First, there is a slightly new look to the Wagon today. Notice it? Get ready.
All right, back to Alan Greenspan. His premise in acting as he did throughout his tenure, as he states, was that firms and particularly banks would act in their own self interest. Part and parcel of acting in self interest is not exposing your firm to undue risk, not acting cavalierly with stockholder interests, not gaming results to produce short term gains at the expense of long term health and producing steady, reliable growth. My premise is that was right all along – firms and particularly banks would and should act this way. He’s also wrong – firms and banks have lost the institutional wherewithal to self direct. Instead, they are guided by executives and directors whose self interest is at odds with the institution’s interest.
If you are an executive, you are at least presumably compensated for your ability to grow the value of the company. The value of the company can be expressed in myriad different ways, but the most facile and popular expression of this is the share price. Therefore, many executives are compensated with stock options. As the thought goes, if the executive does a good job, the company does well, people want to invest in the healthy concern, the share price rises and the executive gains.
One large problem with this is that there is always a time line for producing these results. I believe it was John Maynard Keynes who, when speaking of long term economic policy, said “in the long run, we are all dead.” The institution’s self interest has an indefinite time frame. Ideally, it responds and adapts - perhaps even shapes – the market’s will and continues to provide increasing value to the market and its shareholders. Sustainable growth. Alternately, the institution could reach a point where its size and market share are maximized, but through effective management, consistent profits are achieved. Reliable profitability. Either of these scenarios are wonderful long term situations for the institution and its investors. The theory is it’s a wonderful scenario for option-compensated executives.
A tentacle of the problem seems to be that executives are increasingly mobile. The stodgy, idealized portrait of the CEO looks like an Andrew Carnegie or J.P. Morgan: an individual whose whole identity is barely separable from that of his firm. His interests, continuing through his death (as his heirs will be indefinite stakeholders in the firm), are the firm’s interests and vice versa. The reality is that CEOs live in a world where better offers come along, particularly when you have put in an all star performance or two. Take the case of “Chainsaw” Al Dunlap, whose tenure at Sunbeam made him a celebrity CEO. By pretty much all accounts, the guy was an asshole of the highest order. He was known to scream at and belittle junior executives and have absolutely no empathy for employees. He also took Sunbeam from a lagging operation to a tremendously profitable operation by slashing costs and cutting out corporate fat, hence the “Chainsaw” nickname. He did so well at Sunbeam that other offers came along, and he took advantage. I forget what his exact career path was, but the gist is that it became obvious that his tactics at Sunbeam meant that the company had no new products under development, sales were declining due to the elimination of promotional spending, and everyone who had the opportunity to leave the company left. They didn’t want to work for the next “Chainsaw.” Just as this all was beginning to come clear, there was still room to postulate that Sunbeam had really lost its way because Dunlap had left. As it turned out, his tactics were bearing the same fruit at whatever company he’d moved on to, and it was falling apart as well. He left the circle of celebrity executives in disgrace.
Jack Welch is another good example. It seems that Welch was probably a more talented manager than Dunlap, and also a better gamer of the system. Under Welch’s leadership, the company hit its numbers quarter after quarter in an unprecedented streak. Being a particularly diverse company, it seemed in hindsight that while there were indeed many good things happening on Welch’s watch, there was also a pretty well constructed shell game being played to hit the quarterly marks. Losses were moved off balance sheets, numbers were pulled forward or pushed backward as needed to produce the correct “now” number, etc. As soon as Welch left, the new CEO started having trouble producing the same miraculous reliability. How ever will the world replace Jack? Well, it became clear that he’d been no stranger to a little accounting chicanery and that his strongest performance was pulling the levers in just the right way to make sure everyone looked at what he wanted them to see and not what he’d swept under the rug. Of course, his final coup was engineering a retirement package that ensured that no matter what happened at GE once he was gone, he would have his unbelievable lifestyle paid for by the company ad infinitum.
The story is really no different with what’s happened on Wall Street, with the additional twist that one needn’t have been at the CEO level to game the system. Department heads and heads of trading floors were able to secure compensation schemes that lavishly rewarded short term performance, yet didn’t have the mechanism for ensuring long term action in the company’s interest. So when the opportunity came to make insane sums of money by selling fundamentally dodgy investment instruments, or by offering ‘profitable’ mortgages to people who had no business buying homes, these guys stepped up to the buffet with all they had and made a killing. Whether they even had the knowledge that these houses of cards were guaranteed to fail or not is irrelevant. Their compensation schemes guaranteed that their near term benefit was so outsized that even if things fell apart, they’d have made so much money that it wouldn’t really matter. A well known Wall Street concept is the “fuck off” number, this being an amount of net worth so unassailable that you can tell the rest of the world to “fuck off” and live the rest of your life any way you see fit. I wonder how many Wall Street guys hit their “fuck off” number and got out of Dodge in the past five years?
The democratization of these ridiculous pay schemes is a big deal. When someone who isn’t even at director level, and thus is really at a stage where his self interest overwhelms that of his interest in the company, is able to create such wealth for himself while laying off all of the risk on his company, problems are a guarantee.
So while Greenspan is mostly correct in identifying the flaw in his premise, I think he’s missed the important point that institutions no longer act in their self interest because they’ve lost the ability to do so.