I’ll go out on a limb and say that common sense should have steered the (reputable) likes of Citi, AIG and Merrill down a different path of less exposure to defaulting assets. Same for Standard and Poor’s, Moody’s, and Fitch, whose ratings models declared packaged tranches of toxic sub-prime mortgages to be practically risk free. To understand what a tremendous gaff this was, consider that Standard and Poor’s default models didn’t have parameters to model declining house prices. They modeled scenarios of only flat or increasing prices, which is idiotic for a risk model. Wall Street isn’t stupid, but they were socialized to make stupid assessments of default risk for sub-prime mortgages.
The first conclusion is TRUST NO ONE. Or at least trust very selectively. Given the dangers of herd behavior, the premium on independent thinking seems drastically higher today than it did six months ago. In fact, showing a track record for independent thinking may be a way to become “trusted selectively.”
The second conclusion is a question: what comes next? The public ownership structure that dominates our economy depends on trust: trust between big corporations, owners of those corporations, and the investment bankers that often broker the relationships between the two. But what happens (besides the market crash) when that trust evaporates?
I predict a stronger role for private capital. One manifestation of this role may be smaller privately held companies. Another possibility is the rise of enormous funds of the likes of Berkshire Hathaway that will either buy companies outright or control large chunks of them and steer management. The managers of these funds will be people to be “trusted selectively” (e.g. Buffet).
This is not the end of public ownership. But it is a strong blow. Are there other ways that private capital can sneak in play a stronger role?