Dominic D'Alessandro dissects the free lunch

Dominic D'Alessandro in today's Financial Post: “we all seem to have forgotten that there is no such thing as a free lunch. We wanted to have our cake and eat it too”.....he then goes on to define “we” in a way the excludes himself by talking about consumers and governments.......what about HIS decision to issue variable rate annuities tied to the market, but without hedging these risks, when all his insurance company peers did? The intent of which was to boost Manulife’s earnings per share?

Was that not a blatant exercise in attempting to garner a “free lunch” and/or “have his cake and eat it too”?

Interestingly, Dominic then goes on to observe “Rules-based systems will always be "gamed" by the clever.”, which speaks directly to why managers of corporations were so intent on killing income trusts, as their higher discipline concerning payout of earnings and the requirement that acquisition be “accretive”, combined with the manner in which trust managements are compensated (i.e via participation in increased distribution levels and not via stock options tied to market gains that may be a result of nothing of management’s economic doing) explain why they wanted the trust model killed, since it wasn’t so easily “gamed” to management’s personal advantage. That is the entire trust policy objective in a nutshell. Just imagine what this is costing Canadians to cater to these people’s “games”, as explained by this quote from the Globe of November 2, 2006:

“High-profile directors and CEOs, meanwhile, had approached Mr. Flaherty personally to express their concerns: Many felt they were being pressed into trusts because of their duty to maximize shareholder value, despite their misgivings about the structure. Paul Desmarais Jr., the well-connected chairman of Power Corp. of Canada, even railed against trusts in a conversation with Prime Minister Stephen Harper during a trip to Mexico?

Dominic D'Alessandro dissects the meltdown

Financial markets were turned into veritable casinos

By: Dominic D'Alessandro, President and Ceo, Manulife Financial, 
Financial Post  
May 13, 2009

Integrity is the foundation on which everything else depends. Without it, one may still get to the top; but it's almost certain that one's stay there will be neither successful nor long. More than ever, people want leaders they can trust, who stand for something and who can be relied upon to do the right thing.

The irony of discussing leadership and integrity, given the tumultuous developments in global financial markets, is not lost on me. Every day brings new revelations that these qualities, sadly for everyone, were too often absent in many parts of the financial services industry.

What has happened is simply unbelievable. Who would have thought a few months ago that we would witness the nationalization or forced sale of major portions of the banking industry in Europe, the United States and elsewhere? That investment banking, as we know it, would virtually disappear? That AIG, once the world's largest financial institution, would be on life support almost certainly never to regain anything remotely like its former stature?

I am pleased, as I think we all should be, that the situation in Canada is a far healthier one. Our financial institutions are strong.

And I believe that when all is said and done there are really two main reasons for the difficult situation that exists today.

First is the inexcusable sin of failing to properly regulate our financial markets. Indeed, for the past 30 years or so, deregulation has been the religion of policymakers in many parts of the world. The result is that the financial markets were turned into veritable casinos. The fallout is affecting everyone, even those of us who have run our businesses in a disciplined and prudent manner.

Second, we all seem to have forgotten that there is no such thing as a free lunch. We wanted to have our cake and eat it too, whether consumers buying houses they couldn't afford or governments financing expenditures with borrowed money.

As a result of the global financial crisis, we can expect that a number of far-reaching and profound changes will be made to the regulations governing how our financial institutions operate. Already, there are many lessons that can be drawn from the sad, recent experience. Here are a few that I think are particularly important:

Policymakers ought to rid themselves once and for all of the attitude that the "market is always right." It is this attitude which is more than anything else at the heart of the current crisis. It should be obvious that sound regulation is necessary if markets are to operate properly. That such regulation should be harmonized and consistent across geographies and markets goes without saying. The challenge, of course, will be to keep regulation intelligent - we don't need another SOX 404, for example; but we do need rules of the road.

As a matter of some urgency, policymakers should carefully examine the operations of hedge funds and the derivative markets in order to assess the extent to which they pose systemic risk. Based on what has been reported about their size, complexity and use of leverage, it would seem obvious that they do. As this is the case, these activities ought to be subjected to the same regulatory oversight that applies to more traditional financial activities.

Questions should also be asked as to whether or not recent innovations in the financial markets are proceeding in a reckless and uncontrolled manner. Again, it is now obvious that many of the innovative instruments at the centre of the current crisis are fiendishly complex, not properly understood by anyone and certainly not well controlled by any of the risk-management systems in effect at many of the world's largest financial institutions. I believe that a slowdown in the pace of innovation to allow for a more comprehensive assessment of risk would be a very good thing.

Moreover, we desperately need to move to a principles-based system of financial reporting. Rules-based systems will always be "gamed" by the clever. However, I question whether the wholesale adoption of fair-value accounting as currently proposed by the standard setters is a step in the right direction. Time will show, I think, that this global financial crisis was greatly exacerbated by the accounting practices requiring assets be written down to reflect current pricing levels regardless of the highly unsettled market conditions that prevail.

The many adverse consequences of adopting reporting standards that greatly exaggerate performance, either positively or negatively, seem to be of no concern to rulemakers. For those organizations that have the intention and the demonstrated capacity to hold assets for the long term, fair value is useful as supplementary disclosure. It is much less meaningful when periodic changes in fair value are co-mingled with operating results.

Whatever happened to the "going concern" principle that served us so well for so long? Doesn't fair-value accounting encourage the type of behaviour, the short-termism, that so many of us deplore? And, doesn't it make the building of stable, productive enterprises much more problematic and difficult?

Now, I suggest, would be a good time to pause and re-examine whether the move to fair-value accounting does in fact produce the improved financial reporting model that was envisaged.

I want to conclude on a positive note. We should all take comfort from the very bold and pragmatic actions that the authorities around the world are taking in a collaborative and co-ordinated fashion to deal with the situation. Central banks are providing liquidity to the markets on a massive scale.

The global banking system is rapidly deleveraging and many of the world's leading banks are being recapitalized. While much remains to be done and stresses still remain, I am confident that the worst is behind us.

Financial Post

-- This is an edited excerpt from a speech delivered by Dominic D'Alessandro on Oct. 29 in Toronto, where he received the 2008 Ivey Business Leader Award.


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