Alignment of Interests Requires New and Different Metrics

Umair Haque wrote quite the blog entitled "How to Build A 21st Century Investment Bank" that I posted a fairly long comment on and that I now want to expand into a post. I am still waiting for Umair's feedback that I hope will come soon.

Umair opened with,

"Let's admit it. Finance as we know it is, despite the protestations of your friendly local narcisisstically sociopathic investment banker, pretty much useless to people, society, and humanity. It's an engine of crisis and instability (when it's not a motive force of dumbification and social fracture)--far from a lever of human prosperity, it's more a bulldozer of great achievement."

He then proceeds to lay out some very rough (by his own admission) examples of more socially and financially responsible deals and financings. Here are two examples from Umair's post:

I (CEO) receive options as part of my compensation package. If my company seriously harms people, communities, or society, my options vest, my shares are sold, and the proceeds go to charity.

I (community) buy a product from you (bank). Indexed to authentic measures of human prosperity, it pays out if the needle doesn't move upwards. Call it "stagnation insurance".

Umair - It is important to recreate investment banking to focus on the total cost of financing. It is absolutely necessary to realign incentives from net profit-based short term profits on an institutional level and annual bonus on a personal level to something that better reflects a holistic long term view of value/profit.

However, in order to do that, I think it would be most important if you focused on two things:
1. A measure or metric that can be used to determine the value or profit that investment banks, banks or financial institutions create and how that will impact institutional value and personal financial reward (that is still the fastest way to motivate a shift).
2. We need a killer app that proves the total-value view of banking or investment banking. This would be a killer product on which the thesis of holistic value and profits can be measured and rewards delivered based on it.

I would humbly suggest that an initial killer app could be social mortgages. What if we aligned incentives for banks/brokers etc with the home buyers such that bankers were bonused based on the home buyer successfully paying of his mortgage rather than the profits from interest and foreclosures. That would be long term focused and would align interests. Further, we could tap social nets to help people pay off parts of their mortgage when the goings get tough and encourage the banker/broker to help recruit the social circle because he too wants to get the mortgage paid down over time. So by changing one metric of success from short term profits to a simple metric like successful mortgage payoff , we could see a total-value benefit. Fewer people would lose their homes to foreclosures, be stressed by usurious short term interest rates etc. Total net cash profit of a corporation is such a crude measurement tool.

In fact, we need to align incentives and metrics of success on both a micro and macro economic level. As I look out now at the protests sweeping Israel in what could be the first very peaceful Eudaimonic revolution (to use one of Umair's terms), It behooves us all to rethink alignment of our economy to more shared goals. This needs new metrics. If it can;t be measured it will be tough to improve it and coalesce around a goal. The retrenchment of the economy and of mutual social responsibility should be a clarion call for rethinking te types of taxes/revenues we want to raise as well as the people and things society should spend on. It is a unique crisis that we can ill-afford to squander like Obama has squandered it in the USA since 2008. We can use taxes in a positive way to tax short term unproductive economic activities (say day trading) and provide tax incentives on disruptive and enriching goals from sustainable agriculture to exports to long term investment in disruptive technology. But we need to be able to measure our aligned-success with new holistic measurements.

So the key is metrics. If we can fashion total-value or holistic-profit metrics that align incentives and interests between financier and financee then we can begin to change this industry and economies for the betterment of society and business. I for one would love if Umair would work with the lab and develop these metrics product by product in financial services.

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I wrote a now anachronistic post asking why we need banks at all a few years back http://seekingalpha.com/article/120207-why-do-we-need-banks-at-all