Weekend Read-Interview with Vincent Mai03-16-2012
This interview is taken from the upcoming book of essays, 'The Intellectual Origins of the Financial Crisis' originating from the 2009 Hannah Arendt Center Conference.
Roger Berkowitz Interviews Vincent Mai
Roger Berkowitz: When you heard from a friend that the Arendt Center was organizing this conference, you made it known you had strong opinions about the intellectual origins of the financial crisis. I appreciate your making time for this discussion. First I’d like to start just by having you tell me a little bit about your background in business, and how that affects your perspective on the financial crisis that we’ve just been going through.
Vincent Mai: I grew up in South Africa on a farm in the Eastern Cape, a far cry from the financial community in New York. I had the very good fortune when I left South Africa, which I did in the sixties, to go to London, and started my career working for an extraordinary man, a great man, Sir Siegmund Warburg, the founder of S. G. Warburg & Co. There happens to be a biography just on the newsstands right now of Sir Siegmund by Niall Ferguson.
Now, the essence of this man – and it’s all relevant to what defined my approach – was just a passionate view that your reputation was everything and that your reputation was governed by the quality of the advice you gave to people, and the correctness of your advice. He saw himself as the family doctor for companies around the world. And money was secondary. You were in it for the intellectual satisfaction, for your reputation, for doing good, and, you made money, but that wasn’t the prime objective—and that’s a big theme when one reads this book.
Then I came to the United States, I eventually became a partner in Lehman Brothers. Now this was Lehman in the old days when firms were private, when it was a partnership, and it wasn’t all that long ago, 25 years ago. My thinking was very much shaped by the fact that you were a partner in a prestigious firm, your name was everything, your reputation was everything, but your capital, your own personal capital was at risk for everything, and consequently the decisions that were taken about day to day operating things really, really mattered. But your reputation above all mattered.
I don’t mean that everybody was a saint and today they’re all sinners. Far from it. But there was a set of ground rules that governed the way you did business which imposed a discipline which was central to the way Wall Street worked. It was the same in all the firms. And I’ve watched with a combination of fascination and horror at the way the world has changed, turned upside down.
Roger Berkowitz: The next question then would be how has the world turned upside down, the financial world?
Vincent Mai: Well I think, the first thing is just a complete change in the values of the people who are in the financial community in Wall Street, and in the culture. And as I said, it’s not to say that the people in my era were all angels and they’re all devils today. But, having said that, there has been a huge cultural shift which has been driven by several things. The growth of the trading side of the business, the addition to the complexity with these opaque and synthetic instruments which nobody really understands, the technology driven dimensions of the business today, all contributed to an evolving culture of going in there and trying to make as much money as you can. And where reputation, putting your name on a prospectus—is not quite the sacred thing that it was before all these publicly-owned behemoths were created.
I’ll give you a little example of how things have changed. An old friend of mine, I won’t mention his name, used to be a partner of mine at Kuhn, Loeb, was on the Commitments Committee of Lehman Brothers—this was before the collapse. I was having lunch with him, and he was telling me that the Committee has to approve all the deals they’re doing every day, and the investment bankers would come in with these complex C[ollateral] D[ebt] O[bligations]s, and related products and he would start asking questions about it and the team would say, “Look, don’t worry about it, we’re in the moving business, we’re not in the storage business.” And he was saying this as: “Oh my god, can you believe how the world changed.” In other words, once you had distributed the securities, usually within 24 hours, it didn’t matter what happened to the bonds thereafter.
In the old days, we all thought we were in the storage business. In other words you put your name on it and you’re investors in what you finance —you say that the credit is solid because we’ve put our own name on it. And today that is sometimes not the case. If you can get it out there and you can distribute it in twenty-four hours, that’s what matters, because you get big fees. The culture has just changed in very profound ways.
It’s also changed in the sense that the trading side of all these firms has grown disproportionately big – and most big financial institutions in one form or another are sort of massive hedge-funds. Also, as a result, with the huge trading that takes place in the bond markets, in a way they’re frequently trading against their own clients. So the moral responsibility, if you will – back to what I was saying about Siegmund Warburg - doing what’s right for the customer, has shifted in a way that nobody understood … now it’s sometimes what’s right for the customer is what is profitable for the big financial house. That happened in one generation, and it has happened without significant consequences. There was not, it turned out, a huge reputational risk by putting your name on something which actually turned out to be worthless or by having a firm reach a settlement with the SEC and pay a big fine without admitting any wrongdoing.
Roger Berkowitz: Do you have a hypothesis about why, at what time, or why, this concern with reputation has in some way been replaced with a concern to move product in the world of business?
Vincent Mai: It’s a very tough question. I would say it has to do with investment banking firms going public and getting rid of Glass-Steagall. A lot of little things happened. But going public, I think, moved the responsibility from the personal to the institutional level. And then what became the important thing was growth in earnings per quarter, which put a premium on whatever was the way to make the most money that quarter. That started becoming the focal point and gradually without realizing it you start focusing more on that and perhaps once or twice you shortchange a client or investor to make more money but it’s one of those things that happens imperceptibly. But I think being public, and creating the quarterly pressure for earnings growth, versus the proprietary sense that we all felt as owners of the business, was a huge element.
I’m not suggesting turning back the clock. Of course today, these huge firms must be public and there are some excellent boutique firms that are public. What I’m saying is that the managements of these firms have to figure out a way to grow earnings without being imprudent from a risk or reputational standpoint and make clear to all employees that the firm’s culture will never tolerate excessive financial risk or potential reputational damage to achieve more profits.
Siegmund Warburg used to say what’s wrong with sometimes saying “we had the third best level of profits in our history.” It’s a question of managing employee and shareholder expectations intelligently, remembering that in the long term a strong financial position and an excellent reputation are the foundation on which sustainable long term growth is built.
I can’t prove this but it’s a judgment – I think the media and the obsession with who is the most profitable firm, who’s the richest one, or who the biggest billionaire is or who made the most money and so creating sort of rock stars out of wealth—also had something to do with it. So whether it’s television, the financial journals, the newspapers, the whole emphasis became, who’s the richest, who’s number one. You have big egos who are involved in this business and they all say “I’m going to be number one” and so they take risks they shouldn’t take to increase profits; the media didn’t used to obsess twenty-five years ago about all the stuff the way they do today.
Roger Berkowitz: You talk about shifting responsibility, which I think is an important point, and one of the main ways we shift responsibility in our modern world is bureaucracy. But another is lawyers. We say well this may not be totally ethical but it’s legal. How much more active are sort of legal concerns in sort of doing deals today than they were when you began, and is that a way of shifting responsibility: “Well it’s legal, and therefore it’s okay.”
Vincent Mai: I just think that’s not so much the problem. You know, everybody whether it’s in my era in Wall Street or today, wants to be sure, that things are legal, but the rules of the road have always been pretty clear. I think that other factors have been more important.
Roger Berkowitz: What do you think of the rating agencies’ role in this crisis?
Vincent Mai: The ratings process was shown to be totally deficient. The rating agencies get paid by the issuer. The more ratings they give, the more money they make, it became a gravy train. The investment bankers put them under tremendous pressure to rate the senior tranches of these structured instruments Triple A, the agencies oblige and preposterously you have over 1,000 Triple A rated CDO’s and other structured securities many of which turned into junk. There are less than ten industrial companies rated Triple A in the whole United States. To get such a rating is a big deal. The problem is the conflict of interest that is built into the process with the issuers paying the rating agencies. The investors are left holding the bag for all these poor credit judgments and have suffered massive losses as a result. Unfortunately, this matter was not addressed in the financial regulatory reform bills passed last year.
Roger Berkowitz: What about regulation? Was poor regulation at fault for this crisis?
Vincent Mai: I’m not one of these people who blame the regulators and the government although clearly there were serious regulatory lapses. But to me I find it ironic that the same people who say “leave it to the private sector,” and “the market knows best,” say, after this crisis happened, it was the government’s fault. And there was this incredible statement by Alan Greenspan a few months ago where he said: I’m shocked that the leadership of these big financial institutions was not more serious about protecting their interests. Greenspan forgot that greed can trump good judgment and that in certain cases effective regulation can save shareholders and taxpayers from the excesses of a free enterprise system out of control.
There are two things that occurred which I think were very important. One is getting rid of Glass-Steagall which I already mentioned. I worked my whole career on Wall Street where Glass-Steagall was the law– and one could argue, certainly with the benefit of hindsight, that it was the reason the system was working so well. It was a radical change to say we’re going to get rid of Glass-Steagall. Suddenly, we took down all those barriers that separated investment banking, trading, and commercial banking. And everything just became one again. I think that was a shift that was drastic enough to be absolutely decisive when you impose on top of it all the other things that I mentioned. So Glass-Steagall was important. And the other thing, which you don’t read about all that much, was getting rid of the Uptick Rule which was a very important circuit breaker in a down market. And, again when you add all the other things that we talked about, each one is an important element in itself, but it’s a combustible mixture to have all of those things.
Roger Berkowitz: Given that some of this is based in values, a values shift, as you put it, who is responsible? Is someone responsible? Is that the right question to ask? And should people be punished, either legally or financially? It seems I think from many perspectives that very few people in the financial industry have suffered greatly. They may have quit, but came away with huge golden parachutes and things of that sort. They immediately go back to work for other firms. One of the things that I think struck me is the people who were in charge of these failed companies are largely not thought to have done anything wrong. Not only morally or legally but even economically. They’re being hired once again. How do you see that as someone from inside the business community? Do you wish there was more responsibility or do you think it’s been about right?
Vincent Mai: You’re getting to deep philosophical questions here. People should be punished if they’ve done something illegal. I have to say I can completely understand the anger of Main Street, against Wall Street. When you think how many people were not just hurt but whose lives were destroyed by what happened, particularly in losing homes, unemployment—massive dislocations across the country. Then they see Wall Street – where this collapse mostly originated – and they see what you just said: the same people in the same positions. And in the newspapers we read every day these massive bonuses and all the rest. So one has to conclude that the people who were responsible for what happened, which has devastated individuals, the reputation of America, and the credibility of the financial markets, that they have gotten away with it unacceptably lightly if you will.
It seems to me really inappropriate given the magnitude of what happened—that basically you’ve got the same people doing the same things and still earning a lot of money. And then you add on top of that the fact that the government bailed out these major financial institutions. If the government hadn’t they would have collapsed. And so the whole moral hazard question – which is a very legitimate one – has not been addressed. The government really saves the system, and then the system basically continues more or less intact, more or less unscathed, despite the new banking regulatory reform which, I think is pretty tepid given the magnitude of what happened.
Roger Berkowitz: You mentioned a reputational hit to the financial system in the United States. Is that really true in the world? And have individuals suffered reputational hits or for the most part have people been going on as if this wasn’t much of a to-do. And how does this not affect people’s reputation, if it doesn’t?
Vincent Mai: Look, I don’t think it has affected adversely many people’s reputations except the few who were obvious poster boys for what happened. But by and large, people have got through unscathed. I think that it has unquestionably affected our reputation and our credibility in Asia, in countries like China, Japan, India, which are hugely important to us. It was a shock to them that our system could be so toxic, so contaminated, that major firms like Lehman Brothers could be in business one day and out of business the next day. These people have got huge assets of theirs invested in our financial system, and there’s no question – This was a very, very sobering experience for them, because they thought that our system was the model, you know, so it’s been a huge blow to our credibility, and I believe that it’s going to take years – if at all – for us to restore our credibility to where it was. That’s not to say that they’re not going to deal with us because we’re the biggest capital market, the dollar is what it is, people have to deal with us. But I think that they are rethinking a lot of their commitments long-term, they assumed our capital markets were unassailable, and they realize, no, they’re not.
Roger Berkowitz: What’s the best way, going forward, to deal with what you have identified: The upside-down shift from a private partnership, reputation, customer service driven model, to a public company, move the product, earn as much as you can model? Is this a lost cause, do we try and restore it, or is this just the future and we have to deal with it?
Vincent Mai: I’m always optimistic but I have to say on this one, I hate to use the words “lost cause,” but it’s a formidable challenge to try to change the culture. And one of the reasons is the sort of tired, obsolete ideological debates that go on in Washington and New York about the free markets, and “get government off your back,” all of which creates a complete inability to think about the challenges in a strategic way, and in a way where they see us, the US, as a part of a global system. There are economies developing huge investable funds around the world and people have choices and options. And we have to stay abreast of all those changes and be competitive and show that we’re worth putting the trust in us and in our ability to deal with these problems. I find these ideological battles, which have nothing to do with common sense, and nothing to do with the strategy of government and regulators partnering in an effective way with Wall Street to create as strong a foundation as possible. This is what it should be all about. Instead we have a rather acrimonious dialogue, which gets in the way of really sound, long-term strategic decisions that will lead to a secure and dependable banking system that can play the pivotal role it should in our continued economic prosperity.
Roger Berkowitz: What would be the first thing you would want to do, if we could change the dialogue, how would you frame it?
Vincent Mai: I think the financial community has to argue something that’s bigger than its own immediate self-interest. You know, you can argue, don’t do anything—leave us completely alone—because then the maximum flexibility we’ve got, the more money we can make. And I think it’s unfortunate to approach it that way.
I would start off by saying that you want a financial system that is stable, that is predictable, and that you can count on long term. And that’s for all the constituent elements, from the individual consumers to lenders to borrowers to governments, that there’s predictability and a stability to the system. And that the Wall Street community ought to figure out a way with government to impose a regulatory structure that achieves those objectives.
So it’s not one thing, but it’s a process of how you get to the right answer, where you realize or it’s understood that everybody’s interdependent. Because there has to be a much larger objective here than the immediate self-interest of the financial community. And I think the financial community—to its shame—has been excessively active since this whole collapse in working to blunt any effective regulation. Now it may be smart in the short term, but I think we’ve paid a very big price long term. The starting off point has to be the safety and soundness of our banking system and that has not been effectively addressed which is astonishing given the magnitude of what happened.
Roger Berkowitz: A last question. You obviously know a lot about South Africa. Is there anything that we could learn from South Africa as they enter, really into the capitalist, I mean, they’ve become a different country in the last fifteen years, some would say with a sort of ethical groundwork to their government; is this something that we should and could learn from them regarding values in business and government?
Vincent Mai: The first thing, South Africa during this whole collapse: the financial system was completely intact, I mean there was no financial crisis in the banking system but there was no crisis in the banking system in Canada, there was none in Australia. Why? Admittedly, they’re smaller and less complex markets but they had very strong and effective regulation. One could do well to look at why is it that they’ve got these stable systems, the objectives that I talked about – it’s not a utopian thing, they actually exist in some countries, and we could learn from others.
But back to South Africa, look there’s a lot that’s great about what’s happened in South Africa, and there are a lot of big challenges. If I had to see an overarching thing about South Africa which we could learn from and I take this from Nelson Mandela, here’s a guy who’s in prison for twenty-nine years, really lost a life, comes out with the most magnanimous, forgiving attitude, and so the whole idea of truth, forgiveness, reconciliation, and realizing that there’s a bigger goal in life than the ambitions of one individual, well I think that’s to me is a big lesson out of South Africa.