Wednesday, January 7, 2009

Individuals not Institutions

In the midst of a financial crisis everyone (myself included) looks to place blame. And we find a name--the worst of the worst--Madoff. Prior to finding that name we blame the institutions who propogated the crisis. But an institution is nothing more than a conglomeration of individuals who being of sound mind have the capacity and requirement to make judicious and ethical decisions every day.

When an institution makes poor decisions it can typically be mostly blamed on the top decision makers who incentivized the behavior they wanted (e.g. Enron). But in organizations that deal directly with the public, it generally takes a lapse in moral judgement for even the uneducated 20 year old to push inappropriate practices or products.When that institution is found and the blame cast, the chieftons get a slapped hand, legislative efforts are taken to stop the exact same lapse (e.g. Sarbanes Oxley to fix Enron). And that 20 year old learns the benefit of what the senior executives did, even if in the worst case they get caught too.

So the question becomes, why are we trying to legislate corporate morality at the executive and structural levels? After a person has been rewarded for bending the rules for 30 professional years, are they going to change when they are CEO? Is another sworn signature on one more piece of paper or corporate ethics going to be the deterrent from crossing the ethical boundary?
I proposed that instead we attempt to fix the broken system that trains people this way. Let's work more on the corporate culture of America, expose rule bending, and force investors to suffer the consequence of giving money to get that extra 1 percent. Investors have lost their healthy skepticism. Rightfully so. If I owned AIG stock and they bent the rules, I may have lost money, but I am still in the game. And I can even buy more stock of this and other moral hazards.

Let's punish the 20 year old severly. Because he was paid extra to underwrite subprime mortgages over traditional ones, and gave poor advice, make his corporate ladder much more difficult to climb. And make sure future business graduates see it. Sure we should get angry about the excess of today's CEO, but that junior staffer is thinking about how he can circumvent the system in the next 10 years to get that excess. When he walks from the bus stop to work and the CEO pulls into the parking garage in his Farrari, do you think putting that CEO in jail for 6 months and taking away some of his net worth is teaching that new hire peddling subprime mortgages to the next trusting soul? That soul being less than employed and wanting a big screen TV. With the traditional mortgage you get this small house. With this subprime you can get this much bigger house and we'll give you cash on top of it. Every seller of product on financing knows if you give cash back, people will buy. Nobody can be stupid enough to believe it is free money.

That borrower getting the subprime mortgage is easily swayed to get the risky mortgage. The CEO is motivated to increase earnings by underwriting, repackaging and selling a group of them as a CDO. The junior staffer can only be motivated by a compensation structure that entices bad behavior, and may not understand everything, but should have an uneasiness about what is really happening. They don't have a high cost of living to maintain. They want to climb the corporate ladder. If they even think there is a chance of being blackballed from that climb, or that their ladder just got a lot more difficult to climb than their former classmates who were not operating in gray areas, a message will be communicated to coming graduates. And 20 years from now we will have a much better chance at healthy capital markets where skeptics ask how a company can make extra money.