What can the average person do to help the economy?
—Jane Brown, St Louis
Not much that would surprise you, we’re afraid. Just hunker down and don’t panic. Recessions happen, and recessions end. The main thing people can do in the interim is live within their means. Your question, though, raises an interesting point. It was hardly average people who got the economy into its current mess.
Jack and Suzy Welch
First, there were the frighteningly overzealous—or disturbingly clueless—brokers who sold home loans to people who couldn’t afford them. Then there were those people themselves, who took the loans under the guise of too much hope, too little personal responsibility or too vague an understanding of finance, or all three.
Meanwhile, far away on Wall Street, there were the investment bankers, following on years of abundant easy money chasing fewer and fewer deals, financing ever more mediocre acquisitions that ended up not closing as credit markets dried up. And then, there was the cadre of financial engineers who really blew things up. These very un-average brainiacs, working at firms around the world, spent the past two or three years inventing increasingly complex and incomprehensible debt instruments. You’ve heard the acronyms: CDOs, CDSs, SIVs...whatever. Their names were as mysterious as their contents, a strange brew of subprime loans, genuine triple-A stuff and everything in between.
But complexity was not the problem with these instruments. Lots of innovations are complex. The problem was that these newfangled products were sold into a yield-hungry market without enough top management really understanding why or how they made money. When they weren’t making it any more, it launched a fallout that continues today with unprecedented billions of dollars of write-offs.
Now, it has been some time since individual consumers have understood all the products coming out of Wall Street. But the Wall Street leadership buying and selling such products should be expected to understand them, and our point is, we’re not sure that happened this time around. Everywhere we go, we hear experienced executives surprised by the now-revealed toxic nature of the alphabet-soup of new debt instruments. They also seemed shocked by the size of the hole they blew into the earth, and, with a few high-profile exceptions, we doubt the depth of understanding was much deeper at the companies dealing them.
Indeed, we’d speculate that managers at most firms allowed the profits to pour in—they even encouraged and rewarded those profits with huge bonuses—without being able to explain to themselves, or anyone, how all that wonderful cash was actually being earned.
Wrong? Absolutely. But you can easily imagine how it happened. When the complicated debt instruments started to debut, many top managers probably did ask how they worked, and someone who got it probably did try to explain, but both parties probably shrugged off any gap in understanding. The products were new, after all. Who knew how they would fare? Then the products started faring very well, and pretty quickly, managers just let the explanations go.
The profits spoke for themselves, and the hefty bonuses they spawned spoke even louder.
Just briefly, compare that to what happens in a conventional lending or industrial environment. When a product is released—from a leveraged lease to an Apple iPhone—managers know the business model they’re banking on. And if net income unexpectedly surges, everyone can pinpoint why by looking at what’s happening in the marketplace. Profits may not come easy, but they make sense.
In the lucrative frenzy over CDOs, CDSs, SVIs and all the like over the past few years, such old-fashioned transparency didn’t stand a chance. The financial engineers surely understood what they were creating, but their managers probably didn’t. And their managers’ managers—all the way to board level—probably didn’t either. They didn’t dig. They didn’t ask, “Who is going to finally end up owning this paper?” or “How are these products getting such good credit ratings?”
Recent history has shown us that when it comes to management and governance failures, ignorance is no defence. But we didn’t need Enron, or this current credit crunch either, for that lesson. Nor will we necessarily need all the legislation that is sure to arise from this mess.
In business, it has always been that if a profit stream seems too good to be true, it probably is, and it’s a leader’s job to get to the bottom of what’s going on. When they don’t, too many people, average and not, end up paying the price.
©2008/by NYT syndicate
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Jack and Suzy are eager to hear about your career dilemmas and challenges at work, and look forward to answering some of your questions in future columns. Jack and Suzy Welch are the authors of the international best-seller, Winning. Campaign readers can email them questions at firstname.lastname@example.org. Please include your name, occupation and city. Only select questions will be answered.