There has been no more dedicated practitioner of reputation suboptimization recently than JPMorgan bank. Or, more specifically, its Chairman and CEO, Jamie Dimon.
Mr. Dimon has used his position atop the world of global finance as a bully pulpit - literally and figuratively, - lashing out at anyone who dared to question the behavior of the banking industry. Presidents and paupers alike have felt the sting of his lacerating rhetoric as the industry his institution leads shouted its approval of his pushback against the critics who challenged the actions that led to the financial crisis and subsequent recession.
But then the London Whale trading scandal revealed that Morgan bank's own house was in disorder, costing it approximately $6 billion and threatening Mr. Dimon's hold on both the CEO and Chairman positions. Shareholders are now voting to determine whether Mr. Dimon should continue to hold both, or whether, as is increasingly the practice of good governance, to split them between two people. Mr. Dimon prefers to hold both, but the fact that major institutional investors have already indicated they will vote against him is an embarrassing blow, even if he prevails.
In this, JP Morgan and its leader are symptomatic of a larger trend. The issue, as the following article explains, is that too many corporations have forsaken the value their reputations can offer. They believe that record profits enable them to buy the support they need from legislators and regulators or to pay lawyers and accountants to challenge those who refuse to bow to what the bankers and corporate executives believe to be the inevitable - their way.
Sappy historical encomiums to its value aside, reputation is an asset. And like any asset, if misused or wasted, there is a cost. In share price, partnership opportunities, investment possibilities, employee recruitment and the like. Short term interests currently prevail in most business considerations because executives' downsides are protected by the contracts they negotiated before they signed on. Maximizing the present and letting someone else worry about the future is the norm in many cases, as a result. But reputation is an asset whose value accrues over time. Those organizations that choose to depreciate it may find, as has Mr. Dimon, that the costs of that decision may be realized sooner than expected. JL
Steve Denning reports in Forbes:
Banks, accounting firms, auditors, law firms and even the regulators have all become complicit in a system in which reputation plays no role. It is what firms can get away with that matters.
The report that the largest US bank, JPMorgan Chase [JPM], devised “manipulative schemes” that transformed “money-losing power plants into powerful profit centers,” and that one of its most senior executives gave “false and misleading statements” under oath should come as no surprise. Nor should we be taken aback by news that the Office of the Comptroller of the Currency is weighing new enforcement actions against JPMorgan over the way the bank collected credit card debt and its possible failure to alert authorities to suspicions about Bernard L. Madoff.
Nor should we be puzzled that JPMorgan’s share price is unaffected by such scandals. The stock market apparently assumes that, whatever happens, JPMorgan is likely to emerge with a tap on the wrist from regulators and a civil penalty that is minimal in comparison to the profits it is making.
Only a few decades ago, such offenses would have irreparably stained the reputation of a leading Wall Street firm and caused clients to depart en masse to a reputable firm, effectively putting the firm out of business. Now as Jonathan Macey writes in his excellent new book, The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street (2013), there is no other reputable firm to go to.
Cosi Fan Tutti
All the big financial firms like Goldman Sachs [GS], UBS [UBS], Citibank [C], Bank of America [BAC], and JPMorgan Chase, have settled cases involving not just shady practices like price gouging, gaming the system, toll collecting, zero-sum trading and excessive compensation but also illegal practices such price fixing of LIBOR, abuses in foreclosure, money laundering of drug dealers and terrorists, assisting tax evasion and misleading clients with worthless securities. The cases were settled for what is chump change to the banks, without admitting or denying wrongdoing.
Professor Macey describes in graphic detail how much less serious misdoings essentially put Bankers Trust out of business in the 1990s, while today Goldman Sachs gets by “with little or no reputation”. It is no longer true that “cheats never prosper” or that “captains go down with their ship”. In the rare event that a big ship does go down (e.g. Arthur Anderson), the executives and traders simply move to another ship, perhaps even with a raise in pay.
In this world of zero reputation, the management dynamic is to win at all costs. It is “maximizing shareholder value” on steroids. The goal is pure and simple: making money by whatever means are available. Self-interest reigns supreme. These firms practice what George Stalk, Jr. and Rob Lachenauer of the Boston Consulting Group describe in their book as Hardball. The firms are “willing to hurt their rivals”. They are “ruthless”. They “enjoy watching their competitors squirm”. In an effort to win, they go up to the very edge of illegality or if they go over the line, get off with civil penalties that might appear large in absolute terms but are meager in relation to the illicit gains that were made.
Clients deal with these firms at their peril. Indeed they are forewarned, even with legal disclaimers in the client agreement specifying the self-interested practices that the firm may deploy. The horrifying thing is that, as Profess Macey makes clear, all the big financial institutions are now the same. If the clients don’t like what they see, they can’t go somewhere else. There is nowhere else is to go.
We have seen this before
Macey’s excellent book is a comprehensives account of these developments over the last several decades. The book is magnificently detailed, with a blow-by-blow account what went wrong, transaction by transaction, firm by firm. It also points to the further work that needs to be done.
Thus one might get the impression from this book that what happened in the last few decades is a unique development in the history of finance. A broader historical perspective reveals that similar excesses in the financial sector have appeared a number of times throughout history, including the Tulip bubble (The Netherlands—1636), the South Seas Bubble (England: 1711-1720), the Canal Mania (England—1790s), the Rail Mania (England—1840s), the Gilded Age (US: 1890s-early 1900s) and the Roaring Twenties (US-1920s), not just the world of Big Finance of today.
Down through the centuries, these phenomena have emerged for periods ranging from a few years to a few decades. During those periods, banks arrogantly claimed to have invented a new kind of economy, to which economic fundamentals of production of goods and services for real customers didn’t apply. They claimed to be making money out of money. But sadly, these bursts of “creativity” always proved to be unsustainable. The day of reckoning eventually came. Sooner or later, the bubbles burst and the party was over.
In each of the previous appearances, the euphoria has come to an end in a series of partial crises, or in one huge crash, or in some combination of the two. In the better outcomes, new forms of regulation were devised to help ease the transition back to the productive economy. What is now crucial is to devise regulations that will bring the financial sector to rejoin the real economy.
The thinking that drives the banks: shareholder value
The Death of Corporate Reputation points out the shortcomings of the financial regulatory system. It makes an overwhelming case that the regulators bear a significant responsibility for what has happened. At times, the book implies that regulation itself caused the problem: as though once regulators starting bearing down on the banks, it was inevitable that the entire financial sector would go off and try to maximize profit by any means possible.
But what about the banks themselves? It is not historically true that if complaisant regulators create opportunities for malfeasance that banks will automatically pursue those opportunities. If we look at the last four centuries of financial sector history, for most of that time bankers were pillars of the community. People looked on banks as highly trustworthy organizations. Even just a few years ago, Goldman Sachs [GS] was a partnership and nurtured its own capital carefully. It was a very different kind of organization from what it has become today.
In fact, the idea that the goal of a bank is to maximize its own profit at the expense of everything else is quite a recent idea. It got going in the 1970s and took off with a vengeance in the 1980s. That idea was not the driving force of American business for the prior two hundred years or of the financial sector for an even longer period.
A prime candidate for a root cause of the troubles that Professor Macey describes is thus the adoption of the shareholder value theory. It lies behind the shift in emphasis of the big banks from financing the real economy to making money from money, such as the giant gambling casino in derivatives. Making money from money is quicker in the short term than the boring job of funding the real economy. The problem is that the focus on short-term returns generates repeated financial booms and busts, each one larger than the last. In his future work, Professor Macey could perform valuable service by mapping the consequences of the noxious idea of shareholder value in banking.
Accountability of the business schools for the debacle
Furthermore, Professor Macey could explore: where does the noxious idea of shareholder value come from? By all accounts, it comes from the academia, particularly economic faculties and business schools. In fact, most business schools are still propagating it today. So should not academia also share some accountability for what has gone wrong and play a role in educating future business leaders better?
Fixing the financial sector will always appear to be an impossible task if we frame it as one of regulators trying to control and contain the nefarious activities of the banks and the hedge funds. If the issues are seen in a broader context, and the activities of the banks are viewed as one aspect of the way in which the shareholder value notion has been devastating many sectors, then we could get to the root cause of the financial sector’s problem and figure out what would be involved in fixing it.
It’s obviously important to hold both regulators and the banks accountable for their role in the financial debacles that have occurred and urge them to do better. But business schools might also look in the mirror and accept accountability for their own role in generating—and continuing to disseminate even today—the thinking that lies behind the behavior of the banks and the regulators.
What if Professor Macey and his colleagues at Yale Business School, such as Professor Robert Shiller, were to apply their prodigious analytic talents, and their insider-outsider vantage-point, to the programs of instruction at Yale University, documenting the disastrous consequences of shareholder value thinking in banking and assisting the financial sector to reconnect with the real economy? That would be a magnificent contribution not merely to the financial sector but to the entire global economy.
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