" ... What we have here is not a few financial executives gone rogue, or a company gone bad. It’s an entire system that’s lost its way---and dangerously so for the rest of us. ... "
By Joe Rothstein
U.S. Politics Today, March 19, 2012
Why would a letter of resignation from a junior Goldman Sachs executive like Greg Smith create such an international furor? On the face of it, Smith’s parting shot should have found a final obscure resting place in the human resources files of Goldman’s digital warehouse.
But the N.Y. Times chose to elevate the Smith resignation letter to prominence on its op ed page. And then Goldman Sachs and much of Wall Street went nuts reacting to it.
Why? Because Smith’s letter hit an exposed nerve. All involved know that what Smith said rings true. Smith drilled right through Goldman’s excesses into the rot and reality of the U.S. financial system. At its highest levels, U.S. capitalism has become a grab-what-you-can-when-you-can-and-run game divorced from traditional goals such as helping businesses to succeed and serving as a vital lynchpin in long term national growth.
The American Banker magazine has just published a two-part series about a Chase employee fired because she objected to Chase turning over to a collection agency $200 million in credit card accounts, many of which had never been verified as having overdue debt or owing anything at all.
The biggest banks in the U.S. are trying to settle up with the federal government for foreclosing on individual mortgage holders with robotic efficiency that barely noticed whether foreclosures were actually warranted. These are mostly the same banks that brought on the current worldwide financial catastrophe by making trillions of dollars of bad bets with money they didn’t have.
As business columnist Steven Pearlstein writes in the March 18 Washington Post, “What we know from painful experience---from the mortgage and credit bubble, from Enron, Worldcom and the tech and telecom bubble, from the savings-and-loan crisis and the junk bond scandal and generations of penny-stock scandals---is that financial markets are incapable of self-regulation. In fact, they are prone to just about every type of market failure listed in the economics textbooks.
Robert Reich wrote last week “There is moral rot in America but it's not found in the private behavior of ordinary people. It's located in the public behavior of people who control our economy and are turning our democracy into a financial slush pump. It's found in Wall Street fraud, exorbitant pay of top executives, financial conflicts of interest, insider trading, and the outright bribery of public officials through unlimited campaign "donations."
What we have here is not a few financial executives gone rogue, or a company gone bad. It’s an entire system that’s lost its way---and dangerously so for the rest of us.
About the same time the N.Y Times was publishing the Greg Smith letter I sat in on a session at Brookings where the topic was “Corporate Governance and Long-Term, 'Patient' Capital.”
Beneath that fussy title was a lot of alarming data and perspective.
For example, Delaware Supreme Court Justice Jack B. Jacobs pointed out that institutional investors now control about 70 percent of the stock in public companies. These institutions---hedge funds, equity funds, pension funds and the like---are far more interested in short term gains than long term growth. And those who manage companies in those investment portfolios have huge compensation packages tied to quarterly share prices. There's little little incentive to resist short term pressures.
Lawrence E. Mitchell, dean of Case Western Reserve’s law school, pointed out that fifty years ago companies retained 60 to 70% of their earnings. Today it’s 3%. Investments in growth are financed by debt, which fundamentally changes the dynamics of business decisions and increases company vulnerability.
At the top of the financial pyramid, where millions, billions and even trillions trade through lightspeed-like sophisticated software programs, insiders have every advantage and instant profits are the overriding goal.
All of this is disconnected from a healthy capitalist system where long term business growth and stability is anchored to prudent financial management and where banks exist to efficiently channel capital.
What incentive is there today for company managers to invest heavily in R & D that may pay off in five to 10 years? Not much. Not when those managers are shoved under the earnings microscope every three months.
And that’s really the problem, isn’t it? Incentives.
The system needs to reward longer term horizons for investors by taking less of a tax bite out of patient money and making short term windfalls less profitable. Incentives need to protect good managers who want to run and grow stable businesses instead of loading them up with unsustainable debt. Incentives need to steer companies and their acolytes in the legal and accounting worlds away from illegal behavior by enforcing severe punishments for stepping over the line.
What we call “capitalism” has developed systemic failures that reward the bad and punish the good. Until that changes we will continue to be easy marks to have our pockets picked by the handful of too-big-to-fail financial institutions that are too big to know right from wrong. Or even care.
(Joe Rothstein can be contacted at email@example.com)