Hank Greenberg's Rx For Financial Sector Reform

Last Friday's Wall Street Journal featured an editorial by Hank Greenberg, former CEO of AIG, entitled "Six Steps Toward Financial Reform."

His six steps include:

-Improve regulation and regulators
-Tie compensation to long-term performance
-Make rating agencies independent
-Allow our financial institutions to remain competitive
-Institute responsible risk-management systems
-Use stimulus money strategically

Like these sorts of recommendations by other well-known CEOs, public office-holders or academics, Greenberg's list contains some gold and some dross.

His first suggestion is rather tautological, but enduringly debatable. It's a desirable-sounding goal, but seems always to be over the horizon. One could argue, and I do, that the Fed was responsible and well-armed to have identified and stopped much of the irresponsible behavior which contributed, but did not directly, solely cause, the recent financial sector meltdown. For example, Greenberg does not mention, by name, Fannie Mae, Freddie Mac, nor the public officials responsible for fueling the unwise growth of those two agencies. Yet, that growth in low-quality, risky mortgages was the spark that touched off the fuse which caused the financial services sector explosion.

I like Greenberg's second recommendation. As long ago as the late 1990s, I wrote public pieces endorsing such policy. But which CEO or senior manager, in the heat of the moment, faced with a talented trader, or desk, will deny them short-term compensation in some new, clever, regulation-evading manner, in order to book current profits and gain market share in selected markets?

Isn't that, indeed, how we arrived at the current third-party payer health care mess? By causing businesses to evade Congressional restrictions on cash compensation during WWII?

Does any thinking person honestly believe this can be legislated and enforced?

In fact, it's debatable that Greenberg's contention,

"No one is worth a $60 million cash payment a year,"

is true.

If a talented trader or deal-maker at some financial services company is given capital to deploy, and, either through trading or astute M&A activity, engages in activities which bring cash profits to the firm, through closed trades or advice on corporate actions, in the range of hundreds of millions of dollars, who is to say that person isn't worth 5% of that value?

Greenberg's third suggestion is also problematic. Who would judge whether the employees at rating agencies have "the appropriate background and abilities?"

From my discussions with executives at one agency, it became clear that the issue was not one of competence, but opportunity and the market share power of clients.

For someone so hounded by a "government institution," I am shocked that Greenberg would offer this option to ostensibly make rating agencies non-profit in nature.

That said, the very model of client-paid ratings ought to simply cause users to beware. I remain convinced that ratings, in this era, are simply less valuable than they once were. Any investment committee relying solely, or largely, on ratings is probably already in trouble.

Perhaps the most tenuous suggestion is Greenberg's third one, implying allowing "too big to fail" institutions to continue to exist in their current forms, with current government backing. He specifically rejects the Volcker Rule. In that linked post about Volcker's recommendation, I wrote,

"The solution we need isn't more complex regulation, so much as a reasoned return to a past regulation, and better, permanent severing of the riskier finance activities from the federally-insured, mainstays of deposit-taking and basic consumer and commercial lending. "

Greenberg continues to mouth the fallacy that integrated, universal banks are somehow better, and more competitively advantaged in the marketplace.

Which integrated, globe-girding bank didn't experience trouble in 2008? Which major US financial institution didn't risk its shareholder's equity and require taxpayers to provide ultimate backstopping? The only two that come to mind, Wells Fargo and Chase, are sufficiently lackluster to begin with that they were simply too late to the risk party of 2003-2007.

What Greenberg truthfully acknowledges in his comment is that this issue ultimately leads to regulator domicile shopping. In effect, any constraints applied by the US will result in the flight of those companies wishing to be integrated banks.

I say, good riddance. Is the price I pay not having to bail them out? I'm so worried.

Because if it's financial services competitiveness you want, integrated banks aren't where you find that. Typically, that comes, initially, from privately-held monoline financial entities. Trading, asset management, underwriting, can and are all performed in non-publicly-held companies. Often by far more talented people than are left out in the poorer-paying, regulated, publicly-held part of the sector.

Greenberg's views on risk management, while laudable, are equally unenforceable as are his notions about regulation and compensation. It's well and good to call for "responsible risk-management systems."

Just what would one look like? Will ten of the same still be considered 'responsible?'

Because, according to Scott Patterson's recently-published book, The Quants, that's pretty much what happened in 2008. So much for cutting-edge risk management.

By the way, where does leverage factor into this, Hank?

Greenberg's final thought concerning government stimulus money. To me, it's unrelated to the other issues as Greenberg treats it. If he had simply railed against using it as a bailout fund, that would make sense. Instead, he wanders out of the financial sector to make unsupported assertions about economic policy.

Hank Greenberg is a very smart, tough cookie. He has unique and vast experience in the financial services sector. If someone of his stature, intellect and experience can't get this topic right, who can?

Perhaps this, alone, suggests that the solution is not more regulation, but less. End government subsidies to risk-taking entities in the form of deposit insurance. Let rating agencies be who and what they are, with users of their information aware of the conflicts and history of their ratings.

Then, ultimately, let investors bear the risk of assessing their own selections, with no recourse to the political sector for bailouts, do-overs and insurance.

That might be reform which actually brings individual responsibility in line with financial services choices.