A little update on what I have been up to and what happens now...

You may have noticed that things have been a little quiet on APEsphere these last couple of months. I am now able to explain why.

It has long been my view that the global financial crisis is the single biggest responsible business issue of the decade. Yes, even bigger than climate change, because thanks to the global financial crisis efforts to address climate change have been badly set back.

While regulatory reform - specifically a reversal of the deregulatory fervor fo the last thirty years - is clearly needed, what strikes me is the way we talk about the crisis in such abstract terms. It is so standard to talk about what the markets did, or even "the banks", and to talk in aggregate terms about unemployment, foreclosure, bankruptcy.

Of course, those statistics are always worth repeating:

• an increase in the number of people around the world in chronic hunger and poverty by over 100 million, to 1.02 billion;
• between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists;
• an increase in global unemployment by between 29 million and 59 million people;
• one in eight US mortgage borrowers is behind on mortgage payments or facing foreclosure at the end of the second quarter 2009;
• pensioners relying on developed country stock market returns for their retirement incomes have seen their savings fall by 45%.

Not to mention the fact that the crisis is associated with a sharp uptick in mental health problems and suicide rates, children being pulled out of schools and put to work, increases in human trafficking, social unrest and violent conflict.

But all this talk of aggregates repeats part of the problem that got us into this mess in the first place. Aggregates create emotional distance. They enable us to forget that the crisis both impacts and was brought about by individuals.

So Kelsey Timmerman and I are about to set out on a journey to tell some of the personal stories behind the numbers - our very own Financial Crisis Inquiry Commission. Our blog, NOTHING P€R$ONAL, will be the main means by which we keep readers updated on our travels, though I will also post some of those stories here on APEsphere.

Kelsey has penned the first post here, explaining why this project is so personal. You can also join the conversation through our twitter stream @0_personal.

If coverage of the financial crisis seems to you to be missing something important, we hope this blog will fill the void. Enjoy.

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The US Federal Deposit Insurance Corporation that insures US bank deposits is considering billing banks more if they incentivize higher risks.

The FDIC maintains a fund to pay out in the event that depositors lose money frrom the failure of a bank. All insured banks pay into the fund. Banks that according to regulatory assessments incentivize staff to take higher risks are more likely to have such risks materialize. So, the FDIC argues, why not get them to pay higher contributions into the insurance fund. Sounds logical to me.

But lets round this out. We could use a basket of indicators to determine contribution levels, including not just pay plan riskiness but also lobbying spend which is highly correlated with risky lending behaviour.

And rather than just use this for assessing contributions to the FDIC - which are not enormous in the great scheme of things - why not tie bank capital requirements to these factors too?

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The International Monetary Fund is not known for random assaults on the financial establishment.

This makes the results of a new IMF study - A Fistfull of Dollars: Lobbying and the Financial Crisis -  all the more compelling. Large US banks that spend heavily on lobbying are more likely to engage in high-risk lending, and their shares perform less well. The UK's Guardian newspaper notes that finance sector lobbying outstripped all other sectors.

It is 8 days until the Financial Crisis Inquiry Commission begin to take testimony from top bankers. Their lobbying activities should provide one of the core, and still current, seams of questioning.

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In 9 days time the US Financial Crisis Inquiry Commission begins hearing what senior bankers have to say about the causes of the crisis.

I will be keeping a close eye on the Commission’s work and posting background and analysis here on the APEsphere blog. Let me explain why.

The FCIC in a nutshell

Phil Angelides (pictured above), the man appointed to chair the commission, last September defined the FCIC’s mission as being “to conduct a full and fair investigation in the best interests of the nation—pursuing the truth, uncovering the facts, and providing an unbiased, historical accounting of what brought our financial system and our economy to its knees.”

The Commission’s 10 members — six chosen by Democrats, 4 by Republicans – have until December to report back to Congress. They have the power to subpoena witnesses, and to refer individuals for criminal investigation and prosecution.

Who cares?

The Commission is investigating the worst financial crisis since the Great Depression. The Global Financial Crisis (GFC) has produced a longer term Global Economic Crisis that has impacted the everyday lives of real people around the world to an extraordinarily severe degree:

• it has increased the number of people around the world in chronic hunger and poverty by over 100 million, to 1.02 billion;
• widespread conflict and state fragility is being anticipated and has already begun to be realised;
• between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists;
• the crisis has undermined the will to make progress on combating climate change, thus contributing to the ecological, social and political risks associated with that phenomenon. Earlier predictions that the recession would reduce emissions have proved ill-founded;
• an increase in global unemployment by between 29 million and 59 million people;
• one in eight US mortgage borrowers is behind on mortgage payments or facing foreclosure at the end of the second quarter 2009;
• pensioners relying on developed country stock market returns for their retirement incomes have seen their savings fall by 45%. The links between the crisis and retirement incomes are explained here.

No wonder countries are marking an upward trend in stress-related mental illness and crime.

What could this Commission achieve?

We want to ensure that this crisis cannot be repeated. A thorough public investigation of the causes can help channel anger into the political will to undertake effective regulatory reform, including the dismantling of powerful institutions known to be “too big to fail”. While regulatory reform is already underway in Washington and elsewhere, further and more profound reform is a potential outcome of this Commission’s work.

The committee set up in 1934 to investigate the causes of the 1929 crash and the Great Depression that followed it signals what is possible. Once Ferdinand Pecora became the committee’s lead investigator and began cross-examining Wall Street’s leaders the ground was laid for reforms that included the establishment of the Securities and Exchange Commission and the Glass-Steagall Act that separated staid commercial banking from risk-fuelled investment banking – reforms that kept Wall Street out of systemic trouble for forty years.

But the FCIC could achieve much more than this, and needs to do so.

When South Africa emerged from apartheid, a Truth and Reconciliation Commission was established to consign to history the egregious, state-supported human rights violations that were committed against a large section of its people.

In 1995, after decades of the systematic abuse of economic, social and political rights known as apartheid, the South African government set up a Truth and Reconciliation Commission to give ordinary people an opportunity to air their grievances against a system that institutionalized racial segregation and discrimination in all aspects of life.

According to the then Minister of Justice Dullah Omar, "... a commission is a necessary exercise to enable South Africans to come to terms with their past on a morally accepted basis and to advance the cause of reconciliation."

The TRC was a forum in which anyone who felt that he or she was a victim of the system could be heard. Those on both sides who had done wrong could also give testimony and request amnesty.
Now, political establishments around the world have been shown to have placed the interests of a powerful financial minority above those of the majority.

Dead babies will never learn to speak, and how do you give voice to the 100 million starving? But what the FCIC can do is provide public, open and free discussion of the causes of the crisis, confront those responsible with those they have impacted, raise the question of prosecution and possible amnesty rather than assume as now a cosy settlement between corporations and regulators.

How else do governments and financial institutions expect the results of egregious risk taking at great cost to communities and individuals to be put behind us? How else will they lay to rest the cynicism, mistrust of institutions and raw anger that that behaviour has garnered?
 

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It is certainly an ambitious exercise, looking at estimated carbon emissions, company environmental policies and reputation perceptions.

Newsweek defends its methodology on the customary point of criticism: how can you compare a utility, say, with a bank? They point out that over 50% of the score relates to the strength of green policies (which anyone can implement) and reputation, all of which evens out the score somewhat.

I would add that there is no problem comparing high emitting industries with low emitting industries and finding that there is a cluster of high emitters near the bottom of the ranking. That is how it should be. Dirty industries should appear as they are. This table is not a ranking of overall social utility but of environmental credentials. If a cluster of oil extraction companies appeared in the top 100 it would be more than suspect; it would be incredible.

A particular concern I had was whether indirect impacts were adequately taken into account. Financial services have small direct footprints, but are the ultimate dirty industry in that they choose to finance all the others. The analysis of green policies brings this factor into the equation but a lack of transparency about the carbon impact of their loan and investment portfolios reduces the quality of analysis. For me this is a more worrying weak spot than the ranking's validity in comparing companies across different sectors.

One last observation: it is great to see that Newsweek used the extensive experience of two firms whose founders I have had the pleasure to meet: Peter Kinder's KLD Analytics and Paul Scott's CorporateRegister.com. Great to see such high caliber teams involved in producing the detail of something this high profile. Well done both.

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A Newsweek article argues the new Financial Crisis Inquiry Commission should play the role I was advocating for a truth and reconciliation commission to bring daylight and justice to the events leading to the financial crisis.

Michael Hirsh argues:

we don't necessarily need a parade of Wall Streeters headed to the Big House. What we do need, however, is a parade of witnesses who will provide what's been missing so far in this crisis—a prominent outlet for public outrage. In the last nine months, the Obama administration and the grandees in Congress have been designing solutions without much input from the outside, often using experts from Wall Street (especially "Government Sachs"). It's pretty much been a closed system.

Like I said, we need some public, inclusive, truth and reconciliation.

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Having spent a few years as a compliance professional in the financial sector, I was intrigued to read about the detail of the Pfizer settlement.

The drug company Pfizer, you'll recall, has just settled with the US Department of Justice for a total financial penalty of $2.3 billion - the largest ever. The allegations against Pfizer concerned illegal marketing of painkiller Bextra and several other drugs.

What did not come through in the original reports was that in one part of the settlement, the inspector general  of the US Department of Health and Human Services  (HHS) required Pfizer to change the reporting line of the company's compliance department from the General Counsel to the Chief Executive. 

In-house compliance professionals are often in a bit of a bind. They are supposed to advise the business on how it needs to conduct itself if it is to remain within the letter of the regulations. Their reporting line, however, is often to someone with a strong personal interest in the short-term financial success of the business development to which the advice relates. Although compliance departments inevitably attract the label of "business prevention", their reporting lines (and remuneration and retention prospects) in fact incentivise them to bend over backward to accommodate the concerns of their superior. So much for independence.

In Pfizer's case compliance reported to the general counsel. As Lewis Morris, general counsel for the inspector-general's office put it:

"The lawyers tell you whether you can do something, and compliance tells you whether you should ... We think upper management should hear both arguments."

If that is what the lawyers are there to do, then they will be rewarded on the basis of their overall contribution to business development. Compliance reporting into that setup risk ending up singing the same tune, or leaving.

I predict regulators will become more prescriptive about the precise reporting lines of compliance professionals. I am not sure, though, that instituting a reporting line to the chief executive is the most effective course though. Although the CEO has a group-wide interest and won't want the actions of a particular division to threaten the overall reputation of the group, the CEO is still guided by short-term financial incentives. A better solution might be a reporting line into the audit committee of the board, which should be majority comprised of independent non-executives.

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Just premiered in Venice...

UPDATE: The Guardian's review is here.

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Mixed news on the battle brewing over bankers' bonuses.

European finance ministers (with the UK taking a back seat) are coming out strong on curbing banking bonuses.

This I get. Dealing with the excessive (arguably unbounded) risk taking that super-high bonuses encourages, and the crises such excessive risk-taking produce, finding a way of reining in the expectation of high bonuses for excessive risk-taking seems like the only way to ensure the recurrence of such a damaging crisis is avoided.

On the other hand there is something very disturbing about the recently announced French approach: curtailing the bonus upside but also punishing traders for any substantial hit suffered by the bank.

This seems to me merely to raise the stakes - a contributor to the adrenalin fueled environment that leads to excessive risk-taking in the first place.

The French, of course, are feeling somewhat bruised by the whole Kerviel affair in January 2008 when national financial champion Societe Generale was hit with  a 4.9 billion euros ($7 billion) loss due to what the bank maintains was unauthorised trading by Mr Kerviel. The preferred narrative in France is that the bank's systems and controls (including remuneration culture and policies) were not at fault; this was a simple case of a rogue trader. So punishing the trader when the bet goes the wrong way helps reinforce that narrative.

But surely it is better to address the up front incentive for unbridled risk-taking rather than pull your punches in favor of creating stiff personal consequences for the failure of the bet? Rogue traders already know that if the bet goes wrong they stand to lose their jobs and their lifestyles, but "rogue" traders (ie those produced by the prevalent bonus culture) show again and again that they never imagine they will fail, that the bet will go against them.

It is the size of the potential upside that motivates their actions and that is where serious politicians and regulators should focus their attention.

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Was the chairman of the UK's financial watchdog just trying to impress concervatives when he expressed support for a tax on foreign exchange deals?

Development charities are delighted. And why wouldn't they be? The global economic crisis rooted in excessive risk-taking (rooted in remuneration policies that rewarded it) is estimated to have caused some 100 million down to the level of extreme hunger.

Personally I wonder whether a Truth and Reconciliation Commission could help bring some measure of justice by bringing together victims of the crisis perpetrators.

But a Tobin tax on currency transactions could help remedy the material impacts of the crisis rather than simply the emotional and cultural. It is argued that the tax brought in could be used to finance economic development for those who have suffered at the hands of the finance industry.

Lord Turner went on to comment that the UK's financial sector has "grown beyond a socially reasonable size". Hardly seems like posturing towards a future Conservative government to me; more like a note of sense from someone who is not only close to the action as a regulator now, but has himself been a business leader.

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