Dec. 1, 2008
Charles Shinaver, Ph.D.
How did we lose confidence & how do we regain it?
"Trust is the easiest thing in the world to loose,
and the hardest thing in the world to get back."
The U. S. economy is in unfamiliar territory. It appears as if a house of cards is falling around us while the world watches in panic. How did we get in this mess? How do we get out? This introduction is not intended to be an exhaustive analysis on an economic or political level of how we got here. It is much simpler and more common sense analysis. One that might be captured by simply asking: “What were these guys thinking?!”
I am a psychologist. This will be an analysis and critique of leadership and the model we have embraced for quite some time now: the power model. On the simplest level this crisis comes down to a question of leadership. This is leadership on all levels great and small. From the small business owner with his first hire to the largest institutions. The failed model of power leadership looms large in the for-profit sector and as you will see in the ‘quasi-governmental’ organizations. However, I am especially concerned about business, or how ‘business as usual’ has failed. This book is about how to get out of this mess. This is about how you and I will climb out of the abyss and get this country out of this mess, one step at a time. Yes, the politicians will need to do quite a bit to help us, but they need our help too. This book is about how we begin to rebuild.
This introduction is about how we got here, how we got to this abyss and fell in. This writer is a psychologist not an economist. These issues here are in the intersection of psychology and business. I believe that this intersection is where radical change must emerge if we are to rebuild. Furthermore, in the end it will be about trust, relationships and leaders who serve first. Along the way it is going to be a desperately challenging ride. We will be forced to ask this question: Who should we trust and why? This book is about how to answer that question.
How we got here.
The carnage that is presently occurring is related to so many factors that claiming clear and direct causality is simply ridiculous. Yet throughout the tumbling of massive institutions there are consistent themes. Signs of corruption, greed and the interests of profit overwhelm ethics at every turn. If you simply Google the name of any one of these major institutions that is being ‘bailed out’ and add the word ‘scandal’ you will see a trail that seems so blatant and obvious it’s hard to understand how we were left sleeping at the wheel. Certainly hindsight is 20/20, but there have been people who have expected this collapse for quite some time. Robert Greenleaf described a crisis in leadership in the United States back in 1970 when he wrote The Servant as Leader. He wasn’t talking about politics as far as I know. He was talking about the United States as a whole and, arguably, business leaders in the U.S. in particular.
The power model of leadership is what has gotten us here. I recently posed to Kent Keith the question: “How do you view what is going in our economy right now?” Kent Keith, is the Chief Executive Officer of The Greenleaf Servant Leadership Center, a Rhodes Scholar, the author of the ‘paradoxical commandments’ (which Mother Theresa posted on her wall), and the author of the book The Case for Servant Leadership (2008). He simply said that he thought that the power model “got us into this mess”. Keith describes the leadership style based upon the power model in this way in his book The Case for Servant Leadership (2008):
According to the power model, leadership is about how to accumulate and wield power, how to make people do things, how to attack and win. It is about clever strategies, applying pressure, and manipulating people to get what you want. A word that is often used is realpolitik. It means politics and the exercise of power with no reference to morality or ethics. (Keith, p. 19)
The power model is enticing, it is shiny and tempting, but turns out to be fool’s gold. Just look around. So many aspects of this crisis relate to a style of leadership in which the game is clearly “he with the biggest stack of cash wins”. In the process of getting his stack, he might lie, steal, cheat, walk on top of some people, but in the end it is the size of the stack that matters, nothing else. Well, unfortunately, it may need to be in a currency other than American dollars, but that is another story. In this manifestation of the power model of leadership it is all about the money and only the money. Profit is more important than people and ethics. Any means are acceptable if you like the financial end. This is what has gotten us here. If you doubt that this is the case, these examples will startle you. When I added ‘scandal’ to the names of our institutions that are “too big to fail” I was shocked. That is how I found this stuff. I had no idea. Did you?
There is no need for hyperbole. The facts are so dramatic they are hard to believe.
Just start Googling “x-scandal” (in place of ‘x’ put your most recent bailed out institution) and you will find them and even more.
Eventually you will move beyond the first question: “What are these guys thinking?! The question will eventually become this: “Who should we follow and why?” Then the plot begins to thicken: “How do we set up dynamics so that we can nurture the type of leaders that will get us out of this?” “Part of the issue appears to simply be ethics, but another part of the issue appears to be the way we set up organizations themselves. How can we do better? Finally, it is at core about the model of leadership that will lead us out of the mess: servant leadership.
Signs of the times:
American International Group (AIG), the world’s largest insurance group, as reported in several news outlets was given a loan for $85 billion spent $440,000 on a corporate retreat at St. Regis Monarch Beach Resort in Dana Point, California. Fox Business (http://www.foxbusiness.com/story/markets/industries/finance/aig-executives-blow--getting-bailout/) reported that these funds were spent on Sept. 22, 2008 one week after the Federal Reserve gave them the $85 billion dollar loan to keep the company from going bankrupt. Apparently the need for a bailout had stressed out the executives and so they needed a little spa treatment.
As a psychologist I note here that small behaviors tend to be indicative of larger behavioral patterns. I only recently became aware that AIG has an ongoing legal conflict with “former CEO Hank Greenberg and six other former executives, who are accused of misappropriating $20 billion in company stock.” (http://money.cnn.com/magazines/fortune/fortune500/2008/snapshots/2469.html) The spa trip appears to be no isolated incident. Do we see an indicator of a larger pattern of behavior?
Amazingly, or not, I suppose, another behavior consistent with pattern is found within AIG as of Nov. 14, 2008 as reported by Carol D. Leonnig of the Washington post (http://www.washingtonpost.com/wp-dyn/content/article/2008/11/13/AR2008111304446.html):
AIG plans to pay $503 million in deferred compensation to some 6000 of its top talent to keep them from leaving. The AIG spokesman Nicholas Ashooh claimed that the company is trying to keep top talent from leaving by paying them this deferred compensation early. (Washington Post).
What? Pay them the money so they won’t leave? Won’t they just leave after they get the money anyway? This is after these executives have brought the company to losses of $37.63 billion? As Leonnig notes these deferred compensation plans are a way of keeping top talent so they can postpone taking their large incomes until they retire and are then in a lower tax bracket.
The concept is that the company holds the money back with the intent of keeping employees there longer. So, paying them early will keep them at the company? Unbelievable, I don’t think it takes a psychologist to figure out this one, maybe just a parent. Tell your daughter that she can have all her allowance for a year before the year starts. Then give her the list of chores for the year. In a month or so, check on how she is doing on those chores. Do you think you might run into some problems getting her to do her chores? Are you willing to risk it? Does she even have chores? I hope so! The difference here is that this is $503 million dollars. This was a strategy used at Enron. Ashooh, a company spokesman argues quite bizarrely “This is not the taxpayers’ money they are going to run away with” (www.washingpost.com). Oh, so that makes it okay? Isn’t the $37.63 billion in a pool with the $503 million? How do you keep the piles of cash separate anyway? With $37.63 billion in taxpayer money shouldn’t the ‘public good’ be considered in this situation too? No mention of it here.
"Trust is always earned, never given."
The argument has been AIG is just too big to fail so let’s consider scale. This argument will get redundant and tattered as it will be used for every major institution that is bailed out. On the CNNMoney.com listing of the Fortune 500 largest companies in the world in 2008 AIG is ranked 35. (http://money.cnn.com/magazines/fortune/fortune500/2008/snapshots/2469.html) AIG is massive and that is an indicator of the scale of problems which confront us. Does giving massive money to a company which has behaved this way make sense just because it is big? Where do you think the money will go? How are those chores going?
The BIG 3 and Their Big Toys: Planes
Another story widely reported in the unraveling of the financial system of the United States and the world was that US auto executives swaggered into Washington DC on their private jets and then attempted to do their best sales job by feigning neediness with their hats in hands to vie for their version of ‘sympathy sums’ in the billions of dollars. This story was reported Nov. 19, 2008. This occurred almost 2 full months after the AIG spa weekend debacle. I guess the executives don’t read the paper. The moment was captured eloquently in the CNN online article at this link (http://edition.cnn.com/2008/US/11/19/autos.ceo.jets/index.html):
“There is a delicious irony in seeing private luxury jets flying into Washington, D.C., and people coming off them with tin cups in their hand, saying that they’re going to be trimming down and streamlining their businesses,” Rep. Gary Ackerman, D-New York, told the chief executive officers of Ford, Chrysler and General Motors at a hearing of the House Financial Services Committee.” (http://edition.cnn.com/2008/US/11/19/autos.ceo.jets/index.html)
Surprisingly, these executives were scolded and were not immediately given their ‘sympathy sums’. It is a good sign that they were scolded, but I wonder if that is the same thing as an “idle threat” from a parent. At least next time the automakers have to come with some ‘viability plan’ whatever that is.
Yet, substantial questions remain about the role of a public company when it becomes the beneficiary of massive amounts of public funds.
Let’s return to the basic argument, are the US automakers too big to fail? On the CNNMoney.com listing of the Fortune 500 largest companies in the world in 2008 General Motors is ranked 9 (266,000 employees). Ford Motor is ranked 13 (246,000 employees). Daimler is ranked 11 (272,382 employees). (Chrysler is a US subsidiary of Daimler). Again, these are massive companies, true. But how does giving them the money solve the problem? Can a transformation of values and focus occur by handing them billions of dollars and/or ‘government backing’? Has it begun to occur with AIG? Not so much.
Once a massive company becomes the holder of huge ‘sympathy sums’ of taxpayer money do they become holders of the public trust? Do these companies actually consider the ‘public trust’ now? Let’s turn to some examples of ‘companies’ who do lean on the government and are considered ‘quasi-government organizations’ and how they do with the ‘public trust’. One would presume that insights from these companies would give us a hint of what might be to come with the various ‘companies’ who are ‘bailed out’.
”The glue that holds all relationships together -- including the relationship between the leader and the led is trust, and trust is based on integrity.” --Brian Tracy
Freddie Mac is an example of a ‘quasi-governmental’ organization. If you don’t already know about Freddie Mac there are reams of bad news here. Let’s begin here with a sense of scale. CnnMoney.com cites the Fortune 500 in 2008 of the world’s largest corporations and puts Freddie Mac at number 162 in the world with 5,338 employees. I focus on employees because they are people. What places company in the top 500? It appears to be profits and/or revenue.
So how does government ‘guarantee’ work with a public company? Well, profit making becomes the focus, but it is with a twist, an unpleasant one. This is arguably the source of the housing market collapse. It brings into view the conflict government involvement has caused in Freddie Mac and Fannie Mae.
First, let’s consider Freddie Mac. Go backwards in time and you will see that the ‘security’ of government backing combined with the profit focus of a corporation resulted in insane risks that have compromised the public good and ravaged the ‘public trust’, collapsing the housing market with the world economy to follow. Hints of this outrageous behavior have been accumulating for quite some time.
On Dec. 11, 2003 an article in the New York Times captured what one would think might have sounded massive alarm bells in what might have become the largest conflict of interest case in the history of the world. (However, the present creation of some conflicts of interest that are even ‘bigger and better’ may well be underway – we may have to look closely at the Federal Reserve.). This hints at the culture that was created and nurtured at Freddie Mac in a ‘quasi-governmental’ organization. It captures the problems inherent in such a conflict and when the power model of leadership is left to run rampant:
''Freddie Mac cast aside accounting rules, internal controls, disclosure standards, and the public trust in the pursuit of steady earnings growth,'' the report states…In addition, it says, ''senior management and the board failed to establish and maintain adequate internal control systems.''
Later this article actually stated: “Some lawmakers greeted the report as further evidence of the need for an overhaul of the regulation of government-sponsored entities, including Freddie Mac and Fannie Mae.” (http://query.nytimes.com/gst/fullpage.html?res=9E01EFDD173CF932A25751C1A9659C8B63)
Where large sums of money are concerned, it is advisable to trust nobody.
The ‘public trust’ was flouted here. Why? The description of ‘inadequate internal control systems’ almost implies an error of omission when the dysfunction seems even more basic and core. On the most basic level it involved a lack of accountability within the culture of the organization. However that would suggest that such actions were not supported by the leadership. That is unlikely to be the case.
The most obvious question to ask to cut through the subterfuge is: who benefits? In other words, what was the motivator? Profit for shareholders (and themselves) appears to have been the motivation, but the ‘removal’ of risk by what is called the “implicit guarantee” appeared to be a critical factor in setting up this dynamic. This suggests that these were not errors of omission, but errors of commission intentionally developed based upon this ‘implicit guarantee’ which we may appeared to have been extended to AIG in the midst of panic and seemingly other bailouts to follow with the argument simply being “they are too big to fail.”
A probing of this ‘implicit guarantee’ is necessary to explore the possible role these government bail outs might play with other organizations. Answers.com describes the concept of the ‘implicit guarantee’ well:
At the same time, however, Freddie Mac differed from other publicly traded lending institutions because stockholders believed that its loans were underwritten by the U.S. Treasury. The corporation also had special advantages given to it, known as the "implicit guarantee," because of its status as a quasi-governmental organization. Freddie Mac paid no state or local corporate income taxes. Its securities could be used as collateral for loans. Should the institution fail because it made too many risky or bad loans, which nearly happened to Fannie Mae in 1981, investors expected that the government would intervene to protect the corporation, using public money if necessary to protect their investments. In fact, at one point the charters for Freddie Mac and Fannie Mae stated specifically that the U.S. Treasury maintained a line of credit for the institutions so that it could finance $2.25 billion dollars worth of debt. In essence, the federal government guaranteed Freddie's debt, and Freddie helped keep the market stable and provided low-cost loans for low-income families to buy houses.
So this issue of the federal involvement or the notion that the federal government would protect investor money by bailing out the company if they got into trouble actually encouraged recklessness because the investors felt that they had no risk. Big brother will bail us out. In its biography of Gregory J. Parseghian, the brief CEO of Freddie Mac Answers.com (http://www.answers.com/topic/gregory-j-ca-parseghian) captured this confusion about ‘quasi-public’ and how it has led to the flushing of our economy:
Freddie's problem was that its public-service duties conflicted with the interests of its stockholders. In order to maximize their own profits, stockholders encouraged Freddie's management to take risks that other corporations would not dare to take. Freddie Mac and Fannie Mae together maintained a debt load that, according to Jason Thomas in a report on the U.S. Senate's Republican Policy Committee's Web site, was worth almost 40 percent of the entire U.S. public debt in 2003. The two corporations together also had financial assets at that time worth about 44 percent more than the assets of the largest U.S. bank, Citibank. "The scandal at Freddie Mac," Thomas stated, "is a direct product of a strategy, well underway at both firms, to leverage their 'implicit guarantee' to accumulate larger and larger mortgage investment portfolios and increase returns to shareholders" (September 9, 2003). In other words, because stockholders believed that the risks the corporation took fell not on the stockholders themselves, but on U.S. taxpayers, they pressed Freddie Mac's managers to take greater risks, assume greater debts, and make more loans than corporations without the backing of the U.S. government could possibly do. In some ways, stated Bill Mann on the Motley Fool Web site, the "implicit guarantee" gave Freddie and its big sister Fannie monopoly status in the mortgage-lending business. (http://www.answers.com/topic/gregory-j-ca-parseghian)
Thus the most basic conflict is that being government-sponsored and yet a public company creates essentially a vehicle for investors to make massive amounts of money with the ‘guarantee’ of the US government, and thus the taxpayer, you and me. When things fall apart we are responsible for picking up the pieces and the investors walk away with nary a scratch. We are now in the process of creating several more of these situations. As a result it appears that shareholders successfully pressured the company to take risks at a level that is considered outrageous for a typical company. Not just that, Freddie Mac does not pay state or local income taxes, will that be the case with AIG or others?
“History shows that where ethics and economics come in conflict, victory is always with economics. Vested interests have never been known to have willingly divested themselves unless there was sufficient force to compel them.”
Now, consider that AIG is now similar to Fannie Mae and Freddie Mac in that it was bailed out by the government – is it now ‘guaranteed’? We are now setting the stage with dynamics which create more of the same. That is, with shareholders feeling that there is a guarantee for them from the government if the company gets into trouble will they be free to pressure executives to aggressively seek profits? Seems like a difficult temptation to avoid. Should we do the same with the US automakers, etc. etc.?
The story of AIG is one among a likely many stories to follow of abuse of public money and public trust. This was just the first few mistakes and compared to Freddie Mac some of them seem small. Yet the same psychological concept applies: a small behavior like this on the part of AIG is a likely indicator of other behaviors that are consistent with it. Just look in depth at the behavior of Freddie Mac. Additionally, when you set up a situation in which public company investors feel protected from risk they are much more likely to push for profits.
Similarly, the US automakers were simply thumbing their noses at the public and in essence assuming that they too should be among the largest entitlement programs in the history of this country. The question is: Were they showing us their true colors or was that simply an ‘adolescent’ mistake? These are not adolescents! As a psychologist I take behavior seriously. It is an indicator of an attitude and that is likely to produce more behavior consistent with that attitude. If automakers get their sympathy sums will they then take their jets to the spa that AIG left vacant to recoup from all the stress they endured to just get ‘their money’.
Astoundingly, it didn’t even register to the auto executives until they got scolded that their behavior might be unseemly. It appears as if they didn’t even think about this inconsistency. (Back to: What are these guys thinking?) Apparently these executives are focused on themselves, their own convenience and their own luxury. Getting to DC quickly and in style apparently matters a great deal.
These executives don’t appear to have asked themselves any questions about the ‘public trust’. Indeed, being public companies it is likely that they don’t consider the ‘public trust’ as a ‘stakeholder’ and certainly not as ‘shareholders’. The luxury spa dalliance of the executives of AIG after taking taxpayer money seems to be a similar ‘blind spot’.
The ‘blind spot’ is that these executives don’t ask themselves: What is in the best interest of the public? What is best for the company? What is best for the consumer?
I think it can be argued that these executives don’t ask this question about the imbalance of their salaries in relation to their employee’s salaries as that ratio within the US has sky rocked in recent years. I will return to this topic in more detail later in this chapter as it merits thorough consideration. But for now it must be considered that these present CEOs have narrowed their focus upon who is their public. Their public appears to be shareholders and themselves and their own pay.
One would presume that their public would include their own employees, the health of their overall companies, the consumer in general as well as their shareholders. Yet, their behavior does not support that conclusion. Now with our taxpayer money the general public needs to be included. But will we be included? How do we make sure it is included?
Changing the culture of an organization does not begin with a ‘sympathy sum’. How do you change the focus of these executives from serving themselves to serving others? This is a most basic question and consistent concern throughout the stories of the downfall of the American economy. It begins at the beginning with the definition of leadership.
Leadership the Power Way
As noted above, Kent Keith of the Greenleaf Center for Servant Leadership articulately argues against the power model of leadership. Freddie Mac is an excellent example of the power model at work. Consider this finding in light of CEO ‘leadership’ behavior. In a sort of ‘cover story’ one might read about how the CIA manages information and misinformation, (I wonder if one could find this sort of thing in the book 1984), on the internet published the same day as the noted Freddie Mac scandal hit many headlines, was a document published by Freddie Mac itself: “Supplement dated June 11, 2003 to Information Statement dated March 29, 2002”. It announces the new CEO and President Gregory J. Parseghian. What is interesting is that the timing of this release was obviously strategic and an effort to create some positive publicity for Freddie Mac. Yet the primary focus of Freddie Mac described by this new President and CEO Gregory J. Parseghian captured in his own words makes one wonder. Again, keep in mind that the smallest and what might seem to be the most subtle, behaviors are quite ‘telling’ of a person’s overall behavior. This is what I have studied throughout my career as a psychologist for over a decade:
Parseghian said, “Freddie Mac is a company with an outstanding franchise and vital mission. Our focus going forward will be to provide excellent long-term returns on shareholder capital while maintaining our world-class risk management discipline, our unparalleled financial strength and our absolute commitment to expanding homeownership opportunities.” (http://www.freddiemac.com/investors/infostat/pdf/supplement_061103.pdf)
Just like in poker, people give ‘tells’ all the time to alert you to what is in their hand if you just pay attention, people give ‘verbal tells’ all the time as well. Which words they choose, what is said first, how it is said, all these are ‘tells’. The context here is that this is a company that was and is involved in substantial ethics problems which challenge the sincerity with which the mission was being considered. Although he appears to give lip service to the mission he doesn’t delineate it with any detail. Mr. Parseghian’s verbal behavior related to this is quite general and succinct. I am left wondering, what is the mission of Freddie Mac? Isn’t it worth repeating in one of his initial statements as the CEO of the organization or is it not really that important? Apparently, it wasn’t that important. His focus was really on “excellent long-term returns on shareholder capital”. These are his words, not mine. This is his primary focus. As becomes obvious over time that focus apparently was in conflict with the second point he mentioned: ‘world-class risk management discipline’ because as we all know risk management was apparently not working so well in the end.
Mr. Parseghian’s was forced out in 2 months (http://www.answers.com/topic/gregory-j-ca-parseghian) from pressure from the Office of Federal Housing Enterprise Oversight (OFHEO). At answers.com you can read more about Mr. Parseghian which leads to more questions about his behavior that is disconcerting. This is relevant because this institution in crisis chose this man to lead them out. This man clearly uses the power form of leadership. Who are we choosing to lead us out of this crisis? Are they servant leaders or do they subscribe to the power model?
Answer.com quoting Jerry Knight of the Washington Post:
Jerry Knight, writing in the Washington Post, succinctly identified the central issue in the controversy surrounding Parseghian's role: "How can an executive who knew of and participated at least peripherally in efforts to mislead investors restore Freddie's credibility?" (September 1, 2003). (http://www.answers.com/topic/gregory-j-ca-parseghian)
Additionally within the account by answer.com was a personal profit of $3 million to Mr. Parseghian in questionable stock sales which benefited him personally. Within this saga of Freddie Mac is a leadership story about a person who engaged in questionable practices and benefitted personally as did his department and the shareholders. His behavior based upon the asnwers.com article was consistent with a primary focus upon ‘excellent long-term returns on shareholder capital’ and a power model of leadership which focus upon the acquisition of power regardless of the impact upon the greater good of the corporation or those outside of the organization. Yet, this was the man Freddie Mac chose to lead them out of a crisis, until, that is, he was forced out.
Breaking public trust
Trust (some call it faith) is the strong force that binds the particles of the universe. Without it, nothing can co-exist. It is as equally as true in government that when the trust is broken, governments fail. Pride and arrogance precede a fall.
Arthur Anderson, CSFB & Goldman Sachs
The loss of trust expands from players like Freddie Mac to other institutions that supported duplicitous actions and aided in the cover-up. The answers.com discussion of Gregory J. Parseghian includes a description of the companies involved in the accounting irregularities of Freddie Mac. Arthur Anderson LLP which is described as the same firm that helped Enron Corporation hides its true financial situation was involved. Also, Goldman Sachs and CSFB, banks traded on the New York Stock Exchange helped Freddie Mac hide income (http://www.answers.com/topic/gregory-j-ca-parseghian). This was reported by Bill Mann of Motley Fool. Mann also reported that companies like Microsoft and General Electric had also used ‘creative accounting’ to ‘smooth out their earnings and increase their ratings on the stock exchange’. Stunningly answers.com reports: “Although the practice had been widely condemned, it has not been made illegal.” (http://www.answers.com/topic/gregory-j-ca-parseghian) So we have three major players in accounting firms and banks in on the game? The circle of corruption is widening. Additionally these practices are not illegal.
But that is not all, the Freddie Mac outrage has obviously continued. Almost four years later on Sept. 28, 2007 it was reported by the AP that Freddie Mac agreed to pay $50 million to settle additional charges that it was fraudulent in its statement of its earnings over a four-year period. Signonsandiego.com reported in this article: (http://www.signonsandiego.com/uniontrib/20070928/news_1b28fred.html)
Amazingly at that time the chairman and chief executive officer (Wait a minute, both the chairman and chief executive officer at the same time – doesn’t that create a structural problem prone to ethical concerns itself?) of Freddie Mac, Richard Syron stated that the company took the charges seriously and that was the difference between the previous Freddie Mac (2003 version) and his new and improved version of Freddie Mac (20007 version). Huh? Taking the charges seriously is progress? How about preventing the charges from occurring in the first place? This brings to mind a book I found, but have not read yet, but he’s got me with the title:
Wheel, Deal, and Steal: Deceptive Accounting, Deceitful CEOs, and Ineffective Reforms
The title of a Book by D. Quinn Mills Published by Financial Times Prentice Hall; ISBN: OJ 31408046 320 pages (hardcover)
In Sept. 2004, an accounting scandal beset Fannie Mae the No. 1 US mortgage company. Fannie Mae is another example of a ‘quasi-government’ organization. On CnnMoney 500 largest companies in the world Fannie Mae is 161 with 5700 employees. It is big. Yes scale matters. Ethics matter more.
Msnbc.com reported that in Sept. 24, 2004 an 8 month investigation by the office of Federal Housing Enterprise Oversight found “pervasive earnings manipulation designed to meet Wall Street’s expectations and smooth volatility in profits from quarter to quarter.” Sound familiar? This was an intentional culture of deception, dishonesty and a total lack of accountability. On top of this is the fact that the Freddie Mac scandals were well underway which leaves two major institutions with similar severe problems – both ‘quasi-public’ like the leagues of new companies we are buying with taxpayer money. This captures it well:
“Management at Fannie Mae “deliberately developed and adopted” inappropriate accounting policies, supported widespread violations of generally accepted accounting principles, tolerated lax internal controls and failed to properly investigate an employee’s concerns about accounting, OFHEO’s report said.” (http://www.msnbc.msn.com/id/6070704/)
Interestingly is reasonable to assume that these accounting practices in addition to giving the appearance of smoothing earnings delayed the awareness of the general public that there were signs of problems within the housing market perhaps four or five years ago. The institutional dishonesty, deception and focus upon profits and a lack of focus upon the common good or the public good are at the core of the staggering ramifications that we are only just beginning to experience.
Bear Sterns: The Massive Shell Game
Here is one of our bright, newly ‘minted’ government ‘underwritten’ organizations. It is really unclear whether this one would fit the label of ‘quasi-governmental’ or not.
On November 13, 2003 The Street reported that Bear Sterns was alleged to have “created and marketed an ‘electronic routing system’ that made it easier for hedge funds and small brokerages to trade shares of mutual funds.
“The lawsuit alleges that Bear's trading platform was used to permit hedge funds and brokerages to engage in market-timing and late trading, the two main offenses regulators are investigating.
The mutual fund trading platform apparently was a lucrative venture for Bear Stearns. The lawsuit contends Bear Stearns "generated substantial revenues and profits from participating in the illegal conduct" of the traders by collecting a commission on each trade executed. “ (www.thestreet.com; http://www.thestreet.com/markets/matthewgoldstein/10126514.html)
Basically Bears Stearns created the software that helped hedge funds and small brokerages to cheat. They played a massive shell game and circumvented trading rules against ‘market-timing’ and ‘late trading’. Such behavior is plausible when the primary guiding principal of a company is to increase profits. When the power model is used those profits are sought regardless of ethics and independent of the impact on people.
The article continues and notes that Bears Sterns was the focal point for improper trading that occurred in mutual funds sold by Janus and Putnam Investments. So, now, in addition to our quasi-government organizations, some major accounting firms, a bank or two, lets through in a couple mutual funds for good measure.
"We think this is one of the most egregious cases of market-timing and late trading, and documents an incestuous relationships among these players," said Andrew Friedman, an attorney with Bonnett Fairbourn Friedman & Balint in Phoenix. "There is a shocking level of mutual benefits that were reaped by all the defendants to the detriment of the plaintiffs' class." (www.thestreet.com)
So, we have Bear Stearns which is a company as recently as 2007 was ranked number 445 of the Fortune Global 500. It is, or was a company of 13,566 employees, again with a substantial level of deception and duplicitous operations. But there was a real eye-opening story about this company that must be retold. This story involves the impact that just one person can have.
The impact of One Guy – yes One Guy
An article in The Nation.com described a process in which a person ‘bought a bunch of puts’ of Bear Stearns. The bunch was 6 million. The price he/they bought them at was $30 a share when the stock was trading at $60 a share. They describe the ‘puts’ this way: “A put is a piece of paper guaranteeing its owner the right to sell 100 shares of stock at a stated price within a specified period of time. In the case of this bank job, the period of time was as little as five days.” (http://www.thenation.com/doc/20080901/howl)
They note that in the days that followed the stock dropped to $10 a share or less. Yes, it dropped from $60 a share to $10 a share in less than 5 days. That fact in itself is astounding when it was at $60 less than 5 days earlier. Then they bought Bear Stearns at $10 and ”exercised these puts, thereby selling them for $30 and pocketing the difference.” They made $120 million in 5 days.
The nation article quotes established investors who clearly state that no one would have bought such puts unless they had insider information. No one would be able to predict such a precipitous drop without inside information. The name of the person or people who did this is still not released. The same thing happened when the stock was selling for $50 and a person bought puts for $5. These moves on this stock contributed to the downfall of this company. Keep in mind this was the first card that fell – the impact of one guy. Now the house is tumbling down.
So, wait, I’m getting more confused.
The government helped in the buyout of this company, why?
Simply put, it would be much worse for the whole economy if it didn’t.
That’s really the argument. It’s too big to let fail.
These guys should have failed.
No, really it is just really big.
No, I mean really, really big.
That’s it. That’s all you got. It was really really big. These guys deserved to fail, but I guess if you are big enough that doesn’t matter.
Wait, this is the essence of the argument. If you are so big, so connected, with massive power, you are beyond any need for ethical behavior, or ethical checks and balances. Power accumulated in the power model makes ethics irrelevant.
So, with taxpayer money, the government helped in the buyout of this company which showed clear evidence of deception and over-zealousness to attain profit at the expense of well, you know, laws, and, of course, eventually the taxpayer.
Now just consider this, as reported on www.cbsnews.com Bear Stearns was over exposed to the subprime mortgage market. Okay, now I get it. Let’s do the bailout. I mean, how could they have known? They had their hearts in the right place, didn’t they? Besides, they are big, real big. We can’t let them fail.
So, there is a great question in times like this to make sense of such behavior: Who is it that benefits?
Me, you, the tax payer, sure, we have seen the benefits since their bailout. I mean it really slowed down the financial meltdown.
No, really, who benefits?
Well, I’m thinking Bear Stearns, J. P. Morgan Chase & Co who bought them out, but I’m just not seeing how Joe the plumber and I are benefiting. But what is even more unnerving is that this is unprecedented. In the cbsnews.com article (http://www.cbsnews.com/stories/2008/04/02/opinion/main3988999.shtml) they describe the staggering, unusual and outrageous spectacle of this deal. Something with we are starting to find commonplace:
The government’s involvement here is highly irregular - the March 28 report from the non-partisan Congressional Research Service sheds light on just how bizarre the terms of this deal really are. To begin, the Fed has not used this statutory power to bail out a bad company since it was first enacted during the New Deal. Ironically, the bailout is only legal because no private firm would ever agree to its terms. As the governing statute states, the parties involved must be “unable to secure adequate credit accommodations from other banking institutions” for the government to interfere in this way.
“Nothing like this has ever happened,” says John Carney, editor of the financial blog DealBreaker.com. “There isn’t even a court precedent related to this. We’re reaching back to a power they were given ages ago, that nobody thought they would have to use. Suddenly, here they are, pushing JPMorgan, perhaps the only American bank that could do it, to make the deal.”
Even in a sophisticated financial world light years away from the New Deal, the Federal Reserve Bank felt Bear was “too big to fail” - or at least “too connected to fail” - because it was so deeply involved in so many aspects of the homeownership economy. In order to force a buyout, it offered JPM a sweetheart loan, the likes of which no student borrower has ever seen. The $29-billion line of credit comes at the discount interest rate - currently 2.5 percent - over 10 years. This is a rate normally restricted to overnight loans, applied only in special cases to loans that last as long as four weeks.
The only collateral for this loan is the $30 billion in Bear Stearns’s un-sellable mortgage-backed securities, the real value of which is - shall we say - difficult to assess when no one is buying. And unlike most loans the Fed makes, it has no recourse here if the collateral loses some or all of its value. In fact, the CRS report notes, “The agreement has some characteristics more in common with an asset sale than a loan.” The report adds dryly that JPM was unwilling to hold onto these assets itself, perhaps because it “could have believed that the assets were worth . . . significantly less than the current market value of $30 billion.”
“This is not really a loan,” says Garrett. “It’s a put option on these securities by the Fed vis-à-vis JP Morgan.” (http://www.cbsnews.com/stories/2008/04/02/opinion/main3988999.shtml)
This deal is perplexing and the argument that Bear Stearns was too big to fail is the same argument that was made about AIG. I am sure it will be the same argument made about the auto makers and whoever is next in line. Yet, the requirement for accountability of what the company does with such funds is completely absent. As a matter of fact J.P. Morgan according to the cbsnews.com article has no ‘obligation to repay this loan’.
In short, this is a massive government subsidy, another unprecedented entitlement to the rich. I thought the rich were against entitlements. Oh, wait, that was entitlements to the poor that they were against. Okay, now I get it. Yes, many people would have lost their jobs. But aren’t there parallels to the situation at Fannie Mae and Freddie Mac? Doesn’t this set up a structure and dynamic in which JP Morgan has very limited risk? Will this encourage more excessive behavior? I don’t know. Did you give your daughter her allowance for the full year at the beginning of the year? How are those chores going?
Here is a little scale for you. Cbsnews.com notes that the amount of this bailout “doubles all the congress pork projects for this year”, it involved no vote of Congress, and, we the people, have just bought $29 billion in crappy securities.” What is even more baffling is that this amount of money, according to Cbsnews.com is equal to the entire Federal Reserve Banks entire annual profit. WAIT, so, if this is the entire profit of the Fed then where is the money from the other buyouts coming from? Oh, wait, I get it, they’ll just print it.
But back to who benefits? Cbsnews.com notes that J.P. Morgan is a company worth $146 billion, did they need this help? Doubtful:
“They take this enormous risk so that JPM, a company worth $146 billion, has enough liquidity to make a major and profitable acquisition for next to nothing. JPM is more than happy to take on Bear’s book of client and counterparty accounts - these were probably never in danger of being lost, and it’s great business for JPM. The ones being rescued are Bear’s bond-holders. They keep their shirts. The stockholders at least keep their socks. The profits from the good times are retained, and the losses are socialized.” (http://www.cbsnews.com/stories/2008/04/02/opinion/main3988999.shtml)
So, the Bear’s bond-holders and J.P. Morgan benefit. The losses are “socialized”. That means we pay for them. We don’t benefit.
One Disturbing fact to consider: The Federal Reserve.
As noted in Wikipedia the Federal Reserve itself is a ‘quasi-public entity.’ We have seen how that concept created massive problems for Freddie Mac and Fannie Mae. Worries and a lack of clarity abound for what that means for AIG. What do you call the Bear Stearns-JP Morgan deal? What does it mean in the case of the Federal Reserve? Again, it is unclear, but there is concern about potential conflicts as is indicated by the Gramm-Leach-Billey Act of 1999 which required the study of potential conflicts of interest. Yet, I was not able to find much on those conflicts.
Disband the Fed is one answer according to Jim Rogers was interviewed on CNBC and can be seen at this website: http://www.subprimeblogger.com/?p=266 He posits that the Federal Reserve should be abolished. He uses the example of the Japanese to argue that they tried to prevent any failures in their financial system like the US is now doing and they are still dealing with these problems 18 years later. He argues that what is happening with the Feds present strategy is debasing the currency of the US. (Remember earlier when I mentioned the American dollar, this is the reason you might want to have another currency.) In short, money is being printed, the dollar is being devalued and inflation is increasing. Rogers argues that this strategy has never worked in the long or medium term and will not work for us. Others would argue there is a risk for deflation. Either way this process of handing billions and trillions of dollars we don’t have to companies with questionable ethics is just baffling.
Rogers used the analogy of a forest fire cleaning out the underbrush to describe how a recession is not bad for an economy. It essentially cleans things up. Given the lack of scruples seen in the companies reviewed it does seem we need some cleaning up. He believes that these companies should be allowed to fail. That is how these corporations will learn, a little tough love.
Sadly, as I expected the Fed is showing the behavior that makes me shudder when I hear the term “quasi-governmental”. Bloomberg reported on Nov. 10, 2008 that the Fed is refusing to identify the “recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral. “ (http://www.bloomberg.com/apps/news?pid=20601087&sid=aatlky_cH.tY&refer=worldwide) This strikes me us unsurprising given the previous consideration of ‘quasi-governmental’. Yet, the article states that Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson “said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system.” (Bloomberg.com) it turns out that according to this article that the fed lent more than the $700 billion in programs that didn’t require congressional approval and so Americans don’t know where there money is going. The argument made in that article is that too much transparency might undermine confidence in the system. Are you kidding? What confidence? We have lost all confidence in this system. Mark this day, today, Dec. 1, 2008 is the beginning of the free fall of the US economy and it is taking the world economy with it. The cleaning out of the underbrush is happening whether we like it or now. Now before all the destruction has occurred it is time to look with tough analysis and realize that to climb out of this will indeed require a new way.
There are many outrageous questions about these bailouts, but primary among them is: How can printing money solve these problems? Yet, the other question lurking in the background is the lack of leadership, the lack of servant leadership, the lack of moral action, ethical consideration and the lack of thought about others.
Derivatives: Beyond Even the Comprehension of Warren Buffett.
Before we can get to more discussion of the solution which will involve one relationship at a time the final ultimate vertigo comes from derivatives. This is where you begin to feel queasy. This brings me to the real reason why the scale of this whole situation has concerned me for about 2 months.
It starts with the core question: “How much is this bailout going to cost?” was the question posed to Ron Paul on CNN found on YouTube (http://www.youtube.com/watch?v=1sfUKZOHtRs). Into the trillions was part of his answer, but the part that is truly disconcerting is this:
“No one understands it because we an economy which is based upon a pyramid of derivatives. When Warren Buffett says he doesn’t have any idea how they work and he stays away from those you know it is very complicated, but I say it is into the trillions, but it’s irrelevant because the market will quit functioning before we are able to handle all that. So, the sooner we get back to the basics, look to the constitution, look to the morality of who gets stuck with the debt and look to the Federal Reserve System. …I tell you what this could get a lot worse, but the answers are there. There just not that difficult. We just make them so much more difficult by compounding our problems and not looking to the basics of a free market economy and sound money.” (www.Youtube.com)
Derivatives are a complicated matter. I do not claim to understand them fully, but I have some basic understanding. Yet, it is not just the complications of derivatives that concern me. It is the incomprehensible scale of these risks.
The article which captured my attention about the derivatives market and what amounts to a ‘house of cards’ upon which our economy is tentatively teetering was found on Financial Sense editorials. It was simply titled “The Coming Disaster in the Derivatives Market by Michael J. Panzer dated Nov. 9, 2005”
Panzer quite effectively uses the analogy of the hurricanes which hit New Orleans to draw his comparison to the derivatives market. Clearly articulating derivatives is beyond the scope of this article but in the end Panzer makes one simple point:
“Indeed, despite the fact that the modern derivatives market has flourished because of big money, complex technology, and highly-paid talent, the culprit when it all goes wrong is likely to be simple: human emotions -- fear and greed -- run amok.” (http://www.financialsense.com/editorials/panzner/2005/1109.html)
Yes, we come back to basic human emotions: fear and greed. That is not all. That fear and greed in one person, that ‘one guy’, can actually have a catastrophic impact. Yet, it is when fear and greed are not checked by morals and ethics and other people that is when it all spirals out of control. The compromise of leadership based upon power unchecked by morals and ethics in the insane dash for cash is what got us here. However, again, the scale here is actually international.
The analogy is that of a house of cards in which bets are made upon bets upon bets with much of it being other people’s money. Terms like credit swaps are used to describe some of these hedged bets. All is well unless one link in the chain fails. If one card falls then the whole house comes down. This is what I see happening. Except it has not been one card. It has been several and there are many I simply did not explore. Bizjournals reports many of the cards that have fallen. I am afraid that there are many, many more to follow, probably hundreds. Here is the initial list (http://www.bizjournals.com/nashville/stories/2008/12/01/daily7.html): Fannie Mae and Freddie Mac are federal takeovers. American International Group (AIG) and Citigroup are individual bail outs. According to bizjournals.com equity buys by the federal government have been made into Bank of America Corp., JP Morgan Chase & Co, Goldman Sachs Group Inc. Federal Reserve help was also offered to American Express as reported by Wikipedia.com. Staggeringly according to Bizjournals.com the federal bailouts have reached $8.5 trillion as of Monday Dec. 1, 2008.
A very impressive and impactful visual rendering of the present situation in historical terms of the “History of Government Bailouts” is captured at this website: http://www.propublica.org/special/government-bailouts. The authors are Jesse Nankin, Eric Umansky, Krista Kjellman & Scott Klein. This was done on Dec. 1, 2008. Historically, according to this chart, the total in bailouts the US has done before 2008 in total was: $347 Billion. Since then, on this chart it has been $1.352.5 Trillion. Yet, that is not totally accurate because federal bailouts have reached $8.5 Trillion. At present that puts the present crisis at 24 times the entire United States history of bailouts. Again, the powerful graphic of this can be found at: http://www.propublica.org/special/government-bailouts.
In short, this economic crisis is unprecedented. Derivatives are involved throughout and they bring this all to this dizzying scale.
Panzer quotes Warren Buffett:
"The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear....[They] are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."
-- Warren Buffett, Chairman and Chief Executive, from his Letter to Shareholders, 2002 Berkshire Hathaway annual report
Realize that this was Buffett quoted in 2002.
On MarketWatch.com Paul B. Farrell truly captures the mind-numbing scale we are talking about here. He quotes Buffet and Gross that it is a “$516 TRILLION bubble is disaster waiting to happen.”
This scale is so massive it overwhelmingly supersedes what the Federal Reserve has available, but it is worse than that.
Farrell makes the critical point that the “Long-Term Capital Management hedge fund almost killed the global monetary system.” This occurred in the late 1990s. What was the amount involved in that situation? A $5 billion trading loss, or $4.6 billion to be exact and we are obviously way past that. As reported by Farrell, Buffett has direct experience with Gen Re, a derivatives group, in which he lost quite a bit of money in getting rid of it. This is when Buffett realized the potency of the derivatives market.
Farrell states that the derivatives market has become an incomprehensible bubble. It reportedly grew from about $100 trillion to $516 trillion by 2007. Where does he get this fact? Well, I have seen this number repeatedly reported in several articles, but he names his source: the Bank of International Settlements, in Basel, Switzerland. He essentially describes this as the place like the cashier’s window at a casino, but on a massive scale. For example, he states that “trade imbalances with Saudi Arabia for all that oil that we guzzle” is settled here. This is where we settle debts with the Chinese. The source appears credible.
Let’s reconsider the issue of scale which Farrell attacks quite thoroughly. These are numbers that begin to address why this is not your grandfather’s depression. This is the ‘biggy-sized’ variety Americans have become accustomed to having. Here is the scale provided by Farrell in his article on MarketWatch.com:
- U.S. annual gross domestic product is about $15 trillion
- U.S. money supply is also about $15 trillion
- Current proposed U.S. federal budget is $3 trillion
- U.S. government's maximum legal debt is $9 trillion
- U.S. mutual fund companies manage about $12 trillion
- World's GDPs for all nations is approximately $50 trillion
- Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion
- Total value of the world's real estate is estimated at about $75 trillion
- Total value of world's stock and bond markets is more than $100 trillion
- BIS valuation of world's derivatives back in 2002 was about $100 trillion
- BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion
In short, this scale at $516 trillion is possibly 34 times the gross domestic product of the United States or the US money supply. It is 10 times the WORLD DOMESTIC PRODUCT. Does that mean it will take 10 years to recover? I don’t know.
Yet let me note one qualification that Farrell introduced which was that the $516 would be a maximum value in the case of a meltdown which is clearly occurring. He stated that The 2007 BIS study notes that “$11 trillion “gross market values provides a more accurate measure of the scale of financial risk transfer taking place in the derivatives markets.” (Farrell, March 10, 2008). So, it is possible that the scale is possibly around the size of the US annual gross domestic product which is still ridiculously high compared to the impact a $5 billion meltdown had in the 1990s. At that level it is beyond the US government’s maximum legal debt level and about 4 times the annual federal budget. Again, note that staggeringly according to Bizjournals.com the federal bailouts have reached $8.5 trillion as of Monday Dec. 1, 2008.
Even when you take a ‘best case scenario’ there is simply no way around the fact that the scale of this economic meltdown is unprecedented.
In the Midst of the Chaos and Destruction a New Day is Dawning and the only way out is through a different model of leadership:
As I noted at the outset, I do not offer an economic solution to this. I am proposing a leadership solution to this disaster. From the leadership solution will grow micro-economic solutions in the form of small local businesses sprouting up and taking root after the epic forest fire clears away the decaying and corrupted gargantuan trees.
Then, at least for a while, we will know that we need to operate in an altogether different way.
Just as we have come to totally lack confidence in the market and trust in institutions who failed to have our best interests in mind we must rebuild the model of American business from the ground up. We will need to build America from the ground up.
This will involve you and me and members of your family and friends. The number of the unemployed in this nation will continue to grow at dramatic rates.
What will they do?
Some will try to get government jobs.
But there will be many more.
They will start businesses.
They will seek to meet real needs with products and services. Opportunities will be created by the vanishing act that many large national companies will display in this magic show of derivatives and “implicit guarantees".
It is here where I believe a revolution for a different style of leadership will become strong. It will begin slowly, but it will gain momentum.
That approach to leadership is servant leadership proposed by Robert Greenleaf back in 1970. This style of leadership asks provocative questions which have evaporated from corporate America.
That is what this book is about:
How do you nurture servant leadership?
How do you set up conditions for it to grow?
We need to return to challenging questions. As it turns out we thought we knew how to run a country and business well. We were wrong. It is harder than we thought.
We thought it was about power. We thought it was about how to dominate and use power to get ‘ours’. Yet, today we are seeing where this has taken us.
For this to become a great country once again we have to start over and deal with difficult questions. Greenleaf captures what is distinct about this approach to leadership which is so contrary to the power model of leadership displayed by all the leaders discussed above:
A servant-leader, according to Greenleaf, is “one who is a servant first”. He wrote: “It begins with the natural feeling that one wants to serve. Then conscious choice brings one to aspire to lead. The difference manifests itself in the care taken by the servant – first to make sure that other people’s highest priority needs are being served.” Greenleaf provides the test questions for servant-leadership. He asked: “Do those served grow as persons? Do they, while being served, become healthier, wiser, freer, more autonomous, more likely themselves to be servants…? And, what is the effect on the least privileged in society? Will they benefit or at least not be further deprived?”
Robert GreenLeaf: The Servant as Leader. (1970)
Greenleaf identified the crisis in leadership in 1970. It just came to this for us to realize just how bad it had gotten.
As described by a colleague, the previous CEO of the Greenleaf Center for Servant Leadership, Larry Spears:
Larry Spears, who is the CEO of Robert K. Greenleaf Center for Servant Leadership, said “Greenleaf concluded that the great leader is first experienced as a servant to others, and that this simple fact is central to the leader’s greatness.” Spears continued: “True leadership emerges from those whose primary motivation is a deep desire to help others.”
This is a revolutionary notion.
Unfortunately, today we have fallen into the abyss.
It will take a revolution to make our way out of the abyss.
Tomorrow begins the revolution.
Dec. 1, 2008.
Charles Shinaver, Ph.D.
Copyright Dec. 1, 2008 Give Attribution of this work to Charles Shinaver, Ph.D.
Link to www.charlesshinaver.com