Finance Science

The Cost of The Absence of Money

I've often thought that the mismanagement of large sums of money is the worst crime. So much effort by so many people goes into the aggregation of wealth and so much suffering is induced by its absence that financial crimes can be among the cruelest. There are tipping points where the amount of money available can make a big difference in people's lives.

Case

Say, for instance, that a certain hospital has a secure endowment. It has been in operation for a hundred years, has a distinguished history and a handful of specialties that keep its name in the literature. The hospital has a large inner city clientele, most of which can pay at least some of the bills. At some point, an auditor discovers that a lot of the old bequest accounts have been drained to pay the inflated salaries for an executive team that came aboard a few years ago and recently departed. Perhaps no laws have been broken, but it is apparent that the endowment is no longer able to generate the kind of cash flow necessary for basic maintenance.

So what happens? The new management cannot find enough of the kinds of efficiencies and service reductions that had kept the place going in the past. To make the best of a bad situation, they eliminate most of the staff, sell off most of the campus and dedicate the remaining funds to support a small clinic. With the original funding, they might have kept the big facility alive for another ten or even twenty years, but it’s the best they can do now.

Consequence

The local impact is that hundreds of older patients will now have to travel, perhaps an hour, by city transit to another facility. The clinic handles emergencies and such, but chronic patients, diabetes patients with limb deterioration, dialysis patients, emphysema cases, may have to go elsewhere. A certain portion of these folks will give up and die. The other patients may well decide to get treatment less frequently. Some of the diabetes patients will lose limbs as a result. Dialysis patients will spend a lot more time feeling sick and can expect a shortened life span. Most of the staff will find jobs elsewhere. Some won’t. Some will have to leave behind relatives who will suffer to greater or lesser degrees from the lack of support. The man who sells hotdogs on the corner is making a lot less money. His wife is one of the diabetes patients. They don’t run the air conditioner any more so they can save some money. The man who sells papers in the street can’t quite get enough money together for a visit to the dentist. He’s grumpy all the time and won’t let the neighborhood kids help him anymore. Sometimes they hide his papers in the morning.

Context

There are more examples of what happens when the CFO cheats or errs than I can enumerate. Let’s talk about the Orange County derivatives fiasco, the collapse of Enron, pension defaults, stock bubbles, real estate frenzies. I imagine you have your own relevant experiences. The common theme to these rolling catastrophes is that financial errors make people suffer and nobody calls FEMA.

Cause

Everybody has a different explanation for why these things happen. When I read anything related to finance, I could easily be convinced that it’s due to lack of intelligence. The Science of Finance has developed to a point where it reads like Quantum Mechanics. The incorporation of the Black-Scholes formula into hedge fund investing is the best example of this analytic surrealism. Nevertheless, I think most people would insist that these failures have something to do with human nature. An article from CFO Magazine, by Stephen Brown, (by way of Alan L. Nelson) seems to have found a piece of the puzzle. Apparently rogue traders have a tendency, possibly innate, to "double up" after they make a loss. That is, they increase the size of the next risk to cover the previous losses. His solution: keep a closer eye on these guys.

6/9/2005 4:41 PM