How the Leadership Void Feeds the Financial Crisis

I am more afraid of an army of one hundred sheep led by a lion than an army of one hundred lions led by a sheep.

~Charles Maurice, Prince de Talleyrand-Périgord

When the financial crisis erupted in 2008, many questioned the leaders and regulators in place at the time. How could the global financial system be humming along one minute and completely bankrupt the next? Clearly, those in charge either made some very questionable decisions or failed to inform the public of the potential consequences of those decisions. Most likely it was both.

When it came to constructing solutions for the crisis, however, we continued to listen to and implement the ideas of the same people who brought us to the brink. In turn, those people followed policy prescriptions similar to the ones that got us into trouble in the first place. Were there no other options available? There were. They were simply ignored. And what role did we the public play? Were we willing sheep, helpless dupes, or both?

While I’ve been thinking and writing about this exasperating situation for some time now, the reality of it hit home once again this past weekend as Joe Nocera published an excellent exit interview with outgoing FDIC chairwoman Sheila Bair. Ms. Bair added a refreshingly candid piece in the the Washington Post. I highly recommend reading both.

Notes from the Exit Interview

Here are a few points that stood out to me from Nocera’s article:

  • “Not long after she took charge in June 2006, Bair began sounding the alarm about the dangers posed by the explosive growth of subprime mortgages, which she feared would not only ravage neighborhoods when homeowners began to default — as they inevitably did — but also wreak havoc on the banking system. The F.D.I.C. was the only bank regulator in Washington to do so.”
  • “Just a few months ago, she went so far as to send a letter to Standard & Poor’s, the credit-ratings agency, suggesting that its ratings of the big banks were too high because they reflected an expectation of government support. If a too-big-to-fail bank got into trouble, she wrote, the F.D.I.C. would wind it down, not bail it out.”
  • “the last female financial regulator to be labeled difficult was Brooksley Born, the head of the Commodity Futures Trading Commission in the mid-1990s. Fearful that derivatives were becoming a threat to the financial system, Born wanted to regulate them but was stiff-armed by Alan Greenspan and Robert Rubin.” I had the same sense of déjà vu. (If you get a chance, watch the PBS documentary called The Warning that I wrote about in Market Integrity Should Not Be an Oxymoron.)
  • “She favored “market discipline” — meaning shareholders and debt holders would take losses ahead of depositors and taxpayers — over bailouts, which she abhorred. She didn’t spend a lot of time fretting over bank profitability; if banks had to become less profitable, postcrisis, in order to reduce the threat they posed to the system, so be it. (“Our job is to protect bank customers, not banks,” she told me.)”
  • Ms. Bair felt the authorities should have let Bear Stearns fail: “Banks and bank-holding companies are in the safety net. That’s why they have deposit insurance. Investment banks take higher risks, and they are supposed to be outside the safety net. If they make enough mistakes, they are supposed to fail. So, yes, I was amazed when they saved it. I couldn’t believe it.”
  • The FDIC was the lone regulatory agency that foresaw and tried to stem the toxic impact of subprime mortgages. The responses of the Fed, the Office of the Comptroller of the Currency and the Office of Thrift Supervision “were at best tepid and at worst hostile.”
  • As head of the FDIC, Sheila Bair also fought against U.S. adoption of the Basel II accords. Already taken up by most European countries, Basel II “would allow banks to hold capital on a “risk-weighted” basis, meaning that assets with lower risk would require less capital. (As it turned out, triple-A-rated mortgage bonds stuffed with bad subprime mortgages were considered very low risk under the Basel proposal. That is why so many banks loaded up on them in the years leading up to the crisis.) To make matters worse, the Basel II accords, as they were called, permitted banks to evaluate their assets with their own internal risk models.”

It turned out that Bair’s approach, often labeled “difficult” by bankers and fellow regulators, left U.S. banks in a slightly better position than their European counterparts when the credit crisis hit. If they had listened to her ideas with regard to tightening capital requirements and regulations in the first place, however,  perhaps the crisis could have been averted.

In Her Own Words

I can remember watching media coverage of the financial crisis as it unfolded in 2008 and 2009 and wondering what some of the key players were really thinking behind the spin and the rhetoric. Sheila Bair’s Washington Post article on Short-Termism and the Risk of Another Financial Crisis provides a glimpse into what she feels is the primary cause of our economic and financial problems. Given that many of the “solutions” employed continued the policies of short-termism that she abhors, it’s easy to see how frustrating that period of time must have been for the FDIC chairwoman.

Bair begins her op-ed with an incredulous observation that we have quickly returned to “the same untenable business practices that brought [the financial system] to its knees less than three years ago.” She notes that “too many industry leaders, as well as some government officials, compare the crisis to a 100-year flood. ‘Who, us?’ they say. ‘We didn’t do anything wrong. Nobody saw this coming.’ ”

In reality, plenty of people saw this coming. They did the best they could to try to stop it, but no one at the political or public level was listening:

“The truth is, some of us did see this coming. We tried to stop the excessive risk-taking that was fueling the housing bubble and turning our financial markets into gambling parlors. But we were impeded by the culture of short-termism that dominates our society. Our financial markets remain too focused on quick profits, and our political process is driven by a two-year election cycle and its relentless demands for fundraising.”

Just as she did back in 2006, Sheila Bair wants to “sound the alarm again.” The problems created by short-term thinking are “actually getting worse, not better.” Will we listen this time?

I once wrote that strong leadership is one of the missing links in our current, distorted version of capitalism. If so, the only way to change that is to find a way to better educate the public about the long term consequences of short-termism – no small task given our “gotta have it now” society.

(There’s a lot more to both of these articles, so I would urge you to go and read both in their entirety.)

Should we have listened to Sheila Bair and others who warned of the longer term consequences of a lack of market discipline? Why are we still ignoring them?

Written by Kim Petch

6 Responses to How the Leadership Void Feeds the Financial Crisis

  1. Great topic, Two Cents.

    I see the problem as being a circular one. You hear me all the time raving about how the investing “experts” have let us down. They have. But you know what? They’ve let us down because they are afraid of what we would do to them if they told us the straight story. I’ve had “experts” in this field tell me just that.

    We don’t have good leaders because a big part of leadership means telling hard truths and we don’t care to hear them.

    That said, I think we are on our way to fixing our problems. I believe that the next stock crash is going to be an eye-opener for a lot of people. And I see our potential as being virtually unlimited given the new technologies we have created and the things we have learned from use of them . I view these days as the dark days we need to survive to reach a wonderful, inspiring and enriching dawn.

    Just hang on tight!


    • I think you’re right on both sides Rob: 1) We will likely have/need another crash. 2) Once that happens, we can get the clean slate needed to achieve real prosperity. I also think technology will be key to this, but that we need to be careful about replacing humanity with technology. It can be a great catalyst, but I wouldn’t want to live in a world dominated by it.

      I wish the public could handle the real truths and I wish we had leaders who, like you, are willing to take the hits necessary to tell it like it is. Keep it up! 🙂

  2. There are a lot of bright people who have been ignored (think warnings of Madoff). It is simply what happens when governmental employees get complacent in their duties and the private sector allows greed to take over.

    I hope we are getting closer to getting this all figured out. In the meantime, I am out to protect my family as much as possible.

    • Good point on Madoff. Those warnings went on for years and in the end, he was only prosecuted once he confessed. It’s hard not to be frustrated by all of this, but in the end I guess we all need to get on with our lives and make the best of the situation. It sounds like you’re doing just that!

      Thanks for stopping by! 🙂

  3. Awesome piece Two Cents.

    I wrote on this subject extensively a couple of years ago, but it turned off a lot of my readers. I don’t know if it was because they weren’t knowlegdeable about the workings of the financial sector or because they didn’t feel they could change it. There is no doubt the government and finacial elites are in collusion at the expense of taxpayers. Taxpayers would have never voted for the bailouts, but they were completely ignored.

    • Not sure why this type of info would turn off any readers, but maybe that’s why this stuff keeps happening. As long as the markets aren’t tanking and they still have an income, the masses think all is well. The result is an electorate that’s uninformed and ill-equipped to choose credible leaders.

      I used to think there just weren’t any credible leaders out there, but there are a few voices of common sense that leak out once in a while. The problem is, no one listens to them.

      Thanks for your comments Bret!

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