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Wednesday, March 14, 2012

Client-Centered Ethical Leadership: A Recipe for Trust at Goldman Sachs

With its incentive-structure that rewards a quick profit on the next trade even at the expense of advising clients in line with their long-term interests, Wall Street has its work cut out for itself even in maintaining trust, which, after all, is the basis of a market. On March 15, 2012, the New York Times reported that over all, “the percentage of people who have little or no faith in the fairness of investment companies rose to 41 percent in 2011 from 26 percent in 2008, according to Yankelovich Monitor 2011.” Even banks and insurance companies fared better, and household income played no role in the findings. At the time, Goldman Sachs was doing its industry no favors in terms of reputation. Indeed, the “best and the brightest” on Wall Street had created or enabled a rather narrow and self-serving corporate culture and a lack of ethical leadership that could otherwise turn around the bank by transforming its dysfunctional culture.

For support, I am not going to use the SEC investigation into fraud at Goldman (a case which the bank settled without admitting wrongdoing), or to the findings of Sen. Levin’s committee in 2010. Nor am I basing my conclusions on a Delaware judge’s criticism of the bank over the multiple and potentially conflicting roles it played in brokering an energy deal. I not even going off the charges made by the hipsters in Occupy Wall Street movement. Rather, I have in mind what is in my judgment an honest report made publically by a well-placed insider in Goldman—something that is exceedingly rare and thus potentially extremely enlightening.

In his stinging opinion-piece in the Wall Street Journal on March 14, 2012 issued just shortly after he resigned from Goldman Sachs, Greg Smith excoriated the bank where he had worked for twelve years, accusing it of moral turpitude if not sordid, short-sighted, greed. “To put the problem in the simplest terms,” he writes, “the interests of the client continue to be sidelined in the way the firm operates and thinks about making money.” He describes meetings in which the clients’ interests did not even enter into the equation. In fact, according to Smith, the grandson of Lithuanian Jews who had emigrated to Johannesburg, at least five of the executive directors at Goldman regularly refer to their clients as muppets. I suppose this means that the clients are deemed so stupid they can (and should) be easily controlled or managed by their “advisors” at Goldman, who are evidently the smartest kids in the room.

Even as government investigations and a protest movement can get far more press, an essay by an insider can be far more enlightening in terms of what is really going on behind a bank’s mission statement. Undoubtedly aware of this point, Lloyd Blankfein, the CEO at Goldman, and Gary Cohn, the bank’s president, referred in a letter to employees to Smith as “this individual” and to his essay as “an individual opinion.” Lest it be forgotten, leadership too is associated with individuals. Ironically, Smith rather than Blankfein and Cohn was exercising leadership—even ethical and I would say transformational leadership as against a ploy to deny and discredit in order to retain power. Leadership does not reduce to power. Indeed, the ethical, transformative leader must risk it, and Smith—being persona non grata on Wall Street—certainly risked more than that in having his essay published.

One Wall Street executive said it was “unforgivable” for Smith to make his opinions so public; rather, he should have taken them privately to the firm’s senior managers. However, he had doubtlessly done so only to be ignored, given the weight of the bank’s culture going against him. Indeed, as a middle-level manager, his complaint would not have gained much play. So the Wall Street executive’s advice can be rendered as enabling a dysfunctional corporate culture rather than being constructive. Ethical or transformational leadership cannot contravene the logic of power in a firm’s hierarchy, and thus the intervention must be top-down rather than bottom-up.

As an alternative to ethical leadership, relying on customers to discern that they are not being adequately served and thus decide to leave may be advocated by others on Wall Street as the best solution as it makes use of the market mechanism. Thanks to Sen. Carl Levin’s committee, it was already widely known that at least one issue of the sub-prime-mortgage-based derivatives being sold by Goldman was referred to in internal emails as “crap.” The customers to whom it was sold had no basis to know that it was crap, or that Goldman’s sales people thought it was crap. It is not as if the marketing included: Tell the prospective customer that the security is crap. Perhaps the only customer buying that line would be a former governor of Alaska who could see Russia from her house.

Moreover, selling “crap” to “muppets” reflects not only a blatant disregard for customers, but also a marked level of disrespect of those who are ostensibly being served. It is as if the emails had read: “We could serve the idiots dog food and they wouldn’t know any different.” It is from such a haughty place that even the powerful today can fall so far and so unexpectedly fast. Yet it is not clear to me how many of Goldman’s muppets would walk from superior returns, if indeed Goldman has been out-performing its rivals, out of an overriding sense of self-respect. One would think that customers would prefer bankers who have their backs, but some undoubtedly believe in buyer beware (caveat emptor) and virtuously apply the strict doctrine to themselves as if in a Calvinist fit of self-discipline. The trade-off between even short-turn returns and self-respect is itself within a rather sordid corporate culture, and for it to be changed I think we need to consider the prospects for ethical, transformative leadership at the upper-echelons of the bank rather than rely on brave middle-managers or external protestors, investigators, or even customers. To make this case, I need to point to the salience of a firm’s culture—and in particular its ethical dimension.

Lest a firm’s culture be thought to be of marginal significance from the standpoint of the firm as a going concern financially, Smith attributes Goldman’s culture of yesteryear, which “revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients,” as the “secret sauce” that made the place work as a credible and trusted investment bank that thrived financially.  To be sure, the fact that partners had their own fortunes on the line gave them an incentive not to risk losing established clients by undercutting them by a focus on short-term profit über alles. Even so, a bank’s culture can play a large role in whether short-term or long-term greed is the order of the day. According to Gus Levy, who led Goldman Sachs in the 1960s and 1970s, with long-term greed, money was made with clients, not from them. Deciding whether to include or relegate customer interests is a decision or value that spreads like wildfire through an organization. This occurs by means of the organization’s culture. If Smith is correct, the culture at Goldman came to include a lack of regard for customers, or muppets. Because the customers were expecting that their interests would not only be considered, but also emphasized, Goldman’s violation of its corresponding obligation means that the ethical dimension of the culture is particularly salient here.

Lest the moral quality of a firm’s culture be presumed to be an unimportant element of a firm’s culture, Smith makes the startling claim concerning what had come of the bank’s culture: “I truly believe that [the] decline in the firm’s moral fiber represents the single most serious threat to its long-run survival.” A single-minded effort to make money even at the expense of a customer’s immediate interests, such as in selling crap to muppets, turns out not to be a good strategy. Indeed, it is unethical. Indeed, I have been surprised at the positive correlations I have found in hearing of unethical companies, such as Days Inn for instance, being also not very competent, at least at the retail level. Unethical people tend not to be very good at their day jobs. Perhaps a character flaw is the common denominator behind unethical conduct at the expense of customers and incompetence.

However, Goldman Sachs has been financially successful even if its culture and leadership have been rather squalid. To be sure, Smith claims the bank is on borrowed time, given its lack of regard for its muppets. “People who care only about making money will not sustain this firm—or the trust of its clients—for very much longer,” he writes. In any case, the bank could doubtlessly be much better shape financially were ethical leaders installed who did not have such a vested interest in the extant dysfunctional culture.

Smith points the finger principally at Lloyd Blankfein, the sitting CEO who had bragged that Goldman was doing God’s work and yet defensively tried to discredit Smith as only an “individual.” More generally, Smith points to the dearth of ethical leadership at the bank. “The firm changed the way it thought about leadership. Leadership used to be about ideas, setting an example and doing the right thing. Today, if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence.” Leaving the reference to axes aside, Smith’s point is that the ethical dimension of a firm’s culture is very important to the firm’s financial survival, and that ethical leadership is vital for the dimension. Culture, ethics, and ethical leadership are like a pyramid of sorts with the top setting the tone (and rewarding it). Promoting people for unloading toxic securities on unsuspecting muppets is not the way to build ethical leadership, and thus an ethical culture. Lest all this be reduced to practices of questionable legality—as if business ethics reduced to business law--Smith reports no such impropriety. The fatal flaw in Goldman Sachs is moral rather than legal.

If only the problem were legal in nature. Smith’s prescription is much more difficult to implement than catching cheats: “Weed out the morally bankrupt people, no matter how much money they make for the firm. And get the culture right again, so people want to work here for the right reasons.” This medicine attacks the extant culture itself, which, after all, is based on making money for the firm. Unfortunately, the effort must come out of that culture. Therein lies the rub.

How to interlard ethical leadership even at the board level in the midst of moral turpitude is to ask something to renounce what it is in order to become the opposite. Cultures normally resist that sort of thing. The board would have to be sufficiently distant from the managerial culture as to be willing to expunge the extant tip of the managerial iceberg and replace it with an ethical leader who is known as a change agent. It might be that the chair of the board must go to stockholders for support in order to make changes in the board. In any case, a new CEO, one taken from afar rather than even from stakeholders, would be necessary. Once installed, he or she would have to work downward, rooting out the rot; this cannot be done from the middle-level of management. In fact, opposition can be expected from throughout the management structure. Bringing in a powerful change-agent (preferably an ex-marine) in human resources, such as the guy O’Neal brought in at Bank of America, could help the CEO systematically find and extract elements of the old culture and quickly replace them with new, solid oak. That would be God’s work, borne of ethical rather than defensive leadership. The clients would come to appreciate it and reward the visionary victors handsomely, whether in terms of bonuses, profits, or dividends.


Greg Smith, “WhyI Am Leaving Goldman Sachs,” The Wall Street Journal, March 14, 2012. 

Nelson Schwartz, “Public Exit From Goldman Raises Doubt Over a New Ethic,” The New York Times, March 15, 2012.

Susanne Craig and Landon Thomas, “Public Rebuke of Culture at Goldman Opens Debate,” The New York Times, March 15, 2012. 

On Television’s Sunset: Thinking outside the Box

Sometimes I think the human mind is like a train in being limited to the tracks that have already been laid. We are habituated to think it sufficient that we can turn off the main line on to another at the next signal. We think this is change because it involves turning onto a different track, but is it really change if the train is still on track?

A while back, someone thinking outside the box suggested  to me that because many watches and clocks were already computerized as of 2012, we could have sunrise pegged at 7am and sunset at 7pm every day of the year. The number of seconds in a minute would be adjusted accordingly. During the winter, a minute during daylight would have less than sixty seconds and a minute at night would have more. During summer, it would be the reverse. The inventive mind behind this idea was trying to obviate the problems involved with when to go on and off daylight savings time. As it stood in 2012 in the United States, the two dates were not symmetrical with regard to the amount of daylight (going on daylight savings time during the second week in February would match the first week of November). Of course, there is nothing magical about 7, except perhaps in Judaism. Under the inventive scheme, the time of sunset could be extended even to 10pm during the summer (each minute during daylight would have less than sixty seconds), going back to 7pm during the fall, winter and early spring.

Besides the fact that time itself does not change, at least as experienced by us, one problem with “fixing” the times of sunrise and sunset as envisioned by the inventive mind is, as one critic said, “the power of television.” We are habituated to TV Guide, and thus would not want to see 60 Minutes scheduled for fifty minutes one week in one season and seventy-five in another season. Being of a certain length of time, a given television show would be scheduled for different durations, as per the number of seconds in a minute. “Television would never stand for that,” so said one detractor. Absolving myself of responsibility, I replied, “It was all his idea, not mine.” Even though I thought of the idea as a thought experiment having value in stretching the human mind beyond the existing tracks, it occurred to me that the assumption that television has too much power is too narrow. The thought experiment can have value in getting us off the tracks (rather than off track) of our usual way of circumscribed thinking.

                                             Larry King, formerly of CNN, embraced online programming.      CNN

On March 12, 2012, Ora.tv was announced. Financed by Mexican billionaire Carlos Slim Helú and co-founded by Larry King of New York, the planned internet television network “will have a slate of television shows of varying lengths and will stream them via the Internet to computers, phones, and television sets . . . by bypassing traditional television distribution systems,” according to the New York Times (which was itself contending with online competition). Viewable on laptops, ipods, ipads, and smartphones, “television” shows could bypass the overpriced cable systems.

Even without Ora.tv, TV Guide was being relegated by the existence of video on demand, available on a laptop, ipad, or phone. Beyond video on demand, Ora.tv could only have an “irregular” schedule, given the differing lengths of the various programs. Having programs taped at varying lengths, it would not matter how long they run in real time even if there is a schedule (i.e., were the number of seconds in a minute changed so sunset would occur at 7pm year-round). So much for the power of television.

As early as 2010, people had told me they had disconnected their cable and were using their television screens to watch movies on DVD from Netflix or an already-antiquated video store. Television programs, like that which Larry King had on CNN and was planning for Ora.tv in 2012, do not benefit from a big screen as much as does a film like Avatar or Titanic. Hence Larry decided to discontinue his series of specials at CNN so he could turn to the internet venture that he had co-founded. Regarding his decision to depart CNN, King said, “When the train gets to the last station, you know to get off.”

What if technological change itself can outstrip even going onto another existing track? What if we have reached the last station with tracks? Might the human mind be able to travel trackless? Absent a way to rid Earth of its tilt, we are stuck with changing lengths of daylight. I mention proposal as a thought experiment to show how unnecessarily limited our way of thinking typically is (e.g., “television would never allow it.”). The context or paradigm itself can be thought of as variable in nature, rather than static. The human mind can indeed think up changes within a paradigm while simultaneously shifting the paradigm itself. We need not think only in terms of whether to shift the track ahead. Remember the train in one of the Back to the Future films taking off from the track? The human mind can do likewise, if we do not hold ourselves back out of sheer habit. We have only ourselves to blame if we don’t start thinking outside the box, or over yonder from the rusty tracks. It might be that the twenty-first century will be known as the century when weeds started growing through the tracks. We have only ourselves holding us back from getting off track.

Brian Stelter, “New Internet TV Network to Feature Larry King,” The New York Times, March 12, 2012.

Tuesday, March 13, 2012

Justice as Fairness: Writing Down Greek Debt

According to the Wall Street Journal, 80% of Greece’s private creditors agreed to “voluntarily” convert their Greek debt into debt of a bit less than half the face-value (plus a lower interest rate). With such a proportion having agreed to the swap without triggering credit default swap insurance payouts, Greece could get the E.U. to agree to force the remaining 20% to involuntary write-downs. That would trigger the credit default swaps, at least in theory.

Because any write down of Greek debt by other E.U. states or the E.U.’s central bank (equivalent to the Federal Reserve) would be tantamount to additional aid to Greece, the E.U.’s basic law would again need to be amended (which must be unanimous). So the E.U. (and the international IMF) exempted themselves even as they pushed for “voluntary” write downs by private debt-holders. This hardly seems fair. Moreover, any pressure from the E.U. could have been sufficient for the credit default swaps to be triggered. To be truly voluntary, the write downs would have to have come from the private bondholders themselves rather than from governmental pressure. Even so, that 80% agreed, it is only fair that the remaining 20% be forced to capitulate. Otherwise, holding out could be a strategic competitive advantage financially. Refusing to compromise while other similar parties do is unfair whether between private creditors or governments.

In my view, Greece should have secured the E.U.’s approval on instituting the collective bargaining statute in order to get all of the state’s private holders of Greek bonds to take a write down. It would have triggered the credit default swap insurance claims, so the bondholders might actually have preferred being forced even if more of their Greek debt was written off. Furthermore, E.U. officials should have subjected the E.U. states to join the private bondholders. At the time of the 80% voluntary agreement in 2012, Greek debt in 2020 was forecasted to be at 120% of Greece’s total economic activity. This is still quite high, particularly given the recessionary impact of the continued Greek austerity. Unfortunately, the (excessive) power of state officials at the E.U. level meant that a conflict of interest interfered with amending the E.U.’s basic law to permit the state governments and the ECB to take write downs.

In terms of ethical theory, one could apply John Rawls’ Theory of Justice here. In this theory, there is a veil of ignorance concerning where one will be in the system for which one is making rules. Not knowing whether one would represent a government or private bondholder, for example, one would not be likely to add the rule in which only the private bondholders write off their Greek bonds. Not knowing which E.U. state one would represent, one would not add a rule favoring Germany and France over Greece. Not knowing whether one is an official of the E.U. Commission or a member of a state legislature such as the Bundestag, one would not make a rule allowing the states to protect their interests at the expense of the E.U. Rawls adds that because of the veil, any rule would see to it that the position of the least well situated is improved. So it would not be the case that Germany could dictate to the E.U. or so successfully protect German interests at the expense of Greece. Indeed, the bias would be in seeing that the people least well off in the least well off state are not further downtrodden as a result of any proposed rule. This might be part of Rawls penchant for redistribution, however. At the very least, we could say that the rules enacted under justice as fairness would be in the interest of the system itself rather than any particular part thereof. In terms of the writing down of Greek debt, the E.U. could have been fairer in how it went about designing its rules. There was not exactly a veil of ignorance on the vested interests that were in a position to protect themselves at Greece’s expense.

Charles Forelle, Stelios Bouras, and Alkman Granitsas, “Greece Passes Key Debt Test,” The Wall Street Journal, March 9, 2012.

Sunday, March 11, 2012

A Democratic Spring in Russian Cities

The “Arab Spring” of 2011 might have given the world an over-optimistic notion of what political protest can engender in terms of “regime change.” A year later, the Egyptian military was still in control, which suggests that removing one particular dictator had constituted real change. In Myanmar, soldiers still dominated the parliament even after the opposition party won a landslide victory in by-elections in March 2012. Meanwhile, Assad in Syria was getting away with teaching the protesters in his country a bloody lesson while both the Arab League and the UN looked on. Meanwhile, Putin viewed his fraudulent presidential election victory as a mandate to deal more severely with the Russian protesters. The notion that a brave new world of democracy had somehow sprung to life in the Arab Spring suffered an cold snap of sorts from the cold winds of real politik. I suspect that real change happens more incrementally, and from the bottom up. This was evident in Russia in March of 2012.

Under the radar given all the attention being paid to Russia’s presidential election, 71 members of a coalition of independent and opposition activists won seats on Moscow’s 125 district legislative councils, where Putin’s United Russia Party lost ground, according to the Wall Street Journal. The newly elected deputies “will take up grievances closer to home, such as lack of parking space, spotty garbage collection and rundown neighborhood parks.” This laundry list is less exciting than planning a protest march, but according to one such newly-elected deputy, Vera Kichanova, it “can be a beginning for our generation, a way to train ourselves to run the country.”  The 20 year-old student is wise beyond her years. Although she planned to continue to join the protests, she realized that setting up a web-site by which her constituents could communicate with her would build not only grass-roots support, but tacitly convince United Russia supporters that there is another tangible alternative. Activity like cleaning up parks and increasing parking spots is only the tip of the iceberg.

                             Tamara Kornilyeva at a training session for activist candidates in Moscow WSJ

Additionally, independents including ruling-party defectors won several mayoral victories, including Yevgeny Urlashov, an anti-corruption candidate for mayor of Yaroslavl, a city of 600,000. He was supported by opposition leaders. He won a landslide victory with 70% of the vote over the Kremlin-backed opponent. “We have something to say to Mr. Putin,” he said. “Change is coming. Let democracy spring from the city of Yaroslavl.” It was not only in that city. Opposition candidates won in other large cities, including Toganrog and Togliatti. Independent candidates won 10 out of 15 mayoral elections held across Russia in March 2012, according to the Central Election Commission. Fueling the trend was increased grass-roots political activism triggered by the protesting of the parliamentary elections in December 2011. It remained to be seen just how high the opposition might get. If it does not get co-opted, the independents could eventually percolate up to give Putin’s United Russia Party a run for its money.

There are lessons for Americans. Rather than focusing exclusively on Congressional or U.S. Presidential races, Tea Party activists and candidates might concentrate foremost on the precinct level and go from there. Once they reach Congress, they would be firmly ensconced back at home and thus better able to withstand pressure even from the Republican House and Senate leadership.

There is plenty to do at the local level to open up democracy. Once mayor, Urlashov plans to fire corrupt officials and reform the electoral law to prevent mayors from serving more than two terms. In Moscow, some of the independents have been lobbying to shift the city’s power from the City Council and the unelected mayor to the 125 neighborhood councils. This reform would strengthen democracy because it is easier for new parties and independents to get elected at the neighborhood level where door-to-door campaigning can really pay off (this is also a good reason for the principle of subsidiarity). The local and regional levels are in principle most fertile for democracy because the electorates are smallest in size and the entry costs can be lower.

Furthermore, because Russia is itself a federal system, as is the E.U. and U.S., increasing the power of neighborhood councils could be part of an effort to “do federalism” all the way down. This is Althusius’s 1604 theory, where individuals are represented by their guilds and neighborhood councils, which in turn are represented at the City Council level. A provincial council is a federation of city councils, and a kingdom (or republic) is a federation of provincial councils. The imperium, or empire, is a federation of kingdoms or republics (e.g., the U.S., E.U. and Russia). Each level has the same form, and represents only the next lower level. It follows that a neighborhood council would not be a mere advisory body to a city council. All of the federation-levels are equally legitimate. In terms of modern democracy, viewing both the neighborhood and city levels as federations would strengthen democracy itself by making it easier for new faces to become politically active beyond the protest marches.

Richard Boudreaux, “Russian Protester Finds Another Path to Change,” The Wall Street Journal, March 10, 2012.

Althusius, Political Digest (see Carney’s translation).

Michael Schwirtz, “Mayoral Votes Give Russia Opposition a Boost,” The New York Times, April 3, 2012.