In The Lords of strategy veteran journalist and editor Walter Kiechel recounts the birth and evolution of strategy, and the trials and triumphs of the “surprising disruptors who invented it”. They tell the story of the economy, and the reason the strategists didn’t quite succeed when it came to the global financial crisis. An edited excerpt from the chapter And Where Was Strategy when the Global Financial System Collapsed?
The Lords of Strategy: Walter Kiechel III, Harvard Business Press, 347 pages, Rs 995
Spreading the Obloquy Around
To hear strategy consultants tell the story, though, it wasn’t expansion or the more conventional forms of innovation that were the proximate cause of the ?nancial system’s collapse. Like many commentators, BCG’s Philip Evans traces the origins of the crisis back to “global imbalances,” mostly the US trade de?cits that resulted in a vast pool of dollars sloshing around—think of all those Asian countries that, after their own ?nancial crisis in 1997, insisted on holding their reserves in US Treasury securities. After the bursting of the dot-com balloon in 2000, housing became one of the few industries holding out the allure of big money to be made fast, and the Federal Reserve helped the party along. Wanting to spur the recovery, it lowered interest rates from the 6.5% that prevailed in May 2000 down to 1.75% in December 2001. Housing boomed: prices of existing homes rose, construction abounded, and owners borrowed against their rising asset values and spent the cash.
Meanwhile, the deregulation of ?nancial markets, and especially the 1999 repeal of the Glass-Steagall Act, permitted a wave of mergers whereby banks, investment banks, and insurance companies piled into each other’s traditional markets. The question of which agency was going to regulate which business became less clear—why not shop around for the most agreeable overseer, or just yard back the regulation and let the free market work its magic? All of which made it easier for the great ?nancial minds devising products to sell to investors eager for higher returns than the pitiable rates available from, say, plain old bonds in the low-interest rate milieu. How about a nice mortgage-backed security, maybe repackaged into a collateralized debt obligation? Or a credit default swap? By 2007, there had grown up a shadow banking system, mostly beyond the regulatory sunshine illuminating the traditional system, with about $60 trillion in assets—at least on paper—some four times the size of the US gross domestic product.
Selling tactics: Strategy seemed to have disappeared during the crisis
Liberal amounts of gasoline were poured on this con?agration waiting for a match by the combination of ultimately dysfunctional incentives and what Evans labels the “stupidity of bankers” (though surely not any of BCG’s banker clients). Since the mortgages the lenders originated were to be promptly sold off and securitized, the friendly folks at your local mortgage-lending company had every incentive to make as many loans as possible and almost none to worry about whether those loans would eventually be paid back. The ?nancial geniuses on Wall Street and in London inventing derivatives of ever greater complexity were paid their enormous bonuses according to contributions to this year’s pro?ts, not on how what they were selling inured to the long-term bene?t—or detriment—of their employer.
In September 2008, the wheels began to fall off the juggernaut: the abysmal quality of many subprime mortgages became manifest. The housing market, already in decline, tanked. Firms holding securities based on the mortgages failed (Lehman Brothers) or had to be rescued by the government. Stock markets crashed around the world. The enormity of the counterparty risk entailed in AIG’s credit-default business came to light, along with AIG’s inability to pay off on its obligations. Credit markets seized up; even worthy borrowers were unable to get loans. The economies of major nations plunged into recession, or deeper into recessions already under way.
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