Just One Real Leader, and We Could Have Avoided This Mess

By Steven Pearlstein
Friday, December 12, 2008

I'd like to pick up where my last column left off, with the lack of leadership shown by top Wall Street executives. Their leadership failure was a big part of the story of how we got into this mess, and it continues with their stubborn refusal to take responsibility, apologize and ask for a chance to make things right.

You won't be surprised to learn that a number of executives have complained that this indictment is both too broad and too harsh. Given what was known at the time and the competitive and legal pressures that come to bear in these situations, they believe their actions and judgments were reasonable.

In a way, this is really a discussion of what leadership is about, which is something I've been thinking a lot about in recent weeks while working on the launch of a new Web site on leadership at The Post. (Shameless plug: Check it out at http://washingtonpost.com/leadership.)

One thing we know about leadership is that it rarely involves using excuses such as "All the other kids were doing it." That's only a slight oversimplification of what we've heard from the masters of the financial universe in explaining how things could have gone so wrong. The more elaborate explanation goes something like this:

"Yes, we saw that there was a deterioration in underwriting standards for loans, and yes, we understood we were taking on additional risks to our company and to the system by making lots of those loans and putting them on our books. But you have to remember that this was where the big growth in the industry was coming from. If we had refused to go along, we would have effectively put ourselves out of the game. We would have lost market share. Our profitability would have been significantly lower. Our stock price would have been hammered. We would have been crucified by analysts and the financial press, short-sellers would have begun to circle, and before long some hedge fund masquerading as an 'activist investor' would have bought a stake and begun to agitate for a change in management."

Indeed, that probably is the fate that would have befallen any Wall Street executive who refused to jump into the market for riskier loans -- but only if he had also done nothing to change the competitive environment. And that's where leadership comes in. Because real business leaders don't just sit there and accept a competitive dynamic, let alone a dysfunctional one that is likely to result in a bad outcome for everyone. They figure out a way to change that dynamic. Unfortunately, the Wall Street crew didn't even try.

What could they have done?

For starters, just one of them could have shown up at one of those closely watched investor conferences and stolen the show by giving a strong speech declaring that things were getting out of hand, that the competitive drive for fees had warped loan underwriting standards and created a credit bubble that would eventually burst and threaten the entire industry. He could have announced that his own company had already sold off most of its risky loans and, going forward, would stay away from risky lending. And he could wind up by acknowledging that this strategy would probably result in lower profits and lost market share in the short run but a better and safer return in the long run. Shareholders who found that unacceptable could be invited to move their money elsewhere.

A clever leader wouldn't stop there, however. His next stop would be in Washington, where, armed with charts and graphs and compelling anecdotes, he would warn regulators about the race to the bottom in underwriting standards in the industry. Then he would head for the editorial offices of respected news organizations, where he would make the same presentation and offer help to journalists interested in digging further.

Let me assure you that if any top Wall Street executive had done that in early 2006, when the credit mania was in full swing, he would have infuriated almost everyone in the industry, from lordly chief executives and investment bankers to the most small-town mortgage and real estate brokers. It would have embarrassed and annoyed the regulators, who like people to think they have everything under control when, in reality, they don't. It would have sent industry analysts rushing to issue sell recommendations and sent the company's stock price into a tailspin. And, of course, it would have delighted journalists.

Then a funny thing would have happened. A week or so later, another thoughtful chief executive at his regular senior staff meeting would have declared that the competitor was right about much of what he had said and ordered them to begin quietly pulling back. The head of a rating agency would have summoned the head of the mortgage-backed division and ordered up a more thorough review of some recent issues of mortgage-backed securities. A powerful congressman would have picked up the phone and called the comptroller of the currency and asked him what he planned to do about these worrisome allegations. And the system would have begun to correct itself, with the biggest benefit going to company that first broke from the pack.

Naive? I don't think so. The fact that we now all shake our heads and say, "What were they thinking?" when we hear of those all-leverage corporate buyouts or subprime mortgages made without income verification -- that's a pretty good indication that it wouldn't have taken much to bring the world to its senses. As the fairy tale reminds, all it takes is a question from a simple child to make everyone see that the emperor has no clothes.

On Wall Street, however, there were no leaders willing to end the self-delusion and call the credit bubble for what it really was. Rather than tell the truth and have faith in people to do the right thing, they cynically played along in a dangerous game that eventually cost employees their jobs, investors their savings and customers their financing. It should hardly be a surprise that those employees, those investors and those customers are now eager to return the favor.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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