Going back to the coalface

A return of a vibrant managerial culture where domain knowledge rules is the only way to control and prevent financial bubbles, argues Will Hopper

There is a lively debate at present about what has caused the financial crisis that led to the recession, how we can counter its effects and whether we can prevent its recurrence. Examples are to be found in Sir David Walker’s review of corporate governance in UK banks and other financial entities; a recent interview with Lord Turner in which he argues that parts of the City are “socially useless” and a lecture called The Crisis and the Policy Response, delivered earlier this year to the London School of Economics by Ben Bernanke, Chair of the Federal Reserve.

Sadly, no clear consensus emerges from these or other arguments. This is unsurprising. The authors are the very same people who were in charge of affairs in business, finance or government when the troubles began. None of them has discarded the rose-tinted spectacles through which they previously viewed the world. Walker chaired the predecessor to our current Financial Services Authority, when the great collapse was already underway. Turner is a classic British ‘Establishment’ figure – a jack of all trades and master of none who has flitted between strategic consultancy, banking and government for decades. On the other side of the Atlantic, and in his former role as Chair of the Council of Economic Advisors, Bernanke was a fervent disciple of the principal architect of the Great Recession, Alan Greenspan, who was his predecessor at the Fed.

The investment banker, Stephen Roach, whose comments on world events are usually worthy of note, has compared Bernanke’s new appointment to asking a doctor found ‘guilty of malpractice’ to prescribe a miracle cure for a dangerous disease. Is there not a case, says Roach, for choosing a new doctor? This is the right question to ask. If I was appointed as that new doctor, I would prescribe two remedies for America’s (and the world’s) economic sickness. The first would be to install an up-dated version of the kind of regulation of the banking market which existed until 1999. The second, much more difficult to achieve, would be to move heaven and earth to restore the vibrant managerial culture that prevailed across the whole of American business and society until the 1970s. It was that same culture which General Douglas MacArthur implanted in Japan under the US Occupation (1945 – 1952) and which caused an economic miracle.

BETTER REGULATION

There are serious limitations on what you can achieve by better regulation; that is because you can legislate against vice but not for virtue. (To promote virtue – in this case, good banking practices – you need a much more positive approach, along the lines discussed below.) However, within its limits, good regulation can be highly effective by preventing undesirable practices from taking root.

During what we call the Golden Age of American Management (say, from 1920 to 1970), management had been conceived of as being in the nature of a craft – something you learned ‘on the job’ under the supervision of a more experienced person.

Compare Canada with the United States from this point of view. In many senses, and in spite of possessing different currencies, these two friendly neighbours constitute a single economic area. Around the turn of the last century, having observed the huge notional profits being earned by the newly deregulated commercial-cum-investment banks of New York and London, Canada’s commercial bankers petitioned for the right to follow suit. Canada has a single regulator for its banks, the Office of the Superintendent of Financial Institutions, which said NO. As a result, there was no banking crisis north of the forty-ninth parallel. Today Canadian commercial banks are opening branches prolifically across the United States because American citizens have concluded that they are more trustworthy than the local variety.

Nor was Canada alone: for similar reasons, Australia, Spain, Italy, Brazil and India all escaped the contagion while Britain, Ireland, Switzerland and Germany did not. There was admittedly a variant of the subprime credit crisis in Spain but it affected only the savings banks or cajas de ahorro. The largest Spanish bank, Banco de Santander has emerged strengthened from the global chaos, enabling it pull some of the British government’s chestnuts from the fire by acquiring no fewer than three troubled building societies or thrifts: Abbey, Alliance & Leicester and Bradford & Bingley. At the end of 2008, Santander ranked as the third largest bank in the world in terms of profits. Good regulation works.

The Glass-Steagall Act of 1933 had separated commercial from investment banking in the United States, established the Federal Deposit Insurance Corporation and introduced other measures to control speculation. Catastrophically, certain provisions of that Act would be repealed on November 12, 1999, by means of the Gramm-Leach-Bliley Act, opening the door wide to subsequent abuses. It is urgent that Gramm-Leach-Bliley be repealed and appropriate legislation introduced in its place. Similar action should take place in Britain and other countries mentioned above.

RESTORING A SOUND BUSINESS CULTURE

The restoration of a sound managerial culture to American business (including banking) cannot be achieved by Act of Congress. However, by legislating intelligently in the regulatory field, Congress will shape the debate and define the long-term objectives of society. In this way, it can say to the world: henceforth, financial bubbles must be prevented or controlled.

There is nothing new about bubbles – indeed, Western capitalism has been characterised by a sequence of them since the early seventeenth century. All bubbles share certain features, while each exhibits its own special characteristics. Common features include rampant speculation and the abuse of debt. Debt is to business what steroids are to an athlete; it enhances performance but, unless used in moderation, at serious cost to economic health. Speculation plus increasingly reckless lending and borrowing – what the Governor of the Bank of England calls ‘casino capitalism’ – have characterized the American and British financial sectors in recent decades. The special feature defining the great bubble which burst in September 2008 was the collapse in America’s inherited organisational culture, a culture – I argue – derived from the country’s Puritan origins. I am speaking here of the whole of business and society, not just banking, but the impact of the bursting of the bubble on banking was particularly severe. Since banks lend to the rest of society, everyone suffers when they fail.

Things started to go wrong in the 1950s, when a new concept of management came into being. I myself witnessed its conception when I worked on Wall Street from 1956 to 1959. Management was being re-conceived as a ‘profession,’ like medicine or the law or dentistry.

During what we call the Golden Age of American Management (say, from 1920 to 1970), management had been conceived of as being in the nature of a craft – something you learned ‘on the job’ under the supervision of a more experienced person. At the mid-twentieth century, young graduates would join a company as junior executives straight from college. As they moved up the ladder of promotion, they would learn how to manage simply by doing. At the same time, they would absorb ‘domain knowledge’ – to use a phrase recently popularised by Jeff Immelt, the present Chairman and CEO of General Electric. Immelt has told us that all managers must possess ‘domain knowledge’. In other words, senior bankers should know an awful lot about banking; senior executives of engineering companies should know an awful lot about engineering, and so on. As he said – probably thinking of his engineer father, also an employee of General Electric – ‘the best jet engines are built by jet engine people’. It may strike the reader as odd that the most senior executive of America’s largest manufacturing company should have felt obliged to state such an obvious truth, but that is the absurd state of affairs that had come to pass in the world’s leading economy by the turn of the last century.

Things started to go wrong in the 1950s, when a new concept of management came into being. I myself witnessed its conception when I worked on Wall Street from 1956 to 1959. Management was being re-conceived as a ‘profession,’ like medicine or the law or dentistry. Instead of learning it ‘on the job’ in the traditional fashion, young men would attend a postgraduate institution and acquire a formal qualification. The implication was that you no longer needed to learn this craft in the traditional fashion, because you had been formally licensed to practise it. You could also flit from company to company or industry to industry – like the above-mentioned Lord Turner – since ‘domain knowledge’ was no longer considered to be critical. Previously, executives had moved only rarely between industries; most spent their entire careers in one company.

One of America’s greatest writers on management, Dr Peter Drucker, foresaw the danger as early as 1954. In his great book The Practice of Management he wrote:

No greater damage could be done to our economy or to our society than to attempt to ‘professionalize’ management by ‘licensing’ managers, for example, or by limiting access to management to people with a special academic degree.

Peter was a colleague and friend of mine when we worked together at W.R. Grace and Company in Hanover Square, New York at that time. Alas, Peter’s warning was disregarded. By the year 2000, over one half of American corporate chief executives were ‘professional’ managers in this sense – and I put the word ‘professional’ in inverted commas, since they were highly unprofessional in other senses of that much misused word. Worse still, in the year 2001 a ‘professional’ manager with a Harvard MBA would enter the Oval Office of the White House to take charge of us all.

How do you manage a company, if you have denied yourself the opportunity: (a) of learning the craft of management ‘on the job’; and (b) of acquiring ‘domain knowledge’ appropriate to your responsibilities? The new style of senior manager exercised control through the medium of spreadsheets and the profit and loss account. Because he focused on figures, rather than the reality that underlay those figures, he attracted to himself an ironic monicker: ‘financial engineer’. The appalling ‘target culture’, which shapes much of our lives today, was born.

My brother and I predicted the current Great Recession; we did so by projecting forward existing trends obvious to us while we were completing our book late in 2006. We added that, if there was no change in policy, we could see the US economy following the path to extended decline of the British economy in the 1960s and 1970s and of Japan in the 1990s.

By default, the possession and use of essential ‘domain knowledge’ became a function of middle and junior – not senior – management. One of the best-selling books of the period, Re-engineering the Corporation by Michael Hammer and James Champy, said so explicitly in 1993. In this way senior managers detached themselves from the ‘coalface’ of business, identifying themselves instead with the shareholders, who also did not possess ‘domain knowledge’. The outcome was intellectual arrogance and managerial incompetence on a scale inconceivable in earlier generations. Jeff Immelt, who is one of the ‘good guys’ of our book (although himself a Harvard MBA), told us, in a speech delivered at Massachusetts Institute of Technology in 2004, that he “loathed the very notion of ‘professional’ management”.

It is always a good idea to illustrate a general principle with a concrete example. Citigroup inc., until recently the largest bank in the world, was a victim of this declension. (Declension is, by the way, a favourite word among Puritans – I think it means deterioration.) For an entire generation between 1959 and 1984, the bank had been run by two highly competent commercial bankers: George S. Moore, who became president at the beginning of this period, and Walter B. Wriston, who followed suit eight years later. Moore has been described as a ‘feisty Missourian who built the biggest bank in the world’; he was well known for intuitively identifying patterns in human behaviour, once observing that the most important managerial skill was an ability to ‘recognize the same girl with different clothes’. One of Wriston’s favourite sayings was that ‘you are not a real banker until you have made a bad loan’.

Things would go tragically wrong in 1984, however, when a new-style ‘professional’ manager was appointed as chairman and chief executive in the person of John S. Reed. The possessor of no fewer than two business school degrees, he would proudly declare himself to be ‘not a banker’. On his watch in 1991, the bank would suffer a near-death experience, when it lost almost $1 billion and failed to pay an annual dividend for the first time since 1818. Crude cost-cutting followed and morale dropped, as thousands were sacked in an apparently random fashion.

Reed has been described as the kind of boss with whom no-one wished to share bad news; this meant that the flow of accurate information up a line-of-command, which lies at the heart of all good management, could not occur. When he was ousted in 2000, an opportunity existed for a new beginning; regrettably, he would be replaced by two men cast in a similar ‘professional’ mould, both of whom have since been fired – one of them, Robert Rubin, having extracted $115 million in fees. A similar series of events occurred at the Royal Bank of Scotland; I do not need to recount here the sad and amazing history of Fred the Shred. The two largest banks in the world, Citigroup and Royal Bank of Scotland, became effectively bankrupt and had to be rescued at enormous cost by American and British taxpayers.

I have said that the collapse in America’s corporate culture affected not just banking but also the rest of business and even government. Again it is a good practice to quote an example. Events at Citigroup were paralleled by similar developments at General Motors, until recently the largest manufacturer of automobiles in the world. If you do not believe me, I suggest you read an excellent corporate biography called Rude Awakening; the Rise, Fall and Struggle for Recovery of GM by Maryann Keller. An interesting aspect of that book is that it was actually published twenty years ago. In other words the rot set in at General Motors at much the same time as at Citigroup. We are dealing with a nationwide American corporate phenomenon extending back over more than thirty years, which also affected Britain and certain other countries.

My brother and I predicted the current Great Recession; we did so by projecting forward existing trends obvious to us while we were completing our book late in 2006. We added that, if there was no change in policy, we could see the US economy following the path to extended decline of the British economy in the 1960s and 1970s and of Japan in the 1990s. Japan’s so-called Lost Decade has now lasted almost twenty years and shows no sign of ending. Unless the United States addresses its basic financial and managerial problems in the ways described above, it could face a generation of economic stagnation.

Will Hopper is a Visiting Fellow and Executive in Residence at Manchester Business School

He is also Co-author of The Puritan Gift: Reclaiming the American Dream amidst Global Financial Chaos.