THESE THREE ARTICLES APPREAED IN THE GUARDIAN AND OBSERVER ON 14TH AND 15TH FEBRUARY 2009.
The banks couldn't contain dissent
Anthony Evans
guardian.co.uk, Saturday 14 February 2009
Finally! It's almost six months since Lehman Brothers declared bankruptcy
(and in doing so marked the onset of the current financial crisis), but only
now are we seeing evidence that the bank's bosses had been confronted with
concerns about the riskiness of their lending. But no one should be
surprised that the knowledge required to avert this disaster was there all
along.
So far, attention has understandably focused on the incentives of bank
executives, and how it has come to pass that people that were rewarded so
handsomely have failed so miserably. But as the economist Ludwig von
Mises famously pointed out even if bureaucrats are motivated to do the
common good, this is irrelevant without the right knowledge processes.
Organisations that prosper are those with effective ways to share the
information held by employees. This week we have learned that Paul
Moore, former head of risk at HBOS, made warnings to the board that the
company was engaged in excessively risky activity. He is being touted as a
"whistleblower", a term that refers to the unauthorised revelation of
wrongdoing.
But Moore isn't the only person to have been concerned that banks were
overleveraged, and thus dangerously exposed to falling house prices and
mortgage defaults. I suspect they were all ignored for two main reasons.
First, bank executives were more compelled by a different scenario – that
asset prices reflected underlying values, and that financial institutions were
efficiently spreading risk. The Bank of England induced this error; because
what banks thought were valuable assets were merely an inflationary
bubble.
The second reason the heretics were ignored is because there is a
fundamental tendency for companies to suppress dissent. Dissent is an
egalitarian phenomenon, since it combines a willingness to challenge
authority with a moral compulsion to do what is right. However, most
companies have a more hierarchical culture that mistakes dissent for
disloyalty, and thus expels the perpetrator. This explains why hierarchical
remedies (such as more rules and regulations) always fail, and why
whistleblowers end up as martyrs, not mercenaries.
Whereas in society the price mechanism serves as a signpost to coordinate
economic activity, in an organisation it is notoriously difficult to find
adequate knowledge measures. But companies that do take "the knowledge
problem" seriously appreciate that sharing information is not a passive
transfer. Indeed, useful dialogue requires conjectures and argumentation,
which in turn relies upon open minds, honest enquiry, and free speech. Or
as Polanyi might call it, a "republic of the firm".
The credit crunch is not a consequence of too little information, but a lack
of judgment due to ineffective communication. Rather than gather more
"facts", we need to find the most appropriate theory to piece what we
already know together. As TS Eliot lamented in the Rock:
Where is the wisdom we have lost in knowledge? Where is the
knowledge we have lost in information?
* guardian.co.uk © Guardian News and Media Limited 2009
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Inside every chief exec, there's a Soviet planner
Simon Caulkin, management editor
The Observer, Sunday 15 February 2009
The most remarkable thing on show at last week's banking hearings was the capitalists' naivety about capitalism - a gullibility that has endangered both of the economy's major institutions, markets and companies.
Their credulity about markets has been total. In a forthcoming paper, Professor Brendan McSweeney of the Royal Holloway School of Management argues that "market-failure denial" may have actually helped to provoke the economic holocaust. He notes that, by discounting the evident pitfalls of unrestrained purpose and capital-market-driven myopia, assumptions of market infallibility cleared the way for free markets not to self-correct, as believers predicted they would, but to self-destruct.
Likewise self-interest, another article of capitalist faith, was no more effective as a curb on bankers' capacity to self-harm than on sharks in a feeding frenzy. In the financial Götterdämmerung, hedge funds that had successfully taken down everything else that moved did the same to the banks, only to discover they were destroying the source of the funds they needed to gamble with.
As for companies, the capitalist orthodoxy got it wrong from A to Z. Managers miscalculated risk, misallocated resources and created incentives of such outstanding perversity that they brought the entire global financial system crashing down around them.
How could this happen? One answer is that, in their Tarzan-like celebrations following the Cold War triumph over central planning, the high priests of capitalism neglected to notice the sting that the moribund system had left behind. With exquisite irony, while central planning had been largely discredited at macroeconomic level, at microeconomic level it remained alive and kicking - in their own organisations. Veteran systems thinker Russ Ackoff is not alone in noting that while at the macro level the west is vehemently committed to a market economy, at the micro level almost everyone works in "non-market, centrally planned, hierarchically managed" ones.
The truth is that much conventional management is central planning in western disguise. This is why most companies are zombie-like in their structural and strategic similarity. This is why, too, they are unable to learn. With their faces toward the CEO and their arses towards the customer - in the immortal words of GE's former CEO, Jack Welch - what would they learn from? No wonder warnings of disaster were suppressed or auto-censored at the banks, or that the only messages heard were those that fitted with the earnings targets that managers managed by. In turn, the learning failure explains why so many companies adhere to the Zimbabwe school of change management - altering course only after ruin, by coup d'état.
Central planning imposes a huge co-ordination burden - which is why there's just so much management. If work is fragmented so that people have no direct line of sight to the customer, people have to be driven by signals from above rather than below. So each company has its own little State Planning Committee, a management factory remote from the people doing the real work, where managers devise top-down production schedules, targets, procedures and carrot-and-stick performance management and pay schemes, with complex systems to keep track of it all.
The cost of maintaining the management factory is immense. Consider that the world's most efficient large conventionally managed corporation, GE, spends 40% - that is, $60bn - of its revenues on administration and overheads. For every direct worker there's an indirect one to check or "manage" the work. If anything, overhead costs are increasing as work breeds more work. In less effective organisations, of course, hidden indirect costs are much higher.
None of this adds value for the customer. But although management clearly isn't costless, we weren't expecting the balance sheet to be negative. Yet while capitalists chortle over the absurdities of Soviet-style central planning - not to mention over-management in our own public sector - nothing in the pantheon of Soviet nonsenses (plants making a single giant steel bar or only left-foot shoes) compares, for destructive firepower, with the complex instruments rolling off the production lines of Wall Street and the City of London. Warren Buffett's description of derivatives as weapons of mass destruction was exactly right.
As it turns out, the managers of large western corporations have much more in common with the apparatchiks of the command economies than is recognised. The aim may be different, but they share the same conception of management - faith in targets and incentives, separation of "management" and "work" - and, ultimately, the same neglect of customers and product markets. If capitalism is to be saved, don't expect salvation to come from the capitalists.
simon.caulkin@observer.co.uk
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A club that refuses to accept its failures
Nick Cohen
The Observer, Sunday 15 February 2009
Loud were the snorts from RBS staff as they watched the men who had led their bank to ruin make their excuses to MPs. Although the press described the "humiliation" of Sir Tom McKillop, the former chairman, and Sir Fred Goodwin, the former chief executive, insiders knew the pair had got away with murder over the vastly inflated price they paid for Dutch bank ABN Amro in the autumn of 2007.
Economic historians have the nice word "euphoria" to describe the mania that overcomes excited minds at the peak of a bubble. As the market soars, everyone except wise investors believes the insane valuations of assets and thinks that any debt is worth taking on if it allows them to buy into an unlosable game. To me, the euphoric credulity of the era was encapsulated by Damien Hirst charging £50m for a kitsch, diamond-encrusted skull. Others will never forget Northern Rock's 125% mortgages or Gordon Brown's claims to have abolished boom and bust.
I've no doubt, however, that economic historians of the future will see the bidding war between Barclays and RBS for the soon-to-be worthless Amro as the moment when the market cut its moorings to reason and careered into a world of make-believe. RBS admits to £10bn going down the drain. Others say it is closer to £20bn. But McKillop and Goodwin were adamant that it was only with the benefit of hindsight that their critics could damn them.
Buying Amro was not an attempt by the Napoleonic Goodwin to extend his business empire, McKillop explained to the Treasury select committee. RBS's "strategy group and the executive team" weighed the options. The board approved every step. The Financial Services Authority gave its assent. (Although he did not add that one is hard pressed to find examples of the world's worst regulators disapproving of anything the City wanted to do.)
Goodwin was next and harrumphed that, yes, yes, all right, the bid did look a disaster now, but at the time "it did not seem like a bad mistake". He was a man of action and had to operate on the facts before him in 2007. The shareholders agreed with him, the regulators agreed with him, the board agreed with him, everyone agreed with him. To which senior staff at RBS in 2007 say: "Phooey!"
They suspected that their leaders were out of their minds. As one explained to me: "The figure they kept quoting was the cost-income ratio [the proportion of a bank's income consumed by operating costs]. Ours was meant to be 47%. Amro's was meant to be 96%. So the idea was that we move in, slash jobs, cut costs and get profits."
You did not need to be a financial genius to see the flaw in Goodwin's plan. If 96p in every pound was going on operating costs, it would take only a small fall in profits to turn Amro into a loss-making bank. As it was, there was a catastrophic fall and it all but collapsed. Equally, everyone who had to try to make RBS work knew its operating costs were so low because Goodwin had refused to invest in basic control systems. "The whole place was held together with bits of string," one told me.
Why didn't they speak out at the time? Because they would have been fired.
The picture they gave me of Goodwin was of a borderline sociopath running a cult of the personality. Everyone at RBS kept their heads downs. On the rare occasions they were asked for an opinion, they mouthed cheery slogans about the all-round brilliance of the strategy and the incontrovertible excellence of their bank.
As one source put it: "I would see some of the most senior people in the bank trembling before meeting him and saying, 'I hope it's not my term to be carpeted.' If you raised doubts, you were accused of belonging to the 'business prevention unit' and told to shape up or get out."
The same autocratic style dominated Sir James Crosby's HBOS. I understand why last week's revelations captured the imagination. They boiled down the grotesque negligence with which Labour regulated finance capital to one bite-sized story. Even though he is driving Halifax and the Bank of Scotland over a cliff, Crosby is appointed to the FSA, the body that is meant to police bankers, not provide them with a second income. He stays even when HBOS goes bust and only has to resign when Paul Moore, HBOS head of risk, reveals he warned Sir James of a looming calamity and was sacked for his pains.
Yet hardly any commentator was surprised that Crosby sacked the admirable Moore. Their indifference reflected the reality of working life. All hierarchies, public or private, have the potential to become cults. If the men and women at the top decide that argument is a species of treason, then everyone who values their career shuts up and knuckles down.
No law can change this basic fact of corporate life. You cannot legislate against arrogance. As I keep writing, a reforming centre-left government should, instead, legislate to create a financial structure where the damage the next Crosby or Goodwin can do is limited.
Perhaps I should stop writing it because how can a government led by Gordon Brown take the sensible step of turning banks into utilities, banned from playing at the tables of casino capitalism? Brown created the FSA and showered Crosby, Goodwin, McKillop and many another banker with knighthoods and peerages. He cannot go back to the world before the crash and he cannot change the system because reform would be an admission of his own failure as chancellor.
Italian Marxist Antonio Gramsci left us the eerie sentence: "The old is dead and the new cannot be born; in this interregnum, many morbid symptoms appear." And that's how Britain under Brown feels: a morbid country stuck between a lost past and an unrealisable future, with a glowering leader unable to move because he is paralysed by the weight of his own history.
