Common Sense that's not so Common

If there is a silver lining to the current state of the financial markets it's that many of the events of the past few months will serve to fill a whole new generation of economic and financial textbooks - education future analysts and managers on what not to do. Last week, IndyMac became the second largest financial institution to be seized by the Federal Deposit Insurance Corporation (FDIC) after a run on the bank left it short on cash. Having seen its stock price fall from a peak of $50.11 in mid 2006 to a closing price of $0.28 on July 11, it certainly looked as though the markets could see what was coming, so why didn't the bank's managers?

IndyMac was, not surprisingly, [too] heavily involved in the so-called Alt-A mortgages and, of those mortgages, [too] heavily concentrated in California - the second worst hit real estate market in the U.S. Many now suggest that IndyMac could have avoided its collapse by altering its business practices when it began to see a peak in the real estate markets; of course, hindsight is 20-20 and we all seem wiser after the fact. That said, one of the first things that anyone learns when studying finance is diversification; how can the leaders of financial institutions like Bears Stearn and now IndyMac be so complacent in their responsibilities to diversify their businesses? 

Even if you don't know anything about investing, you've probably heard the saying 'not to put all your eggs in one basket'. I personally don't believe that IndyMac could have fairly spotted a market peak and adjusted its business accordingly. I do believe that the use of not-so-common common sense could have very well avoided its collapse. Every market goes through cycles and investing too heavily in just one such market exposes you to those cycles. Diversification is your safety net by compensating you for losses in one market with gains in another; it's so simple. Personally, the management of firms who don't exercise this common principle should be punished in some way - it should not be the federal government (and tax payers, by corollary) who should be held responsible in such circumstances.