Tag Archives: Financial crisis of 2007–2008

09.18.14
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The house of cards versus building economies – the shift to trading from investing

I recently finished reading What Happened to Goldman Sachs: An Insider’s story of organisational drift and its unintended consequences, Steven Mandis’s study of how the priorities of one of Wall Street’s most respected investment banks changed from providing trusted advice about long-term growth of businesses to short-term profit production for its employees and shareholders.

As a former Sachs employee, Mandis was curious about how the Goldman Sachs he joined in the 1990s, which was renowned for its customer-centric ethics and social code, turned into the one of the morally questionable actors of the global financial crisis. It tracks the drift in values since the 1970s and covers a period of rapid growth for the company and the financial services industry.

Mandis noted (pg 98) that the rapid growth in Goldman’s business meant thousands small decisions, made quickly and by many, accumulated into a significant tidal wave of change, and everyone was too busy to notice. Changes included the rise of a culture of undisciplined risk taking driven by the rising prominence of profit-making trading over advice and the dilution in the strength of its cultural norms as the business expanded quickly around the world.

More importantly it highlights the shift from banking to trading (pg 143) and how, as trading produced greater profits for the bank (rather than the clients), the culture shifted from ‘value-added vision and tilt more to making money first’ and asked the question ‘if making money is your vision, to what lengths will you not go?’.

Mandis examined what pressures existed to meet organizational goals generally caused by ‘unintended and unnoticed slow process of change in practices and the implementation of them, which in those cases led to major failures.’ This can be expanded out to the whole investment industry which, when inundated with the retirement savings of ordinary citizens into their mutual funds, suddenly had more sway with the companies than ever before.

Fund managers, wielding the investment power of the accumulation of many citizens’ funds, held more sway with company management. The power for decision-making, and the shaping of global business, resides with a small group of senior managers who make decisions with reference only to a small group of professional investors, i.e. decisions are made by those who manage the money, rather than those who provide and ultimately own the money. It is the beliefs and values of the professional investors that are represented, not those whose capital offers the companies the opportunity to continue business and the superannuation funds a chance to have a business.

Indeed, it is telling when the chief executive of the world’s largest miner BHP Billiton describes spinning off a basket of its lesser performing assets into another company as a way of ‘financial markets’ being happy. No mention is made of the values and views of the citizens’ that provide the capital to the financial markets.

It is also interesting to note that an independent senator in Australia’s parliament, Nick Xenophon, chooses to focus on the decision of the nation’s flag carrier Qantas to only consult with its largest institutional investors about controversial management decisions, rather than include the large number of smaller shareholders. He would perhaps, have been well served to question why the big institutional shareholders made no effort to listen to the views of the thousands of citizens who provide the capital to invest in Qantas. These are the citizens who may also work for Qantas, or are a supplier or contractor to the airline, or even are a frequent flyer.

It is time that large asset management houses created genuine engagement programs with their members to discovery what their investment values really are, in the context of the whole society, not just how much money they want to retire on, and base some of their decisions on that ethical compass, rather than the one that points only to the god of Mammon.

11.27.13
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Only a reassessment of our values will avert another crisis

Most financial service professionals believe tighter regulation of financial markets will not stop another financial crisis, according to a recent survey.

Perhaps a reminder of what happens when greed overtakes reason might help. Today the ratings agency Standard and Poor’s said it estimates that the biggest US banks may still have to pay out more than $US100 billion to settle legal issues surrounding the rush for sub-prime mortgage products that started the global financial crisis in the first place. Not a great long-term return for the banks’ investors.

Or maybe a reality check about what their rampaging greed has meant for the rest of the citizens of the world. The Organisation for Economic Co-operation and Development (OECD) is warning that the fallout of the financial crisis, is starting to affect the elderly with lower and delayed pension payments and the gap between the highest and lowest income households in developed countries widened in the three years since the crisis.

Sadly, the only way to affect real change in behaviour is to change the values of those in power, because it is those in power that set the agenda. Kinetic Partners, the same group that conducted the survey mentioned above also did research that found that most believed it was the culture set by the CEO that influenced whether good decisions were made and another financial crisis could be averted. This is backed by a whole swathe of academic research pointing to the powerful elite prioritising the values of our society.

So what are the most prominent values? Academics Bruno Dyck and David Schroeder suggest materialism and individualism are the twin hallmarks of the moral point of view that underpins management thought. The Protestant focus on work and individual struggle for salvation and emphasis on material success has become normalised in western management and is the ‘incontestable, objective, morally neutral reality’ adopted as the natural facts of life, rather than the moral facts of life. This translates into modern management’s focus on efficiency, productivity, profitability relative to other comparable companies and the expectations of the market.

The central criterion for managerial rhetoric is concerned with economic growth, organisational survival, profit and productivity. In academic texts on corporate finance this belief is reinforced.  According to the Principles of Corporate Finance, ‘the goal of maximising shareholder value is widely accepted in both theory and practice’ because, the authors argue that shareholders want three things, the first of which is ‘to be as rich as possible’. Another perspective on this is offered by Jill McMillan who argues that companies are held captive by ‘the tyranny of the bottom line’ and profits are for the benefit of the ‘privileged class of organisational shareholders who possess the dominant right to maximise return on their investment and the commitment of management to pursue that goal.’

But if much of the money is invested with ‘organisational shareholders’ (meaning institutional investors) comes from citizens investing for their retirement, then it should be us that guides which values dominate investment, and given a chance to have a say, I believe many people would have not ‘profit at all cost’ as their number one value.

Below is a simplified version of my suggested model for a two-way communication system with their members.Model for engagement

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10.02.13
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Greed unfettered by conscience reigns again

Five years ago, the US government and regulators allowed investment bank Lehman Brothers to collapse.  The bank was to be the example to the industry of what happens when greed and the pursuit of profit at all costs prevails.

Sadly, it appears they didn’t learn a thing. Greed unfettered by conscience remains the order of the day.

Investment banks exist to grease the wheels of the economic machine, bringing investors and businesses together. These servants of company development and economic growth, however, appear to have transformed themselves into the masters of the corporate universe.

Investment banks’ role is to arrange companies’ borrowing, issues of shares and conduct a lot of the share trading and broker merger and takeover activity. They put people with money together with people who want that money to invest in their business. This means they have a vested interest in promoting lots of activity, which is what generates their revenue. So it doesn’t matter whether a deal creates long-term social and economic problems or not, their only interest is deals being created. How else will they hit the targets that pay their gigantic bonuses?

Now the UK Chancellor of the Exchequer is going into bat for the financial services sector to protect their ‘right’ to receive uncapped bonuses. There is grave concern that the bonus cap may led to an increase in base pay and that top ‘talent’ may go to non-European competitors who don’t have to comply with the cap. To be clear, the bonus cap will only apply to those who earn more than €500,000 (~$AUD720,000) a year….so they are hardly on struggle street. But a pay packet of this size is not about being paid what someone is worth, it is a way of gaining status through a comparison with peers.

Perhaps a walk along struggle street might help the investment bankers reassess their views about the reward they need to carry on their work. It may also give them some perspective about the devastating impact of their sector’s behaviour and how long it takes to recover. Right now, More than 46 million Americans are living in poverty and the median household slipped, all thanks the hangover created by the global financial crisis. While job growth may by recovering in the richest country in the world, the jobs are in low paying sectors of retail and restaurants. Meanwhile, the stock markets are recovering and the bankers are getting their bonuses again.

Earlier this year, the investment banking industry was asked to explain why they charge institutional investors for access to the chief executives of their client companies, often without the companies even knowing. The investment banks don’t provide the money for anything, institutional investors on our behalf do. Institutional investors need to exercise their financial muscles to wrestle the investment bankers back into their role as servants.

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