Wednesday, July 21, 2010

If Pete Rose ran the banking industry... would probably look...pretty much like it already does.

No, I don't see bankers out setting hitting records. But bankers do bet against their own team. All the time. Trillions of dollars are devoted to hedging; basically just placing bets against your own investments--your own team.

In just about any other industry this would never be tolerated. In sports, this will get you banned from the industry altogether--like Pete Rose who got banned from baseball forever after betting against his own team. Imagine lawyers who could place bets on themselves losing cases. They'd be disbarred faster than you can say "unethical behavior."

Yet we allow this kind of behavior in finance. Of course, there are valid reasons given for why this is appropriate. But a case could be made that lawyers would benefit from this in much the same way that bankers do.

Many lawyers work on a contingency basis, collecting a fee only if they win the case. Of course, lawyers have to take a pretty large cut to justify the risk they take by investing so much time and energy into a project that may pay out absolutely nothing. Imagine if lawyers could hedge by betting against themselves. By removing the risk, lawyers could charge much lower fees to clients who can only afford to pay if they win. Lawyers reduce risk. Clients get lower fees. Everybody wins! Right?

That's pretty much the same argument that's made in the finance industry. Bankers, investors, finance professionals all have to take considerable risks when they pick investments. If they can bet against their own investments, they minimize risk resulting in more predictable returns. And this in turn allows them (theoretically) to charge lower fees for services. So what's wrong with it?

Well, would you hire a lawyer that bets against himself? Finance pros do a much better jobs of concealing this behavior with exotic names for products, but ultimately they're doing the same thing.

Maybe this is the kind of problem that the market would solve if people are simply made aware of what's really going on. But some things are simply too important to wait for the market to achieve what we all know is the desired result. Lawyers aren't allowed to bet against themselves, it creates a clear conflict of interest. So we need to stop bankers, who have an obligation to protect people's investments and by extension their well-being, from betting against themselves and their clients.


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