A lot of us debate if saving the financial system is the right thing to do. Some say that a system on life support is better than one in the coffin. Some say we'd be better off letting it fail and starting from scratch. Some say shoot the wounded and strengthen the healthy. Others say it's time to move to Canada. We're a divided bunch.
One thing that most see eye to eye on, however, is that management of bailed banks should be thrown out. And why not? Most employees can be fired for showing up late, while bank CEOs are still employed after obliterating hundreds of billions of dollars in wealth. It's appalling.
Case in point: Bank of America (NYSE: BAC ) CEO Ken Lewis. After offering nearly a 100% premium for Merrill Lynch, shareholders have seen the majority of their investment go up in smoke. Yet, remarkably, Lewis still has a job, not to mention the full backing of the company's board. Shareholders are infuriated and are suing the pants off of Lewis and former Merrill CEO John Thain. As they should.
That's why I was shocked to see the Financial Times not only defending Lewis' job, but attempting to justify buying Merrill in the first place. As the Times put it:
Last autumn, the entire US banking deck of cards was thrown in the air. How they landed would shape the financial landscape for decades – and sharp bank bosses knew it … Sure, BofA overpaid in retrospect. But had markets surged in the fourth quarter, Mr. Lewis would have been a hero.
Now hiring at Fails 'R Us
I think I can rebut this argument fairly easily:
- True, had the market surged, Lewis would have been a god among gods.
- But it didn't. And shareholders were destroyed as a result.
- Consequently, he should be fired. Easy as that.
Now, I get what the Times was getting at: In order to achieve acceptable return, you have to accept a certain degree of risk, which is what Lewis did. That's true of all businesses in all industries.
Nonetheless, here's where Lewis went catastrophically overboard: If downside risk in a deal is large enough that it could turn your firm into sawdust, it's not a risk worth taking. And if a CEO is unable to accurately price risk in the first place, the deal should be avoided like the plague. Lewis either took an enormously stupid risk, or he didn't understand the risk to begin with -- both of which seem like grounds for getting the boot.
Don't let the door hit you on the way out
Former Treasury Secretary and Citigroup (NYSE: C ) director Robert Rubin provides another example. After resigning last month, he apologetically admitted, "I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today."
Didn't realize the possibility? Really? Rubin's own 2003 memoir includes a chapter appropriately titled "Greed, Fear, and Complacency" which devotes an entire section to the "possibility of extreme circumstances." In his own words:
There is one type of financial risk, the risk of remote contingencies -- which, if they occur, can be devastating -- that market participants of all kinds almost always systematically underestimate. The list of firms and individuals who have gone broke by failing to focus on remote risks is a long one.
When credit was easy and Wall Street was prosperous, management asserted a supreme ability to understand risk. When the tide went out and risks backfired, they conveniently pleaded ignorance. The same type of risk Rubin warned of just six years ago is the same risk that destroyed his own firm. You can't make this stuff up.
It's worthwhile to point out these blunders because other CEOs proved that not acting like drunken madmen was indeed possible. For example:
- When JPMorgan Chase (NYSE: JPM ) bought Bear Stearns, it paid less than the value of Bear's headquarters and made the Fed backstop its riskiest assets before the deal was closed.
- Wells Fargo (NYSE: WFC ) , US Bancorp (NYSE: USB ) , and BB&T (NYSE: BBT ) all managed to escape the credit meltdown relatively unscathed solely because they properly priced risk during the boom years.
- While the market was still liquid, Berkshire Hathaway (NYSE: BRK-B ) unwound over 23,000 derivative contracts inherited through acquisition, knowing full well that they were an accident waiting to happen.
Let's not forget the definition of insanity: Doing the same thing over and over and expecting a different result. There's a very real difference between propping up a bank to keep the financial system alive, and subsidizing a CEO's failed mistakes. With Ken Lewis still in place, we're waist-deep in the latter. It's time for him to go.
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