RE: The Financial Crisis 2. May 2009

Excepts from Chapter 20. "The Realm of Economy: A Search for Riches" in Hans L Zetterberg's forthcoming book The Many-Splendored Society.

Bitter Lessons

Composition and Staffing of Corporate Boards

Corporations are run by a leadership that includes a Chief Executive and a Corporate Board. A modern board has members who represent shareholders as well as members from the outside society.

An ideal corporate board should have creative and constructive members who are totally committed to look out for their corporation and not for themselves, members who make an effort to know the situation of their corporation and its branch. The ideal board may include someone knowledgeable in business history who can see when old stupidities are revived. Corporate boards may also have use for some skeptic from “the school of hard knocks,” (or from science or journalism) who can reveal argumentation which is more persuasive than sound. Also, a board needs members who are totally unimpressed by well-known persons from firms that have made much money on upticks when they think that they are competent to handle any downturn or off-beat situation. Consider also in recruitments to a board what a difference ethically responsible people can make to the quality of board decisions, be these persons morally gifted by nature, or persons who have struggled enough with issues of honor to become moral virtuosos. But such a member should not be put there for his or her PR-value. Lehman Brothers had apparently little moral help from a board member who was a former head of The Red Cross.

Recent events tell that corporate boards ought to have a member or two who understand politics to the extent that they can grasp the consequences of misguided bipartisan efforts to promote home ownership. One can also imagine what difference it would have made during the build-up to the 2008 financial crisis to have had a board with a member with enough mathematical skill to analyze a derivative equation and put reports and promises by salesmen of derivative bonds to task.

When all is said and done, there is no substitute for a board member’s good judgment. The good board member is not bound by prestige: If you do not know, you can ask. Any board member of a financial institution in Switzerland or elsewhere could have asked about the risks of American derivative housing bonds when the proposal of acquisition of such securities reached their board for final approval. When told that the risk had been calculated both by the issuer and the rating agencies by David X. Li's “Gaussian copula function,” the board member could have asked about this formula. The answer would be that this formula in one and the same number summarizes all risks for the security. Yes, the same number for risks in both upturns and downturns. Yes, the same number for the risk assessment of these bonds is valid both when the prices in various local markets are different and when they rise or decline in the entire USA. The inquiring board member should then have had little difficulty in concluding that his institution was dealing with a charlatan.

Such a board member did not exist in reality. Any ideal recruitment to corporate boards is blocked by a special criterion for new recruitments to a typical board. It is considered essential that the candidates are reliable and trusted by the other board members. The candidates are simply not chosen if they question the extraordinary compensation packages that prevail for the leadership in modern corporations.

Fortune Creating Circles

A swindling process that became highly visible in the United States about a half century ago has spread to other capitalist countries. Though a process of institutional evasion of norms it has become widely acceptable and is considered normal. The boards of the larger corporations and their chief executives have constituted themselves as an informal Fortune Creating Circle that anoints (i.e. installs and blesses) their members with fortunes. These fortunes are built by regular honoraria and salaries, perks of many kinds, year-end and departure bonuses, stock options, pensions, and/or anything else that may fit compensation packages.

In recruitment processes to the top, the issue is always raised: “Can we trust him (her)?” This query may be a code for several things; it always includes, explicitly or implicitly, the candidate’s loyalty to the general level of compensation and its annual raises current within the Fortune Creating Circle. In early capitalism you had to be the owner-entrepreneur to reach high fortunes. In mature capitalism it is enough to be top management and/or a board-member.

Critics call the Fortune Creating Circle “a culture of greed.” It is interesting to note that government officials who are set to run socialized enterprises are rapidly drawn into its reward system. The same seems to be true when official from labor unions join the boards and participate in the setting up of compensation packages for executives and fellow board members.

Money has long has been a universal unit of exchange in everyday life for individuals, households and organizations also in the realms of polity, science, art, religion, and welfare. People active in science, the body politic, art, religion, and welfare are rewarded both by title and honor and by money. In business there are few honorific rewards, and the reward system is in effect based on money and money alone. Government officials, scientists, artists, priests, and welfare executives have total rewards that consist much less than 100 percent of sheer money; the balance is honor. When rewards in the economy being practically 100 percent money are compared to rewards in the non-economic realms, a sense of resentment is close at hand. We can, for example, expect much public anger directed at extensive “compensation packages” for top management in those modern societies in which politicians and union representatives have destroyed the honorific reward systems in the name of equality.

In early capitalism you had to be the owner-entrepreneur to reach high fortunes. In the mature capitalism it is enough to be top management and/or board-member. 

The MBAs

Is securitization of derivatives a swindle or just financial inventiveness? Joseph Stiglitz, professor of economics at Columbia University, had his view formulated at the beginning of the bank crash of 2008 when on October 21 he told a congressional committee, that this "securitization was based on the premise that a fool was born every minute. Globalization meant that there was a global landscape on which they could search for those fools — and they found them everywhere."

Most of these fools born every minute have birth certificates in the form of MBA-degrees from business schools. After the turn of the century there has emerged an unfortunate, Harvard-inspired conformity in curriculum and attitudes of the business schools and their student bodies. Business school graduates the world over were given unrealistic birth rights to expect excessive compensation packages. But the main problem with these schools is wider.

The MBA-degree should be considered de-meriting until the business schools learn, not only to better separate swindling from wealth creation, but learn to better see business and economy as a part of a total society in which other societal realms are their equals. To get rich in business is not anything superior to the holding of political office, to have scholarly competence, to deliver artistic beauty, or to carry sacredness or virtue to your community in the course of every-day living.