The Financial Crisis of 2008: On the Role of Negligence Breaching Fiduciary Obligation

Roger Lowenstein laments that “New York Times columnist Joe Nocera lamented that ‘Wall Street bigwigs whose firms took unconscionable risks … aren't even on Justice's radar screen.’ A news story in the Times about a mortgage executive who was convicted of criminal fraud observed, ‘The Justice Dept. has yet to bring charges against an executive who ran a major Wall Street firm leading up to the disaster.’ In the same dispassionate tone, National Public Radio's All Things Considered chimed in, ‘Some of the most publicly reviled figures in the mortgage mess won't face any public accounting.’ New York magazine saw fit to print the estimable opinion of Bernie Madoff, who observed that the dearth of criminal convictions is ‘unbelievable.’ Rolling Stone, which has been beating this drum the longest and with the heaviest hand, reductively asked, ‘Why isn't Wall Street in jail?’”

Lowenstein interprets these sentiments as implying “that the financial crisis was caused by fraud; that people who take big risks should be subject to a criminal investigation; that executives of large financial firms should be criminal suspects after a crash; that public revulsion indicates likely culpability; that it is inconceivable (to Madoff, anyway) that people could lose so much money absent a conspiracy; and that Wall Street bears collective guilt for which a large part of it should be incarcerated.”

Lowenstein argues that “(t)hese assumptions do violence to our system of justice and hinder our understanding of the crisis. The claim that it was ‘caused by financial fraud’ is debatable, but the weight of the evidence is strongly against it. The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.”

Lowenstein also ticks off a loose monetary policy (i.e., extremely low interest rates), unaccountability at Fannie Mae and Freddie Mac, weak financial regulation, and an overconfidence in “risk management” methods in arguing that we should not be reductionist in ascribing the crisis to fraud alone or even primarily.  

Analysis:

Lowenstein is undoubtedly on firm ground in labeling the crisis a “multi-causal” affair. In a general sense, the positive feedback loop wherein everyone benefitted from a rising housing market turned to a negative feedback loop once that market decided to take a hard landing. However, even though he makes a good point that criminal fraud was probably not pervasive on Wall Street, he downplays the litigation that is still possible in going after senior managers at Wall Street banks for negligently breaching their fiduciary obligations to stockholders—the negligence being in the sheer recklessness (which I suspect is a function of individual personalities).

For example, Richard Fuld essentially ignored his risk committee at Lehman Brothers as he added leverage up to forty times value in order to continue buying CDO’s and commercial real estate by the bucketful—his ultimate objective most likely being to bring the bank up to the big league (e.g., with banks such as Goldman Sachs). Would not such recklessness based on egotism constitute fiduciary negligence? It is as though Fuld were under the illusion that the stockholders’ wealth in the bank was his own because of how much of the stock he himself held.

As another example, even Alan Greenberg over at Bear Stearns may have been negligent in not alerting the board as Jim Cayne, the CEO at the time, became “more aloof and full of himself” even as two of the bank’s hedge funds were going down in July 2007 (Greenberg, p. 145). Incredibly, Cayne was playing in a card-game tournament in Nashville for over a week as the executive committee labored daily over whether to liquidate the two hedge funds at the bank that were losing money from their mortgage-related securities and the ensuing redemption calls from nervous investors. Virtually everyone in the senior management of Bear Stearns should have informed the board of Cayne's conduct (i.e., his priorities, which evinced immaturity befitting the man's pot-smoking at the tournaments and even at work). If the directors would have failed to act (e.g., being too cozy with Cayne), the board too should be held by stockholders as woefully negligent.

Furthermore, being on the risk committee, Greenberg may have been negligent in deferring to Warren Spector on the risk issuing from the fixed-income area (e.g., mortgage-backed securities). Claiming that Spector was “imperious” in that area is no excuse for Greenberg failing to exercise diligence given the amount of business the bank was doing in CDOs. Greenberg recounts that “multiple variables contributed to an extremely complex dynamic, yielding consequences that I hadn’t previously encountered” (Greenberg, p. 156). However, he admits to have told Warren a few years earlier to unload CDO’s within 90 days because of the risk involved. Greenberg simply gave up in pushing back from the financial pressure of the large profits being made. Accordingly, he gave up on due diligence on the risk committee and should be held accountable by Stearns stockholders. 

Incidentally, I admire Greenberg for his straightforward recounting of the events leading up to the collapse of his bank, even though I do not buy his account of his role on the risk committee. Perhaps the lesson is that even an ethically solid and competent person is fallable, and may even inadvertantly fall into a negligent pattern of complacency in the midst of momentary profit. The depth of the causes leading to the financial crisis may be evinced, moreover, in that a person such as Greenberg became unintentionally complicit. As Greenberg himself observes, Jamie Diamond at Morgan had urged his bank out of the mortgage-related securities business altogether as far back as 2006 as the housing market was peaking. From this vantage-point, Greenberg himself must surely know in hindsight that he had fellen short.

Whereas Lowenstein claims that one of the causes of the crisis was that risk management methods were followed, I contend that they were relegated or ignored even by the risk averse because the standards stood in the way of large profits. To be sure, Greenberg and others on risk committees relied on the AAA ratings from Moody’s and S & P (though Greenberg had been sufficiently worried to urge quick sales of the bonds). Even so, it should have been prime facie evident that a mortgage-based bond is not a Treasury bond. Furthermore, the rating agencies’ managements should not be held blameless, as they did the bidding of Bear Stearns and Lehman in exchange for lucrative fees;  there was undoubtedly fraud or at least negligence in this conflict of interest.  

Whereas fraud may have been limited largely to salesmen at mortgage brokerage firms and the rating agencies, breaches in fiduciary obligation were, I suspect, running rampant on Wall Street. In other words, money being easy and regulation being light (or non-existent in the case of the CDOs) did not give the banks’ managements a pass on their fiduciary obligation to exercise a duty of care over stockholder’s equity in the banks. Whereas cheap leverage and lack of oversight are context, recklessness with others’ wealth may constitute the principal cause—the lack of concern for risk being part of it.

Generally speaking, boards allowed senior managements—as evinced in the persons of Dick Fuld and Jim Cayne—far too much rope with which to hang themselves. It is astounding to me that people like Fuld and Cayne were able to get anywhere near the authority of a CEO. Their glaring immaturity and incompetence may point to a systemic problem in corporate governance going far beyond what even institutional stockholders realize. It would seem that the boards of Lehman and Stearns were either asleep or in somebody’s pocket (which involves at the very lease a stark conflict of interest). Although holding the managers accountable for their recklessness leading up to the financial crisis of 2008 would be a step in the right direction, stockholder interest warrants systemic reforms to corporate governance itself such that “upper” managements are given much shorter leashes (and stature).  

Sources:

Roger Lowenstein, “Why No Wall St. Bigwig Has Been Prosecuted,” MSNBC.com, May 16, 2011.

Alan Greenberg, The Rise and Fall of Bear Stearns (NY: Simon and Schuster, 2010).

Royalty: Natural or Exaggerated?

On April 29, 2011, the world watched in utter fascination as a crown prince in one of the E.U. states married a wealthy commoner in London's Westminster Church--the same edifice in which Queen Elizabeth had married in 1947.  The prince is of course William, and his bride is Kate (or Catherine to the purists), who in one hour's time went from being the daughter of two wealthy commoners to royalty.  It is as though she leap-frogged from “the many” past “the few” to join “the one”--the firm. My question is whether these distinctions, involving birth as well as wealth, are natural in terms of human nature or exaggeraged artifices borne of excessive privilege and power.

The seemingly-eternal tripartite division was on display during the wedding, as throngs watched large screens in large parks and crowded pubs while a relative few, which had been invited to attend the ceremony in person, took their seats inside the church after which the royal family arrived with great attention to each individual member. Of course, “the one” literally refers to the person of the monarch, Queen Elizabeth II, who uniquely stood deliberately silent as the congregation sang “God Save the Queen.” One might ask whether having a living human be the subject of a national anthem evinces a category mistake wherein a person is taken for the nation as a whole (i.e., an abstraction). Does aristocracy go so far as to end up as standing for a nation itself?

Thomas Jefferson and John Adams both referred to a natural aristocracy of virtue and talent. Such differences do indeed exist between people, and thus are generally agreed to be quite natural. Indeed, most people view it fitting that distinguishing people by their character or effort is a perfectly valid basis for rewards. The two American founders also wrote of an artificial aristocracy based on birth and wealth. While nobility and royalty are typically associated with the latter, a monarch may also serve as a check on the sort of artificial wealth that grabs more than it is entitled to on the basis of character and effort. In other words, a king or queen, being in the job for life, can in theory protect titles from simply being bought. This potential benefit of royalty implies a downside to the aristocracy in the American republics wherein what counts is the size of one’s bank account rather than whether one has been raised well and is talented.

In virtually any of the American states, for example, a boorish used-car businessman or subprime mortgage salesman who has become newly rich by providing lemons could join a country club and thus be reckoned as part of his city’s aristocracy. Similarly, wealthy CEOs like Lew Glucksman and Dick Fuld of Lehman Brothers could be members of the most exclusive country club in New York and yet lack “gentlemanly traits.” Such qualities cannot be purchased like some commodity traded by investment banks; instead, a gentleman is fashioned from birth. Such natural aristocracy is beyond the reach of the vast wealth of the sort like the envious Glucksman and the childish Fuld even if they could buy themselves into exclusive country clubs. In a European state such as Britain, however, the monarch could theoretically forestall a grasping capitalist from buying a title. Hence, even a rich CEO in Europe can remain a commoner regardless of his or her wealth, which in an American state would clearly differentiate him or her from the masses in terms of exclusivity and privilege.  This is not to say, however, that European aristocracy and royalty are without their downsides.

That Kate Middleton, a millionaire’s daughter, would be lumped together with the other “commoners” only to become royal in marriage ignores the rather obvious economic distinction between rich and poor. That is to say, because of Kate's parents’ wealth, there was something artificial in Kate being referred to as a commoner before her wedding. Moreover, royalty itself might be a highly artificial construct in so far as royals come to believe they do not share humanness with other people.

The director Ken Loach points to the irrationality in the behavior of “commoners” when they ignore the artificiality that is in the expectations of royals. Good people “have knelt before the Queen at some point in their lives. . . . the woman you’re kneeling before represents all that is wrong with this country—inherited wealth, inherited privilege, the apex of the class system. Let’s have a bit more dignity than to crawl before that woman, please.” In other words, subjects as well as monarchs are adults and they should all act the part. There is something undignified for people such as the Middletons who created a business from scratch regressing to childlike behavior in front of a person simply because that person is regarded as the symbol of the state. Furthermore, there is something insulting in the royals referring to the Middletons as commoners because the appelation does not recognize the family's achievement in business.

Perhaps Europeans have the potential benefit in royals acting as a check on ugly usurpers grabbing off too much societally, yet at the cost of artificiality in the royal-aristocrat-commoner distinction wherein the common human denominator in all three is ignored or relegated. Ironically, I suspect that the royals themselves may be among the casualties in the severing of a recognition that we are all human beings. In addition to holding themselves to standards of behavior that may be at odds with human nature itself, royals may tend to forget that commoners are just as human as are nobles and royals. For example, we all die, and none of us knows what, if anything, is in store for us after death. So while there are real and artificial distinctions, there is also the shared basis in all of us being human. Accordingly, my instinct should I come in contact with a royal would be to relate to him or her simply as another person, whose need for genuine human contact is just as real as mine.

Source on Ken Loach: “Between Commodity and Communication: Has Film Fulfilled Its Potential?” International Socialist Review, 76 (March-April 2011), 28-44, p. 44.

See my related essay, "On the "Wedding of the Century': History Made or Manufactured?"

Lehman's Dick Fuld as the Antagonist in the film, "Too Big to Fail"

The reporter-author of Too Big to Fail, Andrew Ross Sorkin, expressed the following fear as his 600-plus-page book was being made into a movie: "I went into the process I think worried – as I imagine most writers would be – that it would be sexed up and hollywoodized in some other way." To be sure, putting the Dick Fuld (CEO of Lehman Brothers) character into any sort of sex scene would have been counterproductive at best.

As it was, the director of the tv-movie based on Sorkin’s book let the drama inherent in the historical events to lead the narrative. The only quibble I may have with the historical veracity has to do with Bart McDade replacing Joe Gregory as President of Lehman. According to Larry McDonald, a former distressed-bonds trader at Lehman, the replacement also relegated Fuld even as he remained as CEO only to quell the markets. Specifically, on June 11, 2008, “Fuld was effectively deposed,” according to McDonald, “by Bart McDade with the support of the executive committee” (McDonald, p. 297). In the movie, however, Fuld was still in charge even in September of that year, with McDade still bowing to him in front of the Koreans.

While it could be that Sorkin and McDonald have different sources of information on whether there was a coup within Lehman, the film’s director and screenwriter could have kept Fuld in charge to maintain the character as the principal antagonist. Even so, McDonald’s description of McDade confronting Fuld in Fuld’s office and the subsequent decision of Gregory in the conference room to take the stunned CFO, Erin Callan, down with him in front of the executive committee would have made excellent scenes in the movie.

The other change I would have made to the screenplay would give the viewers an improved insight into how the sub-prime crisis could have been allowed to get so bad. Specifically, the Fuld character could have had a flashback to Mike Gelband’s warning on June 7, 2005 in defiance of Fuld that Lehman should get out of the housing-related CDO market; the bank was then leveraged twenty-two times its net worth (McDonald, p. 136). Meeting with Gelband and other senior executives on the 31^st floor on that day, Fuld and his allies insinuated that Gelband had some kind of attitude problem that needed to be changed “real fast” (McDonald, p. 138).  As a flashback, this scene would have shown the viewer Fuld’s recklessness in terms of risk (and leverage), and thus how the financial system could have been put in such peril by the “experts”. In fact, in the spring of 2007 Fuld decided to bully and belittle Gelband publically at the bank in order to get him to take on even more risk (McDonald, p. 235). This could have been fused into the “attitude problem” meeting, showing the viewer Fuld’s pathology, which goes beyond a bad temper.

Whether one points to Jim Cayne at Bear Stearns or Dick Fuld at Lehman, the role of pathology in the near-demise of Wall Street could uncover for us how recklessness could have gained such traction. In other words, HBO’s Too Big to Fail could have delved into Fuld’s character beyond having him drop some F-bombs. Speaking on Charlie Rose on the evening of the movie’s premiere, Sorkin marveled that it must be difficult for actors to convey their respective characters in just a few scenes. That is true; however, the director and screenwriter could have brought out Fuld’s pathology (beyond his anger) by a few well-chosen additional scenes. Sometimes what a character says, and to whom, can be more damning than how loud he or she says it. Concerning Fuld, the viewers could have been shaking their heads in utter disbelief rather than simply concluding that the guy is arrogant and has a temper.

See related essay: "Leadership at Lehman: On the Failure of Richard Fuld"

Sources:

Kamelia Angelova, “Andrew Ross Sorkin: I was Worried that ‘Too Big to Fail’ Will Be Sexed Up or Hollywoodized as a Movie,” Business Insider, May 24, 2011.

Lawrence McDonald, Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers (New York: Three River Press, 2009).

Fuld’s Arrogance at Lehman: Systemic Risk

Documents released in May 2012 regarding Dick Fuld at Lehman Brothers prove that he was aware of the high risk involved in holding so much real estate (and related security derivatives). This means definitively that “the ‘forces-out-of- our-control’ argument we hear from Wall Street leaders is [self-serving] bunk. It is the ill-advised behavior of one banker after another, day in and day out, that leads to the sort of devastating financial crisis we are only now emerging from.”[1]

The full essay is in Essays on the Financial Crisis, available in print and as an ebook at Amazon.

1. William Cohan, “Lehman Docs Show Wall Street Arrogance Led to Financial Collapse,” The Huffington Post, May 7, 2012.

Leadership at Lehman: On the Failure of Richard Fuld

The failure of Lehman Brother suggests that too much power may go with formal position while non-positional leadership in organizations is not given enough of a chance to check the excesses of office. Richard Fuld could take advantage of much having to do with his formal position so he would not have to lead. In contrast, a competent subordinate, Mike Gelband, faced a considerable headwind in trying to lead through persuasion without the benefit of a position trumping Fuld’s own.

The full essay is in Essays on the Financial Crisis, which is available in print and as an ebook at Amazon.

Related Essays:

 "Fuld's Arrogance at Lehmen: Systemic Risk"

"Lehman's Dick Fuld as the Antagonist in the film, 'Too Big to Fail'"

"Fraud as Fair: Lehman as Beneficiary of Society's Pro-Business Cultural Values"

"Executive Stature: Glimpses of the Man Behind the Curtain"

"Lehman Bros: Insufficient Accountability in Corporate Governance"

Lehman Bros: Insufficient Accountability in Corporate Governance

In an executive meeting at Lehman in the summer of 2008, Skip McGee told Richard Fuld and the other top executives that the market was demanding “that we hold ourselves accountable.”  Essentially, he was pushing for Gregory’s outster.  What strikes me is what he didn’t say–namely, something like, “the stockholders are holding us accountable!”[1]  Had he said this, Fuld might have laughed. Of course, Richard Fuld was a major stockholder, so he might have viewed it as “holding myself accountable to myself.”  Given the inherent ethical conflict of interest in such a statement, I don’t think we can rely on corporate governance as a check on excessive managerial risk-taking when executives hold a substantial share of the stock.  Therefore, in including stock options in executive compensation to align executives' incentives with medium and long-term firm performance, boards should add institutional safeguards or accountability mechanisms to corporate governance. In business-speak, there is a cost incurred that boards may not be aware of in aligning executive compensation (and firm ownership) with future profitability.

The full essay is in Essays on the Financial Crisis.

1. Grace Wong and Aaron Smith, "What Killed Lehman," CNN.com, March 15, 2010.