Stay on Course Back to the Basics

A friend of mine who is a sports expert, Mets fan and therefore Yankees hater, once told me what he believed to be behind the New York Yankees’ success. “The Yankees,” he explained, “are great at baseball fundamentals.” More than their high profile hitting and ace pitching, my friend argued, the Yankees succeed because they know the basics of baseball and perform them well—they know how to run the bases, when to swing and how to throw and catch. 

I agree, though I’ll not bore you with my ideas about team cohesion and what I see as some major wrongs committed by the Yankees’ ownership. But to the point, our financial markets could learn a thing or two from the Yankees, especially now.  

The latest earnings reports from our largest banks are encouraging. JPMorgan Chase netted $3.6 billion in the third quarter. Its earnings (and those of Intel) helped push the Dow Jones Industrial Average above 10,000 for the first time in more than a year. Goldman Sachs followed with $3.19 billion in net earnings in Q3.

Not all the news was good. Citigroup took heavy credit losses that cost shareholders $3.2 billion. Also, Goldman Sachs earmarked more than $5 billion for compensation and bonuses, a jump of more than 80% over its earmark at this point last year, which could lead to a record in payouts for the firm.

While it may be temping to pop the cork on some quality Champagne to celebrate the recovery, now is the time to continue with a cautious approach. These are still troubled financial markets. Banks fell into such dire straights that even responsible consumers were punished with frozen lines of credit and denials of loans.

Those who saw the credit crisis coming were those who looked at the markets from a perspective that applied very simple and basic economic principals and saw through the mountains of various securities and derivatives being traded at breakneck speed around them. These brave few naysayers remembered the basic principles of economics and financial markets, and the endless engineering going on did not make sense to them.

So it is important during this time, when the financial market recovery looks to be in full swing but the macroeconomy is still fragile, that the people running our financial institutions not become too enamored with their own brilliance again. If financial history has taught us anything, it is that those who thought they could engineer away risk have always failed in the end. No manner of complex derivatives can wash away the risk that underlies the credit markets.

As we make our way, slowly, through this recovery, keep the fundamentals in mind, or the gains we’ve made so far this year could evaporate.

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