Wednesday, October 8, 2008

CEOs like Richard Fuld of Lehman are not the root cause of the financial crisis


Recently, I saw some CEOs get cross-examined by Congressional leaders on Capitol Hill. Certain accusations made against Wall Street CEOs may be well-deserved, but many of the politicians are wasting their time. They ask the wrong questions.

The questions that need to be asked of the CEOs do not concern specific "mistakes" made by the leadership of failed companies like Lehman, but how and why the system encouraged CEOs to make certain kinds of investment decisions in the first place.

CEOs are paid to maximize shareholder value. Their firms are traded in a market that is constituted so as to reward short-term quarterly earnings results.

When asked on Capitol Hill about whether he could have prevented the investments that went bad, Lehman CEO Richard Fuld replied that if a few years ago he had gotten out of certain (now disreputable) investments, his decision would not have appeared "rational."

That's the real problem in a nutshell. Short-term opportunity-seeking defines that which is considered rational behavior by the capital markets. The capital markets have rewarded long-term irrationality.

If Richard Fuld had not pursued the money-making opportunities that other investment bankers sought, Fuld probably would not have remained CEO of Lehman Brothers for very long. A more "rational" CEO would have been called upon to replace Fuld. The same story holds for the CEO of any publicly-traded investment bank, and many other banks.

The roots of the financial crisis are systemic. Fundamentally the source of the financial crisis is unrelated to any particular "bad" decision. Fuld was at the wrong place at the wrong time.*
* It is quite suspicious that AIG was bailed out by the government, but Lehman Brothers was left to go bankrupt. Treasury Secretary Pauson's former employer, the rival investment bank Goldman Sachs had a $20 billion exposure to AIG. Paulson is said to have consulted with a Goldman executive just prior to bailing out AIG.
UPDATE: I should qualify the headline to this post. The deeper problem precipitating the financial crisis concerns both the market and regulatory framework within which decisions taken by Wall Street CEOs have been made. To the extent CEOs have lobbied politicians to make advantageous laws -- and block socially constructive reforms -- they should be held to account for the crisis. Congressional leaders ought to have been asking the Lehman CEO Richard Fuld about the extent to which Lehman and its surrogates had lobbied Congress and the White House. But it is no mystery to me why these questions were not asked.

No comments:

Post a Comment

Because all comments on this blog are moderated, there will be some delay before your comment is approved.