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Not Quite a Confession, But a Good Start

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By Steven Pearlstein
Wednesday, April 8, 2009

For the past year, as the nation has engaged in a heated debate about how we got into the current financial mess and how we're going to get out of it, there's been one group noticeably missing from the conversation: leaders of the big Wall Street firms.

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With the exception of the occasional public floggings organized by congressional committees and the quiet off-the-record lunches with newspaper editorial boards, the titans of finance have remained hunkered down in their bunkers. In public, at least, they have declined to accept personal and institutional responsibility for what went wrong, to explain more fully how and why it happened or even to express a simple thank you for the government's extraordinary rescue efforts. At a time when it was most needed, industry leadership has been nonexistent.

Until now. In a speech yesterday in Washington to the Council of Institutional Investors, Lloyd Blankfein, the chairman of Goldman Sachs, took the first trip through the public confessional, acknowledging that "the past year has been deeply humbling" for an industry that held itself out as expert but disappointed customers and shareholders by taking actions that "look self-serving and greedy in hindsight."

"We collectively neglected to raise enough questions about whether some of the trends and practices that became commonplace really served the public's long-term interests," said Blankfein, whose unflashy, straightforward style is more Mr. Whipple than Gordon Gekko.

Explaining why the industry failed to understand the risks it was taking, Blankfein identified the kinds of rationalizations that people latched on to: the growing strength of emerging markets, the plentiful supply of liquidity and the availability of new risk-hedging instruments.

"We rationalized because our self-interest in preserving and growing our market share, as competitors, sometimes blinds us -- especially when exuberance is at its peak," Blankfein said.

He also acknowledged that too much faith was put in risk models that turned out to be badly flawed and that the size of the firms and the complexity of the financial instruments had been allowed to grow faster than the "operational capacity to manage them."

To make sure it doesn't happen again, Blankfein called for stepped-up regulation of banks and even hedge funds. He also laid out a spot-on set of guidelines for industry bonuses that would give greater weight to the performance of the entire firm than just individual performance and reflect long-term risks as well as the short-term gains.

Okay, so it's not exactly up there with the confessions of St. Augustine, but it's a start.

There are some glaring factors, however, that Blankfein, like other Wall Street leaders, tends to overlook.

The most important is culture -- in the case of Wall Street, a culture that not only tolerates but almost celebrates taking advantage of customers. Here is an industry in which brokers traditionally get their start making cold calls to strangers, offering bogus stock tips, and investment bankers cut their teeth peddling bad merger and acquisition ideas to corporate clients. It is an industry in which the majority of money managers consistently underperform the broad market averages, analysts and strategists are almost always bullish, and firms rarely run into a security that can't be brought to market. These days, Wall Street is a place where the trading culture has supplanted the investment culture and score is kept on the basis of how many securities a banker or a firm underwrites rather than whether those securities actually turn out as good investments.

It's hard for anyone who grows up in an industry to see fundamental problems in its culture. But until Wall Street deals with this blind spot, it is likely to careen from one crisis to another.

Blankfein also makes the common mistake to think that the problem with compensation has only to do with how the pay is structured and not with the overall level of pay, which on Wall Street got to be ridiculously out of line with that of similarly skilled and equally successful people in other industries. No matter how it is structured, pay at such astronomical levels has a tendency to swell heads, inflate egos and tempt people to take undue risks of all sorts, ethical as well as financial.

The answer to that problem isn't for Congress to use the tax code to effectively legislate pay caps for Wall Street. In the current climate, however, the only way to beat back such bad ideas is to find some other ways of stopping and reversing the Wall Street arms race on pay.

Of course, an industry that earns so much profit that it can afford to pay multimillion-dollar bonuses to 26-year-old traders also has too much money to lavish on the political process in ways that undermine those who would regulate it. I wouldn't go as far as MIT economist Simon Johnson, who argues in the May Atlantic magazine that the United States has effectively become a banana republic with the Wall Street oligarchy running the show. What is undeniable, however, is that there are regulators here in Washington who have been reluctant to rein in the industry out of fear that they would be thwarted by the White House, the Treasury and key members of Congress acting under pressure from the industry.

It's all well and good for the Goldman Sachs chairman to call for better regulation of the financial industry. But regulators are unlikely to do much better during the next bubble unless we can find better ways to insulate them from Wall Street's outsize political influence.


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