Wednesday, January 20, 2010

(No.75) Financial services deficits: a screed -- Part 1

It has been a bit more than a year since I began That followed my departure from the life insurance business as a salaried executive, a career I had begun with the Mutual Life of Canada and ended as an executive in the Canadian operation of Sun Life. Along the way I had also founded and for some years edited The Canadian Journal of Life Insurance. It was a spare time avocation and a quixotic attempt to contribute to the life insurance industry's mental health.

My years spent as an executive, industry analyst, editor and commentator, interviewer, public speaker, industry association committee chair [CLHIA] and board chair [FPSC] gave me a useful perspective on the financial services business. These roles also provided me with good sightlines on various members of the industry's senior management groups as well as financial services market and rating analysts and media people, the clan I have dubbed the financial services paparazzi.

One of the considerable satisfactions of my business career has been my association with people of quality, men and women whose integrity allowed for no gap between their personal and business ethics. This being the real world I also encountered too many of the other sort, the kind who sailed though life untroubled by the ethical gulf between their personal and business lives.

It was the greed, incompetence and lack of standards of supposedly responsible executives that in large measure caused the financial services conflagration centered in but not limited to the United States. It was a financial fiasco the so-called external experts failed almost entirely to anticipate or even analyze usefully as the causes that made the meltdown inevitable became increasingly evident (e.g., the lunatic expansion of subprime mortgages and related 'packaged' securities).

The recent financial scandals have illustrated a number of unpleasant things for the North American public. Among others -- that widely held public companies, supposedly so responsive to the interests of shareholders are often seriously deficient in accountability and in ways one could hardly imagine in companies like Mutual Life of Canada or Northwestern Mutual. [Some of us well remember, in years past, the aspersions cast and snotty comments made by shareholder company CEOs about the mutual form of organization.]

Indeed the 2008 meltdown of Wall Street financial services firms ought to have shown even the most simplistic among 'free market' cheer leaders that large firms can be and often are led by senior executives whose performance and judgement are seriously deficient, a fault compounded if they are also responsible to boards of directors who are -- at least in the majority -- not only ignorant of the reality of the business the company on whose board they sit is actually in but are incapable of judging and penalizing problematic executive performance and inferior company results ( nor is there any dearth of Canadian examples in insurance and banking).

Over the years my observation of the actual management skills (as distinct from career management 'political' skill) of many members of senior management 'teams' left me not only unimpressed but ultimately unsurprised by the extent to which the causes of the recent financial meltdown can be laid at the door of deficient executive leadership, sophomoric political and business opinions as well as senior management decision-making guided by financial self-interest.

Watching senior management in the financial services industry from a proximate position and equipped with non-public sources of information led me to subscribe to the opinion of the 19th century German Chancellor Otto von Bismarck who concluded in a different context but one applicable to the direction of today's financial services business: " Laws are like sausages. It's better not to see them being made." Certainly over the years I have seen ingredients well past their 'best before' dates being used in too many business sausages.

To add insult to public injury we now hear pathetic defenses of grossly inflated compensation paid to crews of senior executives whose own greed and incompetence helped produce the financial services meltdown. The rationale advanced for resuming the screwing of shareholders and taxpayers alike is that obscene levels of income must be paid to senior executives because they will otherwise leave the companies causing loss of their valuable talents.

It ought to be obvious, even to those executives with IQs dangerously close to room temperature, that the value of such talents (except in the opinion of those actually receiving the inflated compensation) is often more than dubious. Indeed, any sentient person who has been close enough to observe 'sausage making' in financial services companies will have long since wondered what superiority of leadership and vision is required, for example, to hire consultants to deliver commissioned window dressing for fixed policy intentions or to create camouflage under which a senior executive may later shelter from negative results? Or, for that matter, to habitually take credit for the work of others more talented but less politically adept?

What incentive should be on offer to retain the services (for example) of those at AIG who gambled with company funds, treasure which ultimately had to be replaced by $80+ billion of taxpayer money?

Apparently, if one believes the most senior survivors of the 2008 Wall Street Titanic, the answer is that it needs to be incentive as grand as the unreduced compensation of financial services company CEOs whose poor decisions managed to lose billions. And the beauty of it all for these corporate underachievers? To bring off lovely levels of incentive one need only have a board of directors compliant enough to award such largesse to CEOs, even though in some cases it is evident the corporate ship has already struck a financial iceberg.

So large is the accountability deficit in U.S. financial services leadership that the large Wall Street banks are now demonstrating, as my grandmother used to say, more nerve than a canal horse by lobbying against the passage of the Obama administration's relatively modest financial regulatory reform aimed at trying to prevent the recurrence of the economic near-death experience they precipitated.

Bismarck had it right. So does Nobel prize-winning economist Joseph Stiglitz when he argues that the recent financial services fiasco arose not only from an accountability deficit but also from an underlying moral deficit.

[to be continued]

Alastair Rickard