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Preventing the Next Crisis? Not Much Hope There, French Says

Kenneth French, a professor of finance at Dartmouth and one of the founders of DFA, closed out NAPFA's National Conference last week on a rather dim note, saying that because there were so many contributing factors to the financial crisis, there's no silver bullet for preventing the next one from happening. He opened his presentation with:

"The goal is to reduce the probability of a financial crisis, and reduce the severity if another financial crisis happens."

He went into the details of each of the contributing factors--behavior of real estate prices, leverage and derivatives, the Great Moderation and mistakes at the top, and unstable financing. But he didn't provide many solutions for preventing the next crisis, leaving the fee-only advisors in the room with not much hope.

One solution that he pointed to, which is proposed in his book The Squam Lake Report, would be to hold back compensation of key executives at the large financial institutions. This would involve translating their compensation into a dollar amount, and holding back 20 percent of that amount in the bank for five years. If the government has to intervene or if the bank defaults, they sacrifice that "holdback." The idea is that this would change the execs' incentive to take risk with the business. It's a start.

French also told attendees that he doesn't buy the idea that Wall Street execs are less moral than people in any other industry, and I agree with him. He does, however, believe they are more greedy, and that comes with the territory:

"That's like saying priests are more religious. It's not a great insight."

The problem during the crisis was that these execs didn't understand what was going on in their environment, he said.

Overall, French's presentation was a great refresher on the events of the crisis, but it didn't tell us much more than we already know.

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