Never in the history of modern business leadership have CEOs been paid so much to achieve so little at such cost to so many.
At the opening hearing of the Financial Crisis Inquiry Commission held in Washington this week, key players in the worst financial meltdown since the Great Depression admitted they did not see it coming. The chairmen and CEOs of JPMorgan Chase and Goldman Sachs, Jamie Dimon and Lloyd Blankfein, and the chairman of Morgan Stanley, John Mack (who used to be its CEO as well) all testified that they were surprised at what happened. They now agree they were overly leveraged and did not handle risk with the respect it deserved. Mr. Dimon apparently never contemplated the possibility that housing prices would stop rising, much less decline.
It seems that Messrs. Dimon, Blankfein and Mack had as much vision in anticipating the downturn, and the folly of some of their assumptions about growth, as over- extended buyers of subprime mortgages had. Except that Dimon, Blankfein and Mack were not struggling low-income homebuyers who took on one too many bedrooms. They were among the highest paid executives on the planet whose word commanded deference and awe among much of the investing public, the media and an ever-admiring circle of policymaker-groupies.
Over the five years leading up to the subprime debacle in 2008, these three men were collectively paid more than $310 million. For the year 2006 alone, when so many of the seeds of disaster were being sewn on Wall Street and among its top banks, Mr. Dimon was paid $57 million and Mr. Blankfein $38 million. When Mr. Mack rejoined Morgan Stanley in June 2005, he was awarded stock worth $26 million on day-one, and a further $13 million in compensation and benefits for his first five months of work. In December of 2006, Mr. Mack was awarded a bonus of $40 million on top of his $1.4 million salary.
As they were being paid these sums, much of the world was increasingly convinced that these were proper incentives to ensure alignment with shareholder interests. They earned every penny million, it was thought. The prevailing view, especially among the wishful thinking and the non-thinking alike, was that such men were really superheroes whose ability was so unique and so far beyond those of ordinary mortals, the fact that their feet touched the ground when they walked was seen merely as one of their many generous concessions to convention.
They were not alone, of course. There have been hundreds of CEOs who have happily participated in the greatest transfer of wealth of its kind –a transfer that, for all the soaring salaries, bonuses and stock options, has ultimately seen the worst economic crisis since the 1930s, the highest job losses in generations and a stock market performance over the past ten years that has produced virtually zero gains, except for the titans and bankers who managed to cash out before the fall.
The 21st century began with a series of corporate scandals involving companies like Enron, WorldCom, Tyco and Hollinger. It ended its first decade in the throws of the worst financial failure in modern time. One thing stands out to mark the beginning of this period and its end: the folly of executive compensation. In 2002, we warned Congressional committees: “The most corrosive force in modern business today is excessive CEO compensation. Such lofty sums tempt CEOs to take actions that artificially push up the price of the stock in ways that cannot be sustained, and to cash out before the inevitable fall.” The extent of that corrosion and fall is apparent today. The consequences in taxpayer dollars soar into the trillions. The costs in human terms remain beyond calculation, as does the loss of confidence in corporate leadership.
More than just Lehman Brothers, a few banks and a couple of Detroit automakers went bankrupt in this period. The trust of workers, the middle class and pensioners in corporate management and governance has also collapsed. There may be a seismic ruin of jobs, dreams and foreclosed homes on Main Street. But on Wall Street, where people like Mr. Dimon, Mr. Blankfein and Mr. Mack still command adulation for their leadership and vision, the Fed-supported, taxpayer-rescued towers of finance give hope and comfort to those still requiring generous bonuses to get through their Tiffany-challenged day. The magnitude of their gains this year, less than 18 months from a once- in-a-lifetime experience looking into the abyss, promises also to set new records, which, like housing prices, is something Mr. Dimon thinks should go only one way, too. Recently, he announced that he was sick and tired of the criticism being leveled against Wall Street on the compensation front.
These are forceful accelerants to the rise of Turbo Populism, the term we coined on these pages and will be speaking more about in the future.
Had the world the benefit of a modern Churchill capable of battling the monstrosity of betrayal and failure these titans of excess have wrought, he would surely have given voice to a mood that is thundering across the land from kitchen tables and church pews to swelling unemployment lines and Twitter postings: Never in the history of modern business leadership have CEOs been paid so much to achieve so little at such cost to so many.
This is a reality that escaped the CEOs who appeared before the Congressional committee this week. They do not escape our sense of outrage.
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At the opening hearing of the Financial Crisis Inquiry Commission, the bipartisan committee formed by Congress to investigate the causes of the great financial meltdown, there were four chairmen of key Wall Street players in the crisis. There was much anticipation over the proceedings held today in Washington. Since its formation last spring, the Committee has had months to prepare for this day. But there was not a single probing question, as far as we could tell, from chairman Phil Angelides or any other member of the panel, about the role of the board of directors. This is a glaring omission, if you believe that boards matter and what directors did or did not do to avoid the disaster is an important part of the review.
It is one thing for boards to constantly underperform or are not taken as seriously by their executive chairmen as they should be, or as an independent, non-management, chairman might want them to be. It is quite another when an inquiring body appears to forget that, in law and in principles of modern business practice, the buck stops with the board of directors. Where were they?
We will have more on this disappointment soon.
Freedom, in either its political or economic appearance, has never been a lasting guest in the American home when it was merely taken for granted.
The celebration of Thanksgiving in America is rooted, more than anything, in the blessing of freedom and opportunity. Those were the hallmarks that beckoned the first settlers to the far off shores of the new England. They are what is celebrated in the uniquely American way each year at this time.
Through evolution and revolution, titanic wars and epic financial upheavals, America has come to define ideas like a free market, individual choice and accountability among those who exercise power – whether in the economic arena or in the political. In many ways, these principles have become a model for much of the world. But their ascent has not been without cost. And the need to defend these values has, time and again, come with a painful price tag.
As America contemplates its blessings this Thanksgiving, it is timely for it to consider whether it serves the cause of political freedom by propping up corrupt regimes, such as the one that rules Afghanistan today, where, right now, thousands of U.S., Canadian, British and other NATO military personnel are placing their lives on the line, and where so many have paid the ultimate price. It is also wise to consider whether the idea of free market capitalism is well served by the constant enrichment of the regime in China, which promotes not a capitalism which extols individual rights and freedom of choice, but an authoritarian capitalism based on secrecy, tyranny and force. This system was well illustrated earlier this month when President Barack Obama visited Beijing and where his “media conference” was not permitted to see a single question asked. That is the way in China; it is not a model America looks good in adopting.
It is also time to ponder whether America is well-served by its financial system, which, after blundering into the worst crisis since the Great Depression and needing a head-spinning succession of taxpayer bailouts (with perhaps more to come), is rewarding itself with billions in bonuses while millions of Americans are losing their jobs, their homes and their dreams. Then there is the Federal Reserve system, which appears more and more to view its role as pushing out trillions to keep Wall Street happy, while Main Street is left to cope under an almost unfathomable mountain of debt and a coming gale of inflation from which there will be no shelter. Far from preserving the freedom of Americans in recent months, these institutions seem increasingly to have made them hostages to profligacy and misjudgment.
From the battered Pilgrims at Plymouth Rock and the courageous Rangers, Marines and service personnel in Iraq and Afghanistan to a struggling middle class and the steadily vanishing members of the Greatest Generation too often left in poverty and fear, Thanksgiving is a lunch that has never come free. And freedom has never been a lasting guest in the American home when it was merely taken for granted.
The world has become accustomed to the idea of an October Surprise. It has happened in politics, in theaters of war and in the economy (see October 1929). But rarely has this phenomenon had the courtesy to actually appear on October 1st, on the dot. That happened on Wall Street today (and on Bay Street in Toronto), where, in the one case, the Dow slipped by more than 200 points, and in the other the TSX plunged by over 300.
It has become common among some strident analysts to declare the recession over and the prospect of a Dow at 12,000, and then at 14,000, easily within reach. Others, and we include ourselves in this camp, have been more skeptical. If we really had the worst recession since the Great Depression, the idea of equity markets so quickly sprinting back to the heights they reached during the subprime bubble seems perplexing. It is a little like someone suffering a massive heart attack and then expecting to win the Boston Marathon 18 months later. On the other hand, if the recession was overly hyped and not really as bad as most of us had feared, the unprecedented torrent of Fed cash and zero interest rates promises to unleash a terrible inflationary toll down the road. Neither scenario seems to be giving much confidence to investors or to the consuming public. And confidence is still the most needed ingredient in any credible plan for economic recovery.
The lesson from today’s surprise is that there is still no end of experts who are happy to be generous with other people’s money – and are determined that neither common sense nor the laws of physics will prevent them from resuming their party and the over-sized compensation that feeds it. They are the risk-oblivious, reality-blind Pied Pipers of their own self-consuming Gilded Age who led us to the brink of the abyss that was so frightening last October. Why would we think they suddenly know the way back to stability this October?
When the President of the United States, especially this President, and Wall Street, are of the same mind on an important matter like who the Fed chair should be, ordinary citizens need to hold on to their pocketbooks.
Having misjudged the gathering financial storm that would engulf much of the world (and in many ways still does) and then deciding to throw unprecedented amounts of liquidity at the problem (most of which was targeted at propping up and otherwise saving a colossally careless banking sector), Federal Reserve chairman Ben S. Bernanke is an odd choice for re-nomination in that post. Nevertheless, President Barack Obama did so today. Wall Street is pleased. When the President of the United States, especially this President, and Wall Street, are of the same mind on an important matter, ordinary citizens need to hold on to their pocketbooks.
In some respects Mr. Bernanke seems like the character from the Woody Allen movie “Zelig,” where an otherwise unimposing man has the inexplicable capacity to transform his appearance to impress those who surround him. We know that Wall Street and world bankers are impressed with Mr. Bernanke, given the size and generosity of the Fed’s discount window and the hundred and one other programs the Fed established in the prop-up and bailout department. And they are certainly impressed by his zero interest rate policy, which is putting billions into the banks as a result of this Fed-made upward sloping yield curve. It is because of Mr. Bernanke that the bonus compensation train has barely slowed from its previous bullet-like speed and companies like Goldman Sachs have been able to return to early profitability with the help of a (Fed-approved) $13 billion payment from AIG, courtesy of the American taxpayer.
The White House may see in Mr. Bernanke a fitting figure whose help will be needed to accommodate and finance the swelling national debt. Mr. Bernanke has already shown that he is not averse to printing money and using the Fed’s powers in out-of-the-box (i.e., expensive) ways. And a Fed head who presided over the largest expansion ever of that institution’s balance sheet is unlikely to cast too critical a glance at the prospect of a record national deficit.
Even most legislators seemed mesmerized by Mr. Bernanke’s appearances to the point where they forgot he was rather disingenuous when it came to explaining the mystery of the Bear Stearns junk assets, which the Fed claimed to be holding as collateral only to admit later that it owned the whole clunker. There are still unanswered questions about the Fed and Bank of America, the Fed and AIG and the Fed and Lehman Brothers.
Not to be forgotten in all of this is the fact that, as a member of the Fed under Alan Greenspan, Mr. Bernanke adopted the same blind obedience to the market forces that permitted the housing bubble to occur and showed no awareness whatever of the explosion of toxic financial instruments and the risk that was being incurred at the highest levels of American finance. Vision has not exactly been Mr. Bernanke’s forte, yet, looking forward, he claims that the Fed will know precisely when to begin to dismantle its Frankenstein-like creation. He makes it sound as simple as opening a new app on an iPhone.
But the more likely scenario is that the costs and consequences of the economy’s withdrawal from this Fed-led morphine-like addiction that dulled the realities of economic pain will be staggering. When interest rates spike, liquidity is withdrawn and inflation surges to new heights, and the economy again begins to falter from its so-called cure, Mr. Bernanke will become the least popular man in America, just as the Woody Allen character Leonard Zelig eventually lost his capacity to spellbind and incurred the wrath of everyone around him instead.
Larry Summers, long thought to be President Obama’s choice as Fed chair, saw what is looming ahead. That, more than anything, is why Mr. Bernanke gets to keep his job.
Our previous observations and misgivings about Mr. Bernanke and the Fed can be viewed here.
Had there been no board at all at AIG, Bear Stearns, Merrill Lynch, Lehman Brothers, General Motors and so many others, it is hard to imagine how the outcome could have been any worse for those institutions and their investors. This is a stunning indictment of a vital and much relied upon function of modern business that creates real systemic risk. It should not have been overlooked as major focus for reform.
Take any defunct company or failed enterprise of major note in recent years -Enron, Hollinger, Nortel, Bear Stearns and Lehman Brothers jump to mind- and you will see the faint outline of the ghosts of its board desperately seeking to attain meaning in death which it failed to achieve in life. In many cases, the difference between the productivity of a sleeping board and one no longer breathing at all is barely perceptible in any event. These boardroom apparitions have likely tried to make contact with the administration of U.S. President Barack Obama as it prepared its sweeping agenda for reform of the financial system. They have apparently been without success in that endeavor as well.
Whenever there has been a collapse or serious threat to the survival of a company, a first slumbering-and then startled-board of directors has been discovered cowering close by. The inability of directors to properly direct and exercise the informed, independent judgment that is required of their positions was a defining feature of the 20th century’s two great financial upheavals. It is a distinguishing factor in the worst economic crisis of the 21st century, where board after board claimed to be unaware of the true depths to which their companies had fallen and most professed surprise at the extent to which management had run amok with risk and debt.
As we have observed many times in public forums and before legislative committees, no other institution in modern business has so persistently failed to perform its intended mission or brought discredit to otherwise illustrious names of accomplishment and virtue as the board of directors of the publicly traded company. At a time when their size and power have expanded to the point where companies have become too big to fail or require billions in taxpayer support to prevent their total collapse, it is unacceptable-indeed, it is an affront to any concept of sound risk management-that the board of directors is the weakest and most unreliable link in the corporate governance chain.
In the run-up to the subprime debacle that brought the world to the brink of financial collapse, boards at some of America’s oldest and most respected financial institutions were seemingly oblivious to the risks that their companies were incurring or the mortal threats that were gathering on the horizon. Many, like Bear Stearns and Lehman Brothers, seemed to have no effective oversight at all. Citigroup’s directors appeared to be in a constant state of suspended animation, acting always too slow and too late on the few occasions when they actually did anything. When AIG’s directors received warnings about the Financial Products division, whose out-of-control derivatives business eventually brought the company to the edge of ruin, they remained in denial. At Hollinger, big name directors seemed to have all the requisite skills, except the ability to read and ask discerning questions of a constantly scheming management. Even in non-financial companies, like General Motors, the board seemed indifferent to management’s repeated failure and disconnected from the changes that were reshaping the consumer market. (See these companies under categories section for more analysis).
And in virtually every case where the existence of a company has been imperiled, or it has disappeared altogether, the specter of wildly excessive CEO compensation loomed large. Rather than acting as watchful guardians of shareholders’ assets, directors too often seemed to be little more than obliging ushers, happy to facilitate the greatest transfer of wealth of its kind in history to the CEO class of management. It is the failure of boards to properly bring discipline to the compensation file that permitted a situation whereby CEOs were encouraged by oversized bonuses to take the unjustified risks that later led to a cascade of unprecedented failure and stock market calamity.
It is not a matter that accountability and director engagement have had an insufficient presence in the American boardroom. In many cases, they didn’t even make it into the company’s main floor elevator. Had there been no board at all at Enron, AIG, Bear Stearns, Merrill Lynch, Lehman Brothers, Hollinger, Nortel, Livent, General Motors and so many others, it is hard to imagine how the outcome could have been any worse for those institutions and their investors. This is a stunning indictment of a vital and much relied upon function of modern business.
So it is with astonishment that we find the issue of corporate governance and the need to make boards work as intended are nowhere to be found in the Obama administration’s comprehensive agenda for financial regulatory reform. Nor does it appear that the Securities and Exchange Commission is undertaking any significant overview of what has gone wrong at so many boards, as we recommended on these pages some months ago. Indeed, in the executive branch’s proposals for reform, the term “board of directors” as it applies to the publicly traded company appears only once-in passing-in all the report’s 88 pages.
The issue is hardly insignificant. As we said last April:
Here’s something else the SEC is missing: What exactly was the role of boards of directors in the credit and financial meltdowns of the past 18 months, and to what extent did a failure of structure or culture among directors contribute to a global crisis affecting hundreds of millions of individuals, costing trillions of dollars and eventually leading to the collapse of banks around the world?
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What boards did and did not do, and how they were organized, in recent years and months when calamity has been such a frequent guest are lessons that are too important to ignore. We suspect that what will be found is a weak and compliant boardroom culture where the most taxing job for most directors was lifting the rubber stamp marked “yes.” That, in our view, is the real definition of systemic risk.
Boards exist as stewards of other people’s money. The wise use of that trust is central to the principle of capitalism. Without it, capitalism would cease to exist. Either the board of directors occupies an important place in the functioning of the modern, publicly traded, corporation, or it does not. Either there is the need to ensure that management is held accountable and that directors answer for their stewardship to investors, or that charade should come to an end. Either the system of corporate governance that has evolved over the past 100 years and which views the board as the lynchpin of that regime should be accorded its rightful prominence, or an entirely new system needs to be created.
One thing is clear: Oversight of the operation of a company, including its management of risk, the supervision of its ethical standards, the quality of supplier, employee and customer relations and the accuracy of its financial reporting, cannot be left to outside regulators alone. Capitalism and its stakeholders cannot rely on government for every aspect of their survival. That is for other systems of economics and government, not for one that values freedom, individual choice and personal initiative. What capitalism must do is to first look within its own system to ensure that the tenets of fairness and integrity that are essential to its existence are being upheld. Companies need to self -regulate if they are to fulfill the promise of a system that is said to thrive in a climate of least involvement by government. It is the job of the board of directors to perform this self-regulating task, though, sadly, many boards betray discomfort when called upon to protect their own shareholders’ interests, much less serve as guardians of capitalism. Free market advocates and champions of limited government someday need to address this glaring gap in leadership.
Public policy periodically, and generally after some scandal or disaster, has tended to recognize the vital role that boards hold and has attempted to raise their standards of performance and accountability. This happened notably in the 1930s and again after the Enron-era accounting scandals. There is no reason to think that, in the aftermath of the most costly abuses and betrayals on the part of Wall Street and the financial sector since the 1930s, the importance of the board has suddenly been diminished or its need for reform has been averted.
If restoration of confidence in the system of capital markets is the goal of the Obama reforms-if there is a genuine desire to minimize the chances of disaster in the future-the role of the board of directors, and what needs to be done to make it more effective, cannot be overlooked. It was disappointing that the administration, which is otherwise rather astute in its comprehension of economic forces, chose to do so. We look at some ideas to bridge the gap between what boards are supposed to do, and what they have actually done, in Part 2.
