Another issue is that an employees’ manipulation will be quickly noted by a manager:
“The good news is that you mowed twice as many lawns as our average worker. The bad news is that our complaint rate is usually 3%, but 95% of your customers called to complain. We think the other 5% are probably traveling, so you’re fired.”

And in doing so, you should add, become criminals that should be prosecuted with the same determination and severity as robbery, theft and the like is. Those leaving companies in shambles with huge joblosses and such payout packages should go to jail , and not stand a chance to become Colorado’s 2nd largest landowner.

So if you are a member of the board and decide on compensation of managers also consider their legal prosecution…..

A common flaw is to tie compensation or employee assessment to some metric that seemed to correspond to real increased productivity and profit WHEN EMPLOYEES WERE NOT MOTIVATED TO MANIPULATE THE METRIC. Programmers being paid for line-count is a simple instance.

Also, if you haven’t already read it, Malcom Gladwell wrote an article for the New Yorker about how different these sorts of cases of financial malfeasance are compared to those that we are familiar with. I think Gladwell would take the tack that a lot of these situations *are* extremely complicated and difficult to evaluate, but he also writes about the fact that at the end of the day, the information needed to realize that e.g. Merrill is not behaving in a fiscally responsible manner is publically available. He also makes the point on his blog that complicated or not, a lot of the analysis that broke the Enron story was done by Wall Street Journal reporters, so its not as if we’re talking about figuring out whether or not M-Theory is a fraud (no offense intended WSJ reporters).

As absurd as I think it is that anyone with half a brain ever believed the AAA ratings on these securities, I sometimes wonder if perhaps we aren’t already in an overreaction situation. Like, could the same mark-to-market accounting rules that let people like Merrill keep these things on the books at absurdly high values also be forcing them to be marked unrealisitically low now? Obviously, there is no buying side for these securities. The fair market price of someone trying to unload a bunch of these types of deals right this second is de minimus, as I understand it. Also, lets assume the junior tranches are all wiped out. Looking at the senior tranches, how are they set up internally? Do the underlying mortgages get delivered to the CDO holder? It seems extremely unlikely that every single borrower will default, and every single house/motorcyle/credit-card-receivable will have zero value after going through the foreclosure, factoring, or workout process.

I’m not bringing this up cause I like to talk about investment opportunities that are not open to me on other people’s weblogs. I bring it up because is it possible that regulatory controls such as MTM accounting may have an unnecessarily deleterious effect on the real economy? I’m a big bank, I have to mark all my senior CDO tranches to zero since I can’t sell them, but there *are* future cashflows that are due to me even under the most horrific conditions, and they have some net present value, but I can’t recognize it. Consequently, capital constraints force me to sell of other securities, reducing liquidity throughout the system and continuing the vicious cycle. It seems like for a lot of securities, standards intended to promote fair and orderly function of the markets (MTM accounting, for instance) may actually have quite the opposite effect in times of extreme stress. By forcing all “quotational” losses to be recognized don’t we risk accelerating the loss of credit substantially? At some point this becomes systemic and effects the real economy, no?