Stephen H Baum Leadership

Joseph Stiglitz is one of the few economists who identified the bubble and predicted the bubble would burst. So we went to hear him interviewed last night (note: the appearance was, in part, to promote his new book – “FREEFALL”).

By way of background, we were interviewed on Market Watch at the time Stan O’Neal was on the hotplate. At that time we said that more than a few CEOs of financial institutions engaged in reckless, bet-the-ranch risk-taking and even suppressed efforts by risk managers to speak up and mitigate the risks. We said that management incentives were so powerful and short term that leaders could walk away with fortunes and leave others holding the bag when the chickens came home to roost.

Stiglitz confirmed this view and went further. He perceives an “agency problem,” in which financial firms’ managements are no longer connected to the consequences of their actions. When a bank used to lend, the owner(s) lived with their judgment. With derivatives, that is no longer the case. And recent research has deepened the problem by disconnecting total compensation from real performance. In fact, performance pay is no longer performance pay. It is retention pay. No wonder stockholders want some say in pay.

Discussing other factors which contributed to the bubble, we took away these: regulators who did not believe in regulation, a norm of secrecy rather than transparency that metastasized to the Fed who told us we did not need to know where our money went, a belief system on the part of new Obama people that was shaped by their prior experience on Wall Street and inhibited independent thinking. One of my clients interviewed for a job at Treasury and reflected afterward that walking the halls there was like doing it at Goldman — familiar names and faces everywhere.

Finally, we will never know what drove dedicated public servants (dedicated to whom?) to bail out the elites (e.g., big banks, Goldman et al), pay 100% on the dollar for bad assets in some cases, impose few restrictions on recipients of the first $178 billion, soften the landing for foreign banks and generally put the interests of the taxpayer last. And let the core of small business lending — thousands of smaller banks — fail. 

Stiglitz mused that our government violated the rules of capitalism in doing the above, socializing the losses and privatizing the gains. And we have not yet paid the full price.

Now, with financial reform on the table, we should not be surprised at the intensity of lobbying to avoid new restrictions that might lessen the scope and damage from the next bubble. Yes, the next bubble because there will surely be one.

That’s just my view. What’s yours?