An Essay by J. Richard Finlay
on corporate integrity in the post-bailout era
Recent multi-billion dollar settlements involving Bank of America and JPMorgan Chase show the staggering costs of ethical folly and the culture of moral hazard that places too many companies, and capitalism itself, at risk.
It is the curse of giants to believe in their own invincibility. It is also the curse of their acolytes, as the White Star Line discovered with its “unsinkable” Titanic and the Philistines learned with the defeat of their champion Goliath at the hands of a young shepherd boy. Yet these lessons, and countless others, over millennia have not dispelled such illusions in the world of business, where size is seen as an insulator against all manner of misadventures and the too-big-to-fail mentality shows few signs of abating. Indeed, the extent to which America’s major banks and Wall Street icons were on the wrong track when it came to compliance with the law and standards of ethics during the great financial meltdown and even afterwards is becoming even more striking. Recent reports involving Bank of America, Citigroup and JPMorgan Chase vividly make the point.
On these pages in the years and months leading up to the worst financial crisis since the Great Depression, and in numerous op-ed columns before that, I wrote about the dangers of relying on the myths of giants. Until they were categorized as being too big to fail, corporate monoliths like Bank of America, Citigroup and JPMorgan Chase were viewed as being too smart to fail. Trophy directors and fantastically compensated CEOs, with the assistance of huge PR departments that never seemed to sleep, worked overtime to present an image where success was virtually guaranteed. The reality, however, was that too many boards were recklessly disengaged from what was happening around them. Seeds of folly were being sewn by undersupervised employees more interested in creating clever short-term financial devices than sustainable building blocks of long-term business. And too many investors and journalists had become prisoners of what I call cheerleader capture. First cousin to the condition of regulatory capture, this refers to the state where it is virtually impossible for any dissenting voices to penetrate the thundering chorus of cheers by insiders and their loud choir of supporters.
There were warning signs of the unwise effects of that mindset, to be sure. Scandals involving security analysts, for instance, for which Henry Blodget became the poster-boy, revealed the dangers of a culture of cheerleader capture. In too many cases, the analysts who were supposed to be delivering objective assessments of the financial health of companies enjoyed personal and career incentives that caused them to paint a more glowing picture than justified by the facts. Citigroup was touched in several ways by that scandal.
There were the accounting frauds at Nortel, Enron and Worldcom that were so stunning they resulted in landmark legislation known as the Sarbanes-Oxley Act being passed. The collapse of Hollinger and Livent provided an interesting coda to those scandals. If these events of just a few years earlier had been taken seriously, they would have produced a higher standard of boardroom oversight that might have prevented the blunders and financial chicanery that brought the world to the brink of the financial abyss in the first decade of the 21st century.
But even before the gales of that crisis rose to full force, this space questioned the governance practices of companies like JPMorgan Chase, Citigroup, Bank of America, as well as Countrywide and Merrill Lynch, two institutions which BofA bought. We took frequent issue with the sweetheart boardroom deals that propelled their CEOs into the super-compensation stratosphere. We felt that the excessive deference accorded many CEOs reflected a perilous level of disengagement on the part of boards which in turn were failing to exercise the independent judgment needed to fully protect investors and the public franchise of capitalism itself.
Many of the decisions these companies made were fraught with ethical failures, violations of the law and just bad business thinking. Their consequences are coming home to roost even years later. Bank of America recently agreed to pay $9.5 billion in fines to settle civil lawsuits with U.S. federal housing authorities. Ken Lewis, the company’s former CEO, settled with regulators by paying $10 million personally. All told, it has cost BofA some $50 billion to resolve a variety of claims stemming from the subprime era, including the fraudulent actions of Countrywide Financial and misleading statements made in connection with the bank’s purchase of Merrill Lynch.
Improprieties at JPMorgan Chase resulted in an astonishing $20 billion being handed over to various regulatory authorities. The amount barely caused a ripple on Wall Street, where reaction to the announcement registered nothing untoward in respect of JPMorgan’s stock or the reputation of its CEO, Jamie Dimon.
Citigroup, which has also paid out huge amounts to settle regulatory claims, recently failed the Fed’s financial stress test — for the second time in two years. Its stock languishes at the unconsolidated 1-for-10 equivalent of the same $5 range it was at during the bailout crisis. Were its recent history of losses, bailouts and scandals not sufficient, there are new regulatory and legal issues arising from a potential fraud involving Banamex, a Mexican subsidiary. In one day early this April, Citigroup’s shareholders were hit with a double whammy. The company said that it was unlikely to meet a key profit expectation it had set and then announced it was paying $1.12 billion to certain investors to settle claims stemming from mortgage securities sold before the financial crisis.
Yet the level of shareholder outrage one might think would be directed at Citigroup’s board for this Job-like litany of woes has, for the most part, failed to surface, just as tolerance of years of poor boardroom practices and bad decisions earlier led to a cascade of scandals and financial losses culminating in the bank’s liquidity crisis that prompted the U.S. government bailout in 2008.
In no case has any banking or Wall Street executive faced jail time as a result of the misdeeds that resulted in these record massive payouts or those of other companies. By contrast, in any given day on Main Street, courts routinely hand out jail sentences to elderly seniors convicted of shoplifting and single mothers who pass bad cheques for even small amounts.
Like the notion of billions and billions of stars in the cosmos often attributed to the late Carl Sagan (with the help of Johnny Carson), it is hard to get the mind around the scale of these fines, payouts and penalties. And in the case of Bank of America and JPMorgan Chase, and numerous other companies from drug makers to car manufacturers along the way, it seems nobody is even trying.
What seems to be happening instead is that the wrong-headed mindset that gave birth to excessive CEO pay has infected other fields of business responsibility and decision-making. We explore this further in Part II.
AIG’s bonuses have become more than just a tipping point for a long simmering resentment over executive compensation. They have become an entire gravitational force field of umbrage at the greed, arrogance and now horrifically costly stupidity on the part of these Wall Street masters of the universe, as they preferred to be called in times of a calmer CBOE volatility index.
(Wall Street tycoon)
We are shocked, shocked, to find government trying to interfere with free market capitalism.
(Government official)
Here is your share of the TARP bailout, sir.
(Wall Street tycoon)
Thank you very much.
Recent events make it easy to imagine such a remake of Captain Renault’s iconic lines from the classic film, Casablanca. But even the highly creative Epstein brothers, who wrote the original screenplay, would have trouble accepting that the hypocrisy uttered on Wall Street today would make for credible dialogue. Believe it. (more…)
General Motors and Nortel look at bankruptcy. The BCE deal dies. The Bernard Madoff fortune-making machine was a fraud. The demise of once commanding forces takes its toll and causes us to have many questions about the permanency of success and the always-looming specter of disaster.
This week revealed things no mortal was ever supposed to see. (more…)
A brief essay on the subprime credit consequences when CEOs fail to lead, directors fail to direct and regulators fail to regulate
It began as a term that few had even heard of barely 18 months ago and most experts dismissed as an insignificant blip in a fundamentally robust economy. But yesterday, George W. Bush signed into law the most extensive -and expensive- free market repair bill since the Great Depression, thanks to what we have come to know as the subprime mortgage meltdown. The legislation marks another ironic milestone for this Republican, MBA-trained apostle of the private enterprise system. In 2002, he put his signature to the Sarbanes-Oxley Act, which, in the wake of Enron and numerous more accounting-related corporate frauds, also brought the power of the federal government closer to the boardroom than at any time since the 1930s.
The Housing and Economic Recovery Act of 2008, which also serves as a bailout for Fannie Mae and Freddie Mac, addresses precisely the flaws and failures which successive business leaders and government officials said would never occur in the modern era. Depression-time failures, runs on banks, and the collapse of huge financial institutions that were typical of the 1930s, they said, were a thing of the past. But just as those events were a product of human shortcomings and unbridled greed, so too is the present day crisis the result of CEOs whose bonus-obsessed lack of vision made them unsuited to lead, directors whose risk-oblivious nature made them incapable of directing and regulators whose focus on the battles of the past made them incapable of regulating. Exhibit One in this regard is the more than $30 million in compensation the CEOs of Fannie Mae and Freddie Mac, the struggling mortgage giants that prompted the recent government bailout, were awarded by the boards of those companies during the past year when the seeds of their horrific losses were being sewn.
Only a few months ago, the priority of the new treasury secretary, Henry M. Paulson Jr., and the Bush administration was to roll back enforcement under Sarbanes-Oxley, which many in the business community claimed was hampering American competitiveness. Blue ribbon committees composed of impressive and accomplished corporate men and women were formed to look at ways of blunting the regulation of business. All the time they were focused on this objective, the time bomb of the subprime credit disaster was ticking away. But the business world, and Wall Street in particular, disposed typically to hearing only the siren song of great bonuses and increased fees, did not heed the tick, tick, tick of impending calamity that was of their own making. No alarm bells sounded, at least on Wall Street, about the overly complex financial instruments that were being created, or the possibility that the ever- faster moving gravy train would meet with an abrupt generational derailment. So much has the landscape shifted that the man from Wall Street who was brought in to loosen the reins of corporate regulation has now become the architect of the most sweeping government intervention since FDR. And his boss, the first MBA graduate in presidential history, will have presided over the most staggering run up of the national debt in U.S. history.
Republicans and other traditional advocates of government restraint have fallen so far from their Milton Friedman, laissez-faire pedestals that they have given Secretary Paulson what amounts to a blank check for unlimited backing of these government-sponsored enterprises whose names sound like something out of a 1920s Gershwin musical. It is a hard swing from earlier days, when Fed chairman Ben S. Bernanke testified before Congress that he didn’t expect the credit crisis would spread to other parts of the economy. Just days before the meltdown at Fannie and Freddie, Henry Paulson was predicting “we are closer to the end of this problem than we are to the beginning.”
Much of the litter prompting the actions of the Bush clean-up crew came about through Wall Street’s obsession with bigger bonuses and more fees, and insufficient attention as to how they were achieved. A good part of the world, though happily we did not count ourselves among this group, really believed for a while that some of these fellows actually deserved and earned their bonuses, which, in many cases, amounted to $40 million, $50 million or even more than $100 million in a single year. We have long contended on the subject of excessive CEO pay that it is well to remember that its recipients are endowed with no superhuman traits.
Unfortunately, too many in the boardroom and on the stock exchange floor seemed to think the more a CEO received, the more he was able to jump over tall buildings in a single bound. But as Merrill Lynch’s Stanley O’Neal and Citigroup’s Charles O. Prince schlepped out of their offices for the last time after presiding over record multi-billion-dollar losses, they seemed remarkably fallible -even with the millions in bonuses and severance they carted away in the process. Also gone with the toppling of CEO after CEO who failed to live up to their Marvel Action Comics billing is the idea that their compensation is the business just of shareholders. Look at the casualties of home ownership and the record foreclosures that are sweeping America, a trend that can be traced to the creation of flimsy investment vehicles designed only for their quick fee and bonus producing content for Wall Street and mortgage lenders, and you see how much Main Street America has at stake in the compensation inducements that crony boards hand out to their country club CEO buddies.
It was a nice party while it lasted. Shareholders did well. Directors commanded ever higher fees for their slumbering counsel in what was an impressive reprise of their roles during the Enron era scandals and long before, during another time of Wall Street excess culminating in the market crash of 1929. Top management became elevated to god-like status with remuneration packages commensurate with that standing.
The shell game continues. Just this week, Merrill Lynch announced that it was selling off $6.7 billion in what many regard as toxic mortgage investments. The problem is, only two weeks ago those assets were valued by the company at $11.1 billion. The company’s write-downs -so far- we are told exceed some $40 billion. But to be honest, whenever numbers climb over the $25 billion mark we generally have to reach for the oxygen mask and lose track of the details in the process. Another problem: Merrill has to loan the buyer most of the money to take over the sludge. It’s a little like the Fed buying up $29 billion in feeble Bear Stearns assets to help out with the JPMorgan Chase deal. Except they called it a loan at the time. Nobody is calling it that now. Thinking about Fannie Mae, one is reminded of the scandal there when government investigators found top management fiddled with the books in order to prop up their bonuses. In 2006, U.S. regulators filed more than 100 civil charges against former CEO Franklin Raines and other officials of the company, accusing them of manipulating earnings to maximize their bonuses. It was among many ethical lapses that will be uncovered during the heady times of recent years.
Now the party is over. And, as they had to in the 1930s, it is the taxpayer who must pick up the tab for the broken furniture and all the other casualties of the splurge of over-indulgence that marked what we have called before the Modern Gilded Era. When incomes in America begin to approach the level of disparity which existed in the 1920s, as they did in the past couple of years, perhaps it is a warning sign that reason and judgment have reached a dangerous state of undersupply in the economy, and in society as well.
With the stroke of a pen this week, America’s debt will have been increased by nearly a trillion dollars; its deficit now the greatest in the country’s history. Many of the owners of the corporations who gambled and lost on these ill-conceived schemes will be bailed out. Some homeowners may benefit from the legislation, and a higher standard of regulation -which should not have required a Titanic-like catastrophe before its need became obvious, will prove beneficial in the future. But the greatest beneficiary is Wall Street, which has consistently held the view that there is no better system than modern free market capitalism, except, of course, modern government enterprise when it shows up with its purse open. For there is no more beautiful sight to the errant Wall Streeter than when Mr. and Mrs. America come to junior’s rescue after he wraps the BMW of self-aggrandizement around the lamppost of ever looming, but never fully contemplated, reality.
The point of all of this is not to disparage capitalism, especially the idea of responsible capitalism -a principle we have long advocated and believe is fundamental to the innovation, creativity and advancement of a free and prosperous society. But it is to further illustrate that capitalism is merely an engine, not an Adam Smith-invented autopilot. How well it operates, what value it creates, what havoc it wreaks are dependent upon the skills, vision and integrity of the men and women to whom it is entrusted.
Many of the wrong people were entrusted with it this time. The price has been steep. The damage to the reputation of this unique economic system has been considerable. The consequences of insatiable greed, and of governance and regulatory systems that failed to check it, have been historic.
It might be hoped that for the hundreds of billions of dollars American taxpayers are shelling out for the economic debacle which in some respects rivals the Great Depression, they also will have paid for the education of future actors on Wall Street, in the boardroom and in the regulatory halls of government, who will have learned something of the vice of unrestrained excess, something of the virtue of a financial system more grounded in both value and values and something of the sacred trust that is bestowed when society loans power and opportunity to those whom it allows to lead, direct and regulate.
This week marks the 100th anniversary of Edward R. Murrow’s birth. For the generation of my grandparents and parents, his voice was synonymous with integrity in reporting the events that shaped their lives. Few could match his gift for words or their authenticity in describing the seminal events of his era -a war-time Europe in flames; the horror of Germany’s concentration camps; and, later, the terror unleashed by a particularly odious junior senator from Wisconsin.
He practiced the craft of speaking truth to power, which, at its best, is what journalism is about. It is such an important calling in a world where the ability to hold the powerful to account is the lifeblood of freedom and democracy. In sentence after sentence and in program after program, from his days in war-torn London to his legendary “See it Now” series, this icon of American broadcast journalism reminded people how imperative it was that they knew what was happening around them in their world. People invariably felt better-informed and reassured after listing to Mr. Murrow. He did not talk down to his audience, nor did he find the need to engage in the kind of babbling banter that passes for insightful commentary in many newsrooms today. It was the respect he showed for the obligations of the journalist and for the power and responsibility of words themselves that allowed him to gain the trust of the public. How rare those qualities seem today.
Had he lived in this time, I suspect Edward R. Murrow would likely have been a rather iconoclastic figure. He would not be among those of his profession today who appear to sleepwalk while power is moved more and more into the hands of governments and special interests. He would not have remained silent as the voice of the ordinary individual is increasingly drowned out by the lobby of the super rich and those seeking their favor, nor would he have been a passive witness to what I have called the era of the vanishing stakeholder.
Surely, he would have been troubled by a society which is rich in news information but rarely in context or balance, where ratings are the ultimate determinants of what the media portray as the truth, and where the world seems inexorably heading to a point where most people will seek to be informed by that most authoritative of all news sources: YouTube.
Would Mr. Murrow have found today’s culture of mainstream journalism inviting? Or would he have turned to the blogosphere as the only place were a truly independent voice can be raised and heeded? And what would he think about the level of journalistic standards that sees major newspapers still offering Conrad M. Black, currently serving a 78-month sentence for fraud and obstruction of justice, a platform for his opinion on American politics and foreign policy direct from that bastion of academic integrity known as the Coleman federal correctional complex in Florida?
I believe we have a sense of where he would have been on the war in Iraq and the climate that preceded it, where it was considered un-American to question the merits and costs of the war, the evidence offered for its prosecution, or the motives of those who so strongly advocated it.
Here is a quote from a 1953 broadcast that seems especially appropriate today. It is vintage Murrow, and we give the last word, as it should be, to the man himself.
“If we confuse dissent with disloyalty – if we deny the right of the individual to be wrong, unpopular, eccentric or unorthodox – if we deny the essence of racial equality, then hundreds of millions in Asia and Africa who are shopping about for a new allegiance will conclude that we are concerned to defend a myth and our present privileged status. Every act that denies or limits the freedom of the individual in this country costs us the. . . confidence of men and women who aspire to that freedom and independence of which we speak and for which our ancestors fought.”
Benedict XVI came out from behind the long, and for many, saintly shadow of John Paul II this week when he arrived in the United States. His visit instilled a sense of curiosity in millions and a deep outpouring of respect from his American flock. He gave the most contrite apology yet for the terrible sins of wayward clergy in the sexual abuse scandal that has been so costly to the reputation of the Roman Catholic Church and to the lives of those directly affected. It was the act of one who understands that being a leader often means dealing with uncomfortable issues and bringing healing to where it is needed.
His homilies and speeches on human rights, respect for the individual and the challenge of global warming transcend any single religion or nation. They are the common cause of decent men and women everywhere. Yet no other leader can speak with such a direct connection to so many people around the world. He is, in that respect, a universal leader. There are not many of those today.
The celebration of his arrival on the south lawn of the White House this week, with the incomparable soprano, Kathleen Battle, whose voice, accompanied by a golden harp, would move angels to tears, was a uniquely touching spectacle. And for all the criticism President George W. Bush has received for the mistakes and folly of his administration, though much of it is deserved, he was as gracious and considerate as one could ever expect from an American head of state.
Benedict’s attendance at New York’s Park East Synagogue on the start of the Jewish Sabbath before Passover shows this Pope, like his predecessor, to be a figure that respects other faiths and counsels tolerance for all. Many Muslims have also expressed admiration for the message the Pope has brought. These are encouraging steps in the journey toward hope and understanding on a road that is often shaken by violence and hatred.
It is a reminder that, even in a time when billionaire hedge fund managers and search engine kings command so much adulation and wars and economic disparity cause so much division in society, we all have a need to look up to someone who embodies a sense of moral authority and epitomizes the teachings of timeless virtues, such as faith, charity, forgiveness, care for the lesser among us and, especially, peace on earth.
History may well view Pope Benedict XVI’s visit this week as a turning point. John Paul II fills a special place in the Church and in the hearts of millions, some of whom did not even share his religion. But he would be the first to say that each Pope must serve in his time and find his own voice to do so. Benedict found his voice in America.
It is one that should be happily received around the world.
