Tuesday, December 22, 2009

Too big to fail? Limit sources of capital, not size.

There's a funny thing about law firms: You must be an attorney to own a law firm. I suspect this is the result of arcane tradition. Legal scholars probably debate this--I'll look into it. However, two simple implication are that (a) lawyers are on the hook for all the actions of their partners, (b) law firms capital will be constrained by the willingness of a collection of partners to share risks and monitor each others' actions.

Banking and financial services firms might take a lesson from this. If managers of financial firms were only risking their money, and their partners' money, they'd probably be more careful. Oh, and they could get big, but probably not nearly as big as they are today.

There are a lot of issues to consider in this area.

First observation: I think most market participants would agree that Goldman Sachs took far less risk (and still made monstrous profits) when it remained a partnership.

Second observation: shareholder governance as determined by the state of Delaware probably does not work for most if not all complicated financial firms. Here's an example: Non-employee directors of Citigroup receive base compensation of $75,000 annually. For $75k part time representatives of the shareholders are supposed to understand what is going on at one of the most complex financial firms in the world. I would think understanding what is going on within Citigroup to competently protect the interests of investors is a full time, potentially several million dollar a year job. On the other hand, the shareholders can't directly select directors, compensate directors or fire directors. That's Delaware.

So, let's think about financial institutions that may only be employee (and director?) owned.

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