Crisis Revisited: Lazy Greenspan and Other Villains

In 2009 a group of academics at Canada’s Richard Ivey School of Business started a qualitative research project into the causes of the global financial crisis and what should be done going forward.

The team engaged with more than 300 business, public sector and not-for-profit leaders, including those in Asia and the world’s biggest banks. The result is a book called Leadership on Trial: A Manifesto for Leadership Development, one of the earliest studies on the crisis that continues to linger today.
“Where the fault is to be found is with individual leaders, and the way in which they led their companies,” says one of the four co-authors, Dr. Jeffrey Gandz, Professor of General Management at Ivey. Regulators, consumers, the media and almost everyone else are also to blame – including Alan Greenspan, whom Gandz describes as suffering from intellectually induced “laziness,” and business schools themselves.
Gandz sat down with CFO Innovation’s Cesar Bacani in a wide-ranging interview. Excerpts:
Your study appears to conclude that everyone is at fault. Does this imply that it’s the Western capitalist system that’s to blame because all the players, regardless of their best intentions, have been compromised?
No, actually, it’s completely the contrary. Part of the things that initiated this research was a sense that we were hearing from people who said this was a collapse of the system. We poor innocent bankers, we’re just caught in the system meltdown.
It was fairly obvious that there were some banks that weren’t engaged in risky lending, that weren’t out of control with their leverage – whereas others were in it up to their necks. There were some countries whose regulators managed extremely well, Canada and Germany among them. There were others where the system was appalling – Iceland, US, UK. So it wasn’t a system-wide thing at all.
So where does the blame lie for the global financial crisis?
Where the fault is to be found is with individual leaders, and the way in which they led their companies.
It wasn’t a given that you had to be a victim. For example, Goldman Sachs. One can argue that it was one of the originators of a lot of the highly leveraged investments [that contributed to the problem].
But Goldman Sachs understood as early as 2006 that this leverage that was being build up into the system was posing an enormous risk. So they started to de-risk Goldman Sachs in 2006 and were fully collateralised by the time people like Lehman had collapsed and AIG was in trouble. .
A bank like Toronto Dominion Bank, which is one of only two triple-A rated banks in the United States today, was out of structured investment products by 2007, had no involvement in asset- backed commercial paper, had no involvement in sub-prime lending.
Why didn’t other institutions follow Goldman Sachs and Toronto Dominion Bank?
We found three sets of reasons. One I would put under the broad label of ‘competences.’ That includes fundamental competences in risk management, not the least of which was not becoming dependent on mathematical models, the same kind of quantitative models that didn’t work for Long-Term Capital Management [whose failure in the late 1990s forced the U.S. Federal Reserve to orchestrate a massive bailout].
Some of it was incompetence in organisational design. For example, companies that did not have good methods of rolling up the risk that was being taken in individual units, and rolling it up to the corporate level so they would understand the whole risk.
The example of this would be UBS and, to some extent, AIG, where risk was taken by a relatively small unit. The U.S. investment banking units of UBS took on risks that were greater than the whole capital of UBS globally.
The book also discusses character.
It was quite apparent that the judgment of some senior bankers was impaired. They were excessively over-confident. One could argue they were suffering from the hubris of many years of successful operations. That often blinds people to what can happen.
They were closed-minded to dissent even in their own organisations, [to people who were saying] this is clearly wrong, we are way, way over the reasonable terms of risk. They were just making lots and lots of money.
But I don’t think the public explanation of greed is a satisfactory one. What I think is more likely is that they are hyper-competitive. Being competitive is good, but being hyper-competitive may distort your judgment and it becomes winning at all costs.
The book proffers a third set of reasons.
There were bankers who believe there is value in diversity of views and listening to dissenting voices, and discussing things. Others took a more imperious view and [felt] that anybody who doesn’t agree with me must be my enemy.
Some leaders really had a commitment to lead in terms of really understanding what was going on in that business, whereas others enjoyed the position of being a leader, but weren’t necessarily prepared to do the hard work of leadership.
And so you have some senior leaders who appear to be disengaged. They didn’t understand the risks that were going on in their organisation. The classic example is UBS. The Swiss government forced UBS to have an independent inquiry into what went wrong. It was very clear that the leaders . . . didn’t understand that they had a subsidiary that was engaged in a whole pile of these things.
Was compensation part of the problem?
This bank chairman and that bank chairman are paid about the same amount. One led his bank up in this direction, one led in that direction. If it was just compensation, you’d expect them to go the same way.
Again and again, we came back to this notion of character. Some [leaders] simply said, no, it’s not the right thing to do to gamble shareholders’ money in these highly risky ventures. It’s not right for the society in which we operate, it’s not right for our customers, it’s not right for our shareholders. We’re not going to do that even though we may be criticised for not doing it. Remember, there was a lot of money to be made from doing this.
Were the leaders of the Fed not very competent, not committed, lacked character?
If I look at Alan Greenspan in particular, and this is revisionist, it would appear that he was kind of lazy and that he did not test what was going on against some other scenarios.
His laziness was intellectually induced. He had this incredible belief in efficient models and it almost sounds silly. He said: if there’s a problem there, the markets will pick it up [and fix it] because the markets are efficient.  
He gave an interview very soon after the collapse, in which he actually said that in order for this degree of leverage to be sustained, house prices would have had to go up 5% per year in perpetuity.
So he knew intellectually what was going on.
Yes. He knew that it was entirely unreasonable that this degree of leverage can be sustained. But he either doubted his own belief, or he just put it to one side and did not act on it.
What about the U.S. government?
It’s absolutely true as well that the government was very much involved in pumping this liquidity. They had in fact acted in 1999 to lessen oversight of the derivatives market, which had allowed the phantom banking system to be created.
Because it was popular. People could buy houses, and then use the equity in their houses to buy SUVs, boats, country cottages. The US tax system also played a part, because it allows people to claim mortgage interest against income. You have a tax break that encourages people to be in debt on their mortgages. Even people who have wealth [and thus have the money to buy in cash] have mortgages, because it’s a tax-efficient way of using your money.
U.S. consumers are also to blame?
Yes. We talked to people who had lost their houses for this research. And they said: we should never have been in this. Somehow, there was this silly belief that if I’m in too much debt this year, I’ll just wait a year to go by and my house will increase in value. Then I can refinance my house and pay off my debt. Except that they never paid off their debt. They bought more things and got more in debt.
What about the media?
Without the alarmist media, I don’t think there would have been a financial crisis. Within 24 hours of Lehman Brothers going under, CNN was running a programme on the Great Depression of 1929. The stuff that was coming out was alarmist, extremist, not unlike what is coming out about the nuclear reactor in Japan [today].
There’s a section in the report in which we say people suddenly started shutting down. When individuals decide to get out of debt, the implication is that businesses are not going to invest because consumer demand is not there.
And so one of the reasons that the cutting of interest rates has not been that successful in stimulating GDP growth is because individuals had decided they were going to reduce their debt loads. It doesn’t matter how much cheap money you give to business. They’re not going to spend that money if they don’t think the consumer is going to be there.
You’re saying if we don’t have 24-hour new, no Internet, no twitter and Facebook, we wouldn’t have had the crisis?
We would not have the panic . . . We were actually heading into recession that was being driven by the busting of the property bubble, but it looked as though it was going to be a pretty standard cyclical recession . . . Then the 24-hour news cycle in financial markets magnified and amplified every phantom rumour and then expressed horror at the resulting panic.
There is one very encouraging thing. Once [the crisis] started, what the finance ministers of developed and developing countries did was brilliant. How hard it must have been for somebody like [U.S. Federal Reserve Chairman Ben] Bernanke and particularly [U.S. Treasury Secretary Henry] Paulson to say within 24 hours: My God, we got this wrong; we have to change our approach completely.
The decision-making in the ten-day period following the fall of Lehman was brilliant. The decision to save AIG was really the keystone to so many other things happening – the decision to flood liquidity into the major markets, the decision of the G20 to offer stimulus spending despite the risk of inflation, and so on and so forth. It was the capitalist system working at its best.
Maybe so, but it would have been better if those decisions, no matter how brilliant, did not have to be made in the first place. So what needs to be done?
We can minimise the probability of this happening again. I say minimise, not avoid, because the evidence is absolutely clear. Something like this has happened every ten to 20 years since 1456, which is the first recorded time a financial crisis happened. 
Firstly, are we going to allow in future for this system to be so complex that it cannot be managed? The intent of Basel 3 is to stop that happening. There is a difference between being a very complicated system and a complex system. So it’s going to be a very complicated system. For example, [banks and other financial institutions] are going to have to reserve capital against risk and the amount of capital they have to reserve will depend on counterparty risk, which wasn’t the case previously.
There will be a combination of Basel 3 and local regulations because you can’t write a set of rules internationally that can control every circumstance. As you know, there are rules, which is one thing, and there’s policing and then there’s penalty. So every criminologist understands you can have a law but if there’s no policing, it doesn’t work. Even when you have policing, there’s no penalty, it doesn’t work. So what the world is now trying to create is a system of laws, policing and penalties.
We already have Sarbanes-Oxley and other regulations
But they were weak. Sarbanes Oxley was not designed to deal with this. It was designed to deal with corporate fraud and Enron; it really had nothing to do with this.
You can have as many rules as you want but you can always find ways around them.
There are always some criminals, but the vast majority of people are law-abiding . . . The real thrust of this is in the way in which we develop leaders. We can do a better job. Educators, CEOs of companies who are paying for leadership development programmes, HR people who develop these programmes – I think we can all do a better job of balancing the needs for competences, character and commitment.
Does the media have a role to play in educating people as well?
Yes, they do, and so do regulators. What is happening right now in North America is that regulators are asking companies what they are doing to educate their people. Business schools share the blame as well, and we should look at how we can help develop better business leaders.
Do you have confidence that all this will work?
Better than the old system. Do I have confidence to the extent I would bet my pension that there won’t be another problem? No. Humans are inventive about what they will do.

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