are making. This mimetic pattern suggests a financial system that is, in Deming's terms, "out of control". A competently run banking system would permit economic expansion coupled with stable prices.
The banking system requires restructuring to facilitate adoption of competent, quality driven practices with respect to lending. Banks must become competitive. Banks which fail to produce loans that generate net gains to society (i.e., deflationary loans) should be refused access to Federal Reserve bank credit.
This suggests that inflation can be viewed as a quality loss function (see discussion in Taguchi). The target loss should be negative. Economically, diminishing marginal productivity suggests that as more money is created losses will be greater. However, if banks are competently run and have adequate quality processes with respect to project selection, they can offer loans to projects and sustain zero inflation.
The management of banks becomes a critical problem to economic welfare if the banks themselves lack quality management capacity to select loans. This has been the case. It is impossible for outsiders to design quality processes that will improve loan selection because this depends on identification of borrower and project characteristics that are only known to lenders.
There is no literature on selection of entrepreneurial risk by lenders. This is not a topic that academics have treated and it is not a topic that bankers have carefully considered.
As a result of the absence of quality processes in making loans, the financial system has failed to make loans effectively. The current financial process results from quality losses, i.e., the Taguchi loss function among banks is large and so results in bad loans. Consistent inflation since the establishment of the Fed suggests that banks have failed to develop competent quality processes in lending.
Anecdotal evidence suggests that banks have consistently made loans based on incompetent criteria: to large institutions who cannot make good use of the funds; to firms with close connections to the banks and to firms engage in activities that loans other banks are making. This mimetic pattern suggests a financial system that is, in Deming's terms, "out of control". A competently run banking system would permit economic expansion coupled with stable prices.
The banking system requires restructuring to facilitate adoption of competent, quality driven practices with respect to lending. Banks must become competitive. Banks which fail to produce loans that generate net gains to society (i.e., deflationary loans) should be refused access to Federal Reserve bank credit.
Tuesday, March 10, 2009
AFAQ--Uninformed Anarchist
On a blog called Anarchist Writers someone, apparently an anarchist writer, with the pseudonym "afaq" (which seems to stand for "anarchist frequently asked questions"--I guess anarchist writers lack the guts to use their own names) displays some anarchistic ignorance. Afaq, an anarchist* who believes that state violence should suppress private economic activity, writes:
"A 100% reserve system is not a reformed or true banking system. It is the abolition of the banking system. Without fractional reserves, banks cannot make any loans of any kind as they would not be in a position to give their clients their savings if they have made loans. Only someone completely ignorant of a real capitalist economy could make such a suggestion and, unsurprisingly, this position is held by members of the "Austrian" school (particularly its minimum state wing)."
Despite afaq's crude name calling, afaq appears not to have heard of savings banks. Perhaps a reading of Murray Rothbard's Mystery of Banking would inform this confused soul of the difference between full and fractional reserve banking, and of the evolution of fractional reserve banking after the beginnings of capitalism through goldsmiths' fraudulent issuance of notes on non-existent gold. Moreover, several states illegalized fractional reserve banking in the nineteenth century, and capitalism did not suffer.
Only someone ignorant of how banking works and of economic history would be unaware that fractional reserve banking is not full reserve banking. Fractional reserve banking exists where loans are made without reserves, as is done by the US banking system, where loans are 2 to 10 or more times greater than the monetary base or reserves. Eliminating fractional reserve banking means requiring banks to have reserves in order to lend them, not preventing them from lending reserves. Any student of elementary economics learns this, but it is clearly beyond afaq's knowledge, which does not prevent afaq from expounding pointlessly and confusedly on numerous topics about which afaq is ignorant.
It is characteristic of the left to call others ignorant when they themselves lack the most elementary familiarity with a subject.
*Characteristically, the left adopts nomenclature that is opposite to its meaning. "Progressives" advocate ideas that are four centuries old and were characteristic of mercantilists. Their ideas are guaranteed to stop progress. "Radicals" advocate communist ideas that are appropriate to feudalism, were well known two thousand years ago, and whose adoption would but re-enforce the root of current big government corruption. "Liberals" advocate anti-liberalism and statism. And of course, "anarchists" like afaq advocate governmental suppression of freedom.
"A 100% reserve system is not a reformed or true banking system. It is the abolition of the banking system. Without fractional reserves, banks cannot make any loans of any kind as they would not be in a position to give their clients their savings if they have made loans. Only someone completely ignorant of a real capitalist economy could make such a suggestion and, unsurprisingly, this position is held by members of the "Austrian" school (particularly its minimum state wing)."
Despite afaq's crude name calling, afaq appears not to have heard of savings banks. Perhaps a reading of Murray Rothbard's Mystery of Banking would inform this confused soul of the difference between full and fractional reserve banking, and of the evolution of fractional reserve banking after the beginnings of capitalism through goldsmiths' fraudulent issuance of notes on non-existent gold. Moreover, several states illegalized fractional reserve banking in the nineteenth century, and capitalism did not suffer.
Only someone ignorant of how banking works and of economic history would be unaware that fractional reserve banking is not full reserve banking. Fractional reserve banking exists where loans are made without reserves, as is done by the US banking system, where loans are 2 to 10 or more times greater than the monetary base or reserves. Eliminating fractional reserve banking means requiring banks to have reserves in order to lend them, not preventing them from lending reserves. Any student of elementary economics learns this, but it is clearly beyond afaq's knowledge, which does not prevent afaq from expounding pointlessly and confusedly on numerous topics about which afaq is ignorant.
It is characteristic of the left to call others ignorant when they themselves lack the most elementary familiarity with a subject.
*Characteristically, the left adopts nomenclature that is opposite to its meaning. "Progressives" advocate ideas that are four centuries old and were characteristic of mercantilists. Their ideas are guaranteed to stop progress. "Radicals" advocate communist ideas that are appropriate to feudalism, were well known two thousand years ago, and whose adoption would but re-enforce the root of current big government corruption. "Liberals" advocate anti-liberalism and statism. And of course, "anarchists" like afaq advocate governmental suppression of freedom.
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