Saturday, January 26, 2013

WaMu-ellujah! Forgetfulness and greed

The failure of Washington Mutual, and a new paradigm of corporate responsibility.

A blurb on the back of "The Lost Bank", by Kirsten Grind, calls it "entertaining". If having your teeth pulled is entertaining ... perhaps. It is tragedy of a classic sort, except that the main protagonist (the CEO) rides off rich as sin, leaving behind a landscape of smoldering properties, empty bank accounts, and angry mobs.

Washington Mutual began as a well-loved local bank of the northwest, focusing on customer service. It barely survived the S&L crisis, but thrived thereafter, buying up like-minded banks and integrating them into its low-key, family-oriented atmosphere. The key transition during this era was from a beloved CEO, Lou Pepper, to Kerry Killinger, a more MBA-style, somewhat inscrutable, and socially awkward banker. It turned out that he had enormous ambition and energy, however, and drove the bank to new heights of acquisition, all based on its retail banking prowess, honed through many years of takeovers and careful back-office integration.

Eventually, the company outgrew its small town values, became the sixth-largest bank in the US, hosted blowout parties featuring such inspirational messages as WaMu-ellujah! Along the way, the company acquired mysterious loan issuers in Southern California that reaped ever-increasing profits, while keeping the details murky. For a bank, loans equal assets. This means that if customers can be convinced to take out loans far beyond their ability to pay, the loan is, at least in the short term, booked as a higher asset for the bank.

Washington Mutual spent a long time torn between its addiction to these profits, and its underwriting standards, which gradually fell by the board. Risk officers came and went like ghosts in the night. Killinger became a rock star, by the standards of the business press, at least. As S&L crisis veteran Bill Black explains with regularity, the easiest way to rob a bank is to own one and run a control fraud on it. The money is guaranteed. (Short term, at least.)

The question that the author does not address is the most difficult one- how much of this was conscious, and how much unconscious? How much was the bubbly atmosphere where collapsing house prices were inconceivable, real estate assessors were bullied into marking to the desired price rather than to value, ratings agencies colluded with their bank customers to mark toilet paper as AAA, and real estate bundled-security investors trusted that someone else was minding the store?

Or how much was a conscious decision by Killinger and his lieutenants to throw the core banking concept of underwriting standards into the circular file and let the money roll in? How much was the negligence of auditors, investors, regulators, analysts, and journalists to connect the flow of profits to the sewer of underwriting that Washington Mutual was tending in secret?

We are not told, and it might take a psychoanalyst to address properly. In any case, we have heard a great deal about "moral hazard", a concept that applies here in spades. The institution of Washington Mutual was destroyed, absorbed into the ever-growing colossus of JPMorgan. But the executives responsible for all the bad decisions and betrayed standards and trusts ... they kept their loot and retired in comfort.

This is a problem- that corporations and their officers pay insufficient attention to the long term. Only corporations that thumb their noses at conventional business advice and analyst pressures (think Apple) have an inner culture strong enough to ignore the short term temptations and to focus on the long-term. The default criterion is the quarterly earnings, by which executives live and die, and get the bonuses and options whose time horizon is a few years at most. Take the money and run has become the normal way of business in the US, and it is damaging not only in rare crises, but in broader cultural terms.

Washington Mutual was mainlining the drug of greed- raking in money from its shady lending operations, and getting patted on the back in the bargain for extending credit to previously underserved communities(!) Internal risk assessment was subverted, long-standing cultural norms over-ridden. The regulatory establishment likewise lost its mind, likewise captured by criminal amnesia (especially considering the S&L crisis had blown through less than two decades before) and subject to the same Minsky cycle of forgetfulness as the bankers.

What to do? I think the answer is to create a societal mechanism to extend clawbacks deep into the ill-gotten gains of the executives and others profiting from this kind of toxic, antisocial activity. We need to think beyond simple criminal accountability. Corporations are organized to have limited liability. And as far as shareholders, that is perfectly fine. They takes their risks, and they gets their rewards. But when it comes to the general public interest, no such liability protection is appropriate. If corporations are to be people, they can not be immune from basic duties to the public interest, especially in view of their vastly expanded influence on that public interest, relative to the scope available to an individual citizen, due to their size and organization.

Just as lawyers are deemed officers of the court, and are held to some professional standards that go beyond fulfilling the letter of the law, corporate executives should be deemed officers of the state, with extra duties and liabilities that extend beyond the letter of the law. Prime among them would be general and long-term liability for all their gains beyond a base salary of perhaps the median for their company. All other monies would be subject to long-term review and surrender based on legislative findings of culpable irresponsibility and harm to the public good.

Now, all businesses are in the more or less culpable in cutting corners, transforming public goods into private gains, imparing markets, and the like. This proposal wouldn't be aimed at typical businesses. On the other hand, there are many corporate endeavors that are socially positive but are not sufficiently rewarded in the market. Those who invent the lasers, microchips, diagnostic tests, and other great things do not always get their due, and might be beneficiaries of some of the funds gathered from the malefactors held to account by the above process.

Obviously, this is a highly problematic type of proposal. Now that corruption is standard practice in the revolving door between business and government, how could we possibly expect this nakedly political process to work any better than the criminal process that has already so obviously failed to bring financial criminals to account? Would this new process of accountability not skirt the protections of the rule of law and lead to hyper-political battles that leave the country even more corrupt, and well-connected but disastrous businessmen even better off than before?

I do not have good answers. All I know that it is fundamentally unjust and wrong to see someone like Mr. Killinger hide his ill-gotten gains behind a curtain of legalism, when the whole idea of law is to create a just society, and the whole idea of business is to render people useful to each other, not only for a New York minute, but over the long term.

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