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I contend that Robert Benmosche, CEO of AIG, had an incorrect understanding of corporate governance when he told Harvey Golub, then-chairman of the board, on July 14, 2010, “One of us should stay and one of us should go.” He should have, “Please let me know if the board would like me to go.” Put bluntly, the CEO works for the board, not vice versa. The previous May, Benmosche told Golub, “We can’t work together. I need a partner who I can bounce ideas off and give me advice.” However,a CEO and a chairman do not work together as partners. Rather, the chairman—and the board more generally—act on behalf of the stockholders to oversee the management, which the board has hired. In other words, a CEO is an employee whereas a chairman is not. Benmosche’s comment is actually rather presumptuous.

Benmosche’s upside-down approach to corporate governance is evident from the way he went about trying to sell AIG’s biggest overseas life insurer, AIA, to Prudential. Rather than being surprised that Golub did not support the sale, he should have taken note of Golub’s surprise that he had not informed the board earlier. As another example, rather than being annoyed that the board didn’t push Treasury’s pay czar harder to sign off on his $10 million pay package, Benmosche might have asked the board if they supported the proposed compensation.

One of the principal jobs of a corporate board is to assess the CEO (and hence the management) and to fire him or her if the board decides it would be in the stockholders’ interest. The CEO works for the board, not vice versa. It is not a partnership arrangement. It is the CEO’s responsibility to act within the support of the board, rather than to threaten its chair for not playing ball. Benmosche illustrates the arrogance that come occur when an employee is over-compensated and spoiled.  Benmosche should have been grateful to the AIG board for having agreed to a compensation package of $10 million rather than critizicing them for not essentially working for him in pressuring the Treasury.

From this case, we can extract the following lesson. A CEO should not chair the board whose task it is to assess him or her. Such duality is a contradiction in terms—effectively attempting to interiorize within the CEO accountability that is external (i.e., interpersonal). As Benmosche had already turned to Robert Miller, who replaced Golub, for advice and found him to be supportive, AIG may have essentially installed a puppet—hence compromising the board’s role in overseeing the CEO.

I once asked Armstrong when he was both CEO and chairman of ATT whether he saw any conflict of interest in his chairing of the body tasked with assessing him. He replied that the buck stopped with him—that he needed the authority to integrate cable, computer and telephone technologies into broad-band. However, in hiring him, the board should have signed off on his strategy, hence giving him all the authority he needed to implement it. In effect, Armstrong was over-reaching in claiming that such authority was not sufficient. When his strategy failed, the external accountability function of the board was compromised.

In general terms, CEOs are too powerful with respect to “their” boards.  In being an enabling partner rather than a parent, too many boards are unwittingly undercutting their raison d’etre. To the extent that the managements of banks contributed to the crisis in September, 2008, corporate governance with real accountability can be seen as critical not only to our financial system, but to the economy itself. We can ill-afford too many spoiled adult-children.

Source: Joann S. Lubin and Serena Ng, “Battle at AIG Board: You Go, or I Do.” The Wall Street Journal (July 16, 2010), pp. C1, C4.

Goldman Sachs’ (GS) board considered buying AIG in late June, 2008, so GS could use AIG’s premium float for capital (rather than becoming a bank holding company and using deposits to fund trades or as collatoral for leveraged trading).  Strangely, GS’s board didn’t realize that another part of GS was questioning the “mark to market” valuations that AIG was making on its swaps.  Also, AIG had revised its Nov and Dec 07 losses from $1b to $5b.  GS and AIG had the same public accountant (Price), which GS was using to get AIG to down-value the value of its assets. On that week in Sept, 2008, when Lehman went under, JP Morgan and GS were working to put together a loan of $50 billion to cover AIG’s deepening hole  At the same time, the two banks were demanding new collateral payments from AIG, pushing the insurance giant deeper into its hole.  The Fed and AIG wondered if the fees and interest rate being set by the two banks for themselves and other contributing banks wasn’t essentially stealing the company.

As it turned out, AIG received funding from the Federal Reserve in exchange for the government taking warrants on a 79.9% ownership of the company.  Goldman had bought $20 billion of insurance from AIG and received as much as $13 billion from AIG when the Fed funded AIG with $90 billion.  The counterparties were paid in full, rather than the sixty cents on the dollar that AIG negotiators had been pressing. Even though GS was hedged because it had purchased credit default swaps in case AIG were to default, one has to ask whether Blankfein at GS used Paulson to have the government pay GS through AIG.  Blankfein claims that his bank would not have gone under had AIG imploded, but surely GS relies on there being a financial market. Also, when the Fed essentially took over AIG, Paulson wanted to appoint a new CEO.  Paulson was of course an ex-CEO of GS.  Paulson had one of his advisors, also a GS alum, look at candidates.  The aid favored Ed Liddy, who was on GS’s board.   GS would be running AIG.  Hence, the insurance giant would not run interferance on the $13 billion going to GS.

Besides these conflicts of interest, Goldman trades securities for big firms and pension funds. It also acts as adviser to many of the companies whose securities it trades.   In other words, the problem is in its core business. So a person could be excused for wincing at Lloyd Blankfein’s statement that his bank is performing not only a social function in providing capital to firms so they can expand, but is “doing God’s work” as well.   John D. Rockefeller used the same expression in regard to his Standard Oil monopoly that offered its remaining competitors the choice to be bought up or drowned.  According to Rockefeller, Standard Oil was Noah’s Ark, saving the oil refining industry from destructive competition.   So what if the uncooperative were put under?  They deserved it. Besides, the industry would be saved.  In this regard, the monopolist viewed himself as a Christ figure.   Are the golden boys the incarnation of this figure?   It goes without saying, but I will anyway, that Blankfein has no misgivings in paying (and being paid) record bonuses in 2009.    The presumptuousness of those bankers aside, Jefferson’s dictum that a national bank would be more dangerous than a standing army to democracy seems apt.  We, the American citizens, have an amazing ability not to see things, and then to tacitly enable that which is in actuality hardly a savior.

Source: http://www.timesonline.co.uk/tol/news/world/us_and_americas/article6907681.ece?token=null&offset=0&page=1

The financial reform bill approved in December, 2009 by the US House of Representatives proposed to regulate the financial industry and keep firms from growing “too big to fail.” The bill can be likened to a ship made of Swiss cheeze, yet seemingly seaworthy. A key intention of the bill was to gain control over the vast market in “over the counter” derivatives by forcing trading onto open exchanges, where regulators can monitor it. Unregulated derivatives were behind much of the havoc that nearly brought down the financial system in 2008, including the subprime-mortgage-backed securities that put many firms underwater and the credit default swaps sold by AIG, the giant insurance company that sucked up about $180 billion in bailout money. The $592 trillion global market in these mostly unmonitored derivatives remained in 2009 among the most profitable businesses for the biggest banks—Goldman Sachs, JPMorgan Chase, Citigroup, Bank of America, and Morgan Stanley—and Wall Street doesn’t want Washington tampering with it. Early versions of Frank’s bill allowed many derivatives to continue trading off exchanges. The bill, Frank wrote, “could be subject to manipulation” by “clever financial firms” seeking to evade a requirement that they trade derivatives on open exchanges.

The story of how those loopholes got into the derivatives bill, even with Frank at the helm and the wind of public outrage at his back, shows just how powerful the Wall Street banking lobby remained nonetheless—and just how complex Wall Street’s financial instruments had become. Many of the key lobbyists were in 2009 in the same gang that helped get us into this mess before, and they were spending huge sums a year after the near meltdown. In the first three quarters of 2009, financial-industry interests  spent $344 million on lobbying efforts, putting them on pace to break all records. This did not include political donations and issue ads. Even more impressive was the lobbying strategy that money was buying. The banks sought to stay in the background and put their corporate customers—a who’s who of American business, including Apple, Whirlpool, and John Deere—out in front of the campaign. “This is an orchestrated, well-funded effort by the banks to manipulate our legislation and leave no fingerprints,” says a congressional staffer involved in drafting the legislation. The financial industry argued that curbs on derivatives do hurt just Wall Street, but also the corporations in Main Street America—the “end users” —that need them to hedge risks.  However, the more custom-made and out of public sight a derivative is, the harder it is for investors—and regulators—to assess its fair value and real risk. This makes it easier for the banks to charge a large “spread” and earn big profits. Frank heatedly denied that he'd been fooled, though he conceded he was catching up on some of the details of the bills he was pushing through. “I’ve become responsible for dealing with a lot of things that are new to me. I didn’t have a great deal of knowledge. I’ve been relying on a whole lot of people,” Frank said. In allowing some exemptions from exchange trading, Frank said he was merely accommodating the corporate end users—not Wall Street—who want to continue doing these private trades in derivatives.  The Wall Street lobby didn’t give up. After Frank had toughened up his stance on derivatives, the lobby tried to redefine what certain kinds of exchanges do.

The money that the industry can use to mollify congressional critics and bolster allies was not the only problem. The problem was even more intractable. Both Frank and his staff (and the corresponding committee in the US Senate) relied on the expertise of the banking industry in the fashioning of regulation for the industry.  Frank admitted that he didn’t know enough to keep on top of the drafts submitted by the industry (and end-users).  Additionally, it was difficult for him and his staff to assess where the industry’s “recommendations” were more “convenient” (meaning self-serving for the banks) than informational.   The financial instruments (e.g., derivatives based on mortgages) were at the time so complicated that congressional staffers who wrote the legislation depended on drafts submitted by the industry itself without being able to adequately screen them for bias.  There is an inherent conflict of interest in an industry even providing information. Therefore, I wonder whether the practice was worth its benefits to congressional staffers. 

The case seems to me like that of having a wolf provide the sketches for the design of the chicken koop, as if the design were an objective plan without any holes.   Even so, without the information from the industry with the vested interest, legislative staffs often do not feel competent to legislate on the complex markets of modern finance.  Indeed, they may not be, given the complexity out there.  But that is not a given.  We miss this point. To reduce the informational asymetry, Congress could direct that the markets be simplified to what they and the regulatory agencies could understand and thus regulate effectively. Opponents of the House bill claimed that the changes ensuing from the bill would limit consumer choice and stunt financial market innovation. Shortly after the House bill passed, President Obama suggested these risks are worth taking.

While applauding House passage of overhaul legislation, the President expressed frustration with banks that were helped by a taxpayer bailout and even as they were “fighting tooth and nail with their lobbyists” against new government controls.  The bank lobbyists spent more than $300 million in 2009 trying to scuttle the bill.  This alone should be enough to shut every congressional office to the lobbyists.  How widespread is the fecklessness!  As the wake of the bill’s passage, Obama said the economy was only then beginning to recover from the “irresponsibility” of Wall Street institutions that “gambled on risky loans and complex financial products” in pursuit of short-term profits and big bonuses with little regard for long-term consequences. “Americans don’t choose to be victimized by mysterious fees, changing terms and pages and pages of fine print. And while innovation should be encouraged, risky schemes that threaten our entire economy should not,” he said. “We can’t afford to let the same phony arguments and bad habits of Washington kill financial reform and leave American consumers and our economy vulnerable to another meltdown.”

So where were our legislators on this point?  Missing in action, most of them.  However much Obama's remarks can serve as a palliative, it must be admitted that the President could have gotten on the banks and refuse to sign a final bill containing deflating loopholes gained by the efforts of the lobby with a vested interest in the legislation.   I don’t believe the President would have risked his re-election contributions from Wall Street by telling Congress to be firmer in resisting the banker taskmasters.  Hence, the U.S. Government is unlikely to take on the very existence of the banks too big to fail even as the most profitable of them quickly returned to risky trading on their own accounts.

Too often, congressional legislators (and the President) wince when it counts, ignoring the inherent conflict of interest in the industry’s warning of Armegeddon.  We need to accept the fact that ery reform has a cost, and that “reform” does not mean “catastrophe.”  If we capitulate to the wolves because there might be a cost otherwise, we miss the greater cost in capitulating.  That cost is not only economic, for it includes the selling of ourselves and our government to the highest bidder and the loudest bully.  When I look around the world, I see fecklessness at home.

By comparison, the British and French states of the E.U. set a 50% windfall tax on ALL banker bonuses within their respective states.   Throughout the U.S., it has been difficult simply dealing with the bonuses of the bankers at the banks that were bailed out; we were so afraid that the credit markets would collapse from a tax or that we shouldn’t touch the other bonuses.  Treasury limited the cash compensation for executives at companies that received the largest taxpayer bailouts to $500,000 and delayed some other payouts. The 25th through the 100th top earners at Citigroup, GMAC, American International Group and General Motors had to take more than half their compensation in stock, and at least half had to be delayed for three or more years. About 12 executives were granted exemptions to the $500,000 cash cap because they were necessary for the companies to “thrive, be able to compete, and not lose key people.”  The European industry-wide approach was stronger, and less apt to result in “talent poaching” that was likely to occur where only TARP reciprients are targeted.

Why is that we were convinced that we couldn't or shouldn’t go beyond the TARP reciprients in limiting exorbitant executive compensation?  Is imposing compensation (in all its forms) limits to protect the market from firms too big to fail really beyond the pale?  Is it really so much a threat to economic freedom? Certainly, it is a legitimate role of a government to protect the viability of the market.  The lack of any enacted windfall tax on bank bonuses (or compensation) in the Congress in 2009 or 2010 intimates the subterranean power of Wall Street in Washington.  Indeed, according to The New York Times, “heeding complaints from banks, the House rejected an effort to allow bankruptcy judges to restructure mortgage payments, a plan that has passed the House before but not the Senate.”  When the same thing happened in the U.S. Senate, Sen. Dick Durbin said publically that the banking lobby owns Congress.  House members also agreed to relax some of the proposed new controls on trading in derivatives. Rather than subject all over-the-counter derivatives to open trading, the bill would have subjected such derivatives only if they were traded between Wall Street firms, or with a major player like AIG. But the transactions between dealers and customers will remain largely hidden, so customers will not be able to compare the prices they are being charged with the prices charged to other customers.  That’s nice for the banks.  We miss this point, paying attention instead to speeches.  Words.

We are not keeping our eyes on the ball, folks; rather, we all too easily allow ourselves to get distracted.  In watering down financial reform, we agree to construct fake walls  on what reform is viable and constructive.  We convince ourselves that we must play inside the pen because insiders have told us that we should. We take harsh words against the pen on our behalf as tantamount to tearing it down.   In actuality, the words are a subterfuge meant to assuage us so we don’t vote differently in the future.  The wolves know that mere words can’t tear down the walls they have directed our representatives to observe.  We have become like herd animals, and our leaders like subterfuges.  It is no wonder that “real change” contrary to the vested interests has been restrained at best.  If a new consumer protection agency is the high-water mark of reform (i.e., banks too big to fail being allowed to go on…even as they have returned to risky trades for much of their 2009 income), we really do deserve the next financial crisis.  …or can a speech going after the financial industry obviate such a thing from happening again?

Sources: http://www.newsweek.com/id/225781 ; http://www.nytimes.com/2009/12/11/business/global/11bonus.html?_r=1&ref=world ; http://www.msnbc.msn.com/id/34380551/ns/business-us_business/ ; http://www.nytimes.com/2009/12/12/business/12regulate.html?_r=1&ref=business ; http://www.msnbc.msn.com/id/34393630/ns/politics-white_house/