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Thursday, June 16, 2011

A documentary explains "The Capture Hypothesis"

We have avoided disaster and we are recovering... But the men and institutions that caused the crisis are still in power... and that needs to change. They (mammoth banks) will tell us that we need them, and that what they do is too complicated for us to understand. They will tell us it wont happen again... It wont be easy, but some things are worth fighting for.

Finally, I got some time to watch last year's academy award winning documentary, "Inside Job". And what a masterpiece it was! Perhaps, it is the finest documentary I have seen in my life. Neat and straight. It is based on the catastrophic financial crisis from which we are still trying to recover. Last year, I read a book by Suzanne McGee, "Chasing Goldman Sachs: How the masters of the universe melted Wall Street down... and why they will take us to the brink again." The reasons why I like this book and this documentary are the timing, my education and my area of interest. I was about to graduate from business school in  the midst of this crisis. And I was exposed directly or indirectly to majority of the events listed in the book and shown in the documentary.

"Inside Job" emphasizes on the critical issues like political influence, lobbying power of Wall St, corruption- collectively "Wall Street Government" and other market changing events like introduction of derivatives in early 90's, housing bubble, ponzi schemes, subprime lending and the rise of structured products like MBS, CDO and credit derivatives like CDS. But the most important thing I have understood through this documentary is an industry regulation theory, "Capture Hypothesis". According to this theory, regulators of different industries are elected/selected from the pool of experienced and influencing candidates from their respective industries only. For example, regulator for environmental issues cannot be selected from the finance & banking industry. And that is the reason why regulators are more biased towards industry rather than consumers. If they do not support the industry, their spot will become endangered. That is what happened with the failure of 3 big Iceland banks. That is what happened with the regulators' decisions(influenced by Henry Paulson and other top executives from number of big banks) of permitting banks' leverage ratio to rise as much as 20:1 and loosening the regulations on derivatives. Eventually, this led to the collapse of Lehman Brothers, AIG, Bear Sterns, Merrill Lynch, Washington Mutual, Wachovia and many others.

When I was in grad school, I had to watch Wall Street, Boiler Room and Rogue Trader. I am sure that B-school finance majors will have to watch documentaries like "Inside Job" down the roads since ethics and finance and banking and investment are all coherent with one another.