The answer to the question of whether we learn from our past missteps: "No."

Over at Credit Slips, there's an Adam Levitin post on the new QM/QRM mortgage rules (here).  Couldn't have said it better myself, and his post is worth reading.

CEOs and off-the-job behavior.

Today's New York Times includes a report by Floyd Norris on a paper that links a CEO's off-the-job rule-flouting behavior with an increase in the likelihood that the CEO's company is going to have to restate earnings or that it might engage in fraud.

I'm looking forward to reading the paper.  My gut tells me that people who routinely break some rules make it easier for them to break others (a la classic cognitive dissonance theory).  It's not a huge leap from that conclusion to the conclusion that people who report to rule-flouting CEOs will likewise be tempted to bend the rules.

It's not what you say; it's how you say it--and to whom.

I loved James B. Stewart's story in today's New York Times (Boss's Remark, Employee's Deed and Moral Quandary).  When one is a boss, one needs to be painfully aware of how even the most tossed-aside comment will sound to an employee.  My favorite part of the story:

No one asserts that Mr. Corzine told Ms. O’Brien to take customer money. Mr. Corzine’s lawyer, Andrew J. Levander, said Mr. Corzine was told the night before that the firm had $82 million in cash and another $602 million in unencumbered securities, and “it never dawned on him” that Ms. O’Brien or anyone else might “violate the golden rule” about safeguarding customer assets.

But how would Ms. O’Brien have interpreted Mr. Corzine’s comment? When I discussed this with John Hasnas, director of the Georgetown Institute for the Study of Markets and Ethics, he drew an analogy to the murder of Thomas Becket, archbishop of Canterbury, after Henry II is said to have uttered, “Will no one rid me of this troublesome priest?”

“He didn’t actually tell anyone to murder the archbishop,” Professor Hasnas noted. “But people knew what would make him happy.” Indeed, history records that four of Henry’s courtiers promptly set off and dispatched the archbishop in the nave of Canterbury Cathedral. 

Yep.   And do I believe that Corzine's request added a silent "legally, of course" kicker?  Not for a minute. 

Let's assume, for the sake of argument, that the allegations about B of A are true.

Here's a story about the allegations.  If those allegations are true, and I have no idea if they are, then what we have here is a classic case of creating incentives that trigger exactly the behavior that the bank got from its employees.  An example from the news story:

“We were regularly drilled that it was our job to maximize fees for the bank by fostering and extending delay of the HAMP modification process by any means we could,” Gordon said. Managers instructed staff to “delay modifications by telling homeowners who called in that their documents were ‘under review,’ when in fact, there had been no review,” she said. 

Any employee is likely to work to do more of what the employer rewards and less of what the employer ignores or punishes.  Want your employees to serve customers better?  Then the incentives can't include "how many customers can you serve in an hour?," or you'll get cursory responses to tens of customers an hour.  Want your employees to process documents quickly?  Make sure that "accurately" is also in the incentive equation.

Everyone responds to incentives.  Companies need to pay attention to what their incentives really ask their employees to do.

What do these two things have in common?

The stor(ies) on Titanic II (e.g., here) and this story on how the banks are back to bundling up risky loans again. 

My favorite quote from the NYT story:

Banks have won over investors by taking steps to make this generation of structured products safer than the last one. But with demand for these products on the rise, credit ratings agencies and regulators are warning that the additional protections are already dwindling, allowing some of the old excesses to creep back into the market. 

And my favorite quote from the Daily Mail story:

Mr Kanerva, of Finnish boat designers Deltamarin, added: 'I can assure you that from a safety point of view it will be absolutely the most safe cruise ship in the world.'
'We are taking into account all of the possible incidents and accidents and we try to simulate all of those occasions.'

And people wonder why we keep making the same mistakes over and over....

A very smart op-ed about executive pay.

By Gretchen Morgenson, whose columns I always like.  Here.

No consequences? That's why LinkedIn was hacked.

See story (here).  Oh, part of the problem is that smart people tend to forget that bad things can happen to them.  Part of the problem is flat-out hubris.  But the biggest problem?  If there are no real consequences to bonehead mistakes, then the incentive to avoid those mistakes is very, very low. 

Will heads roll at LinkedIn?  Maybe.  But I don't know if the right heads will roll.  Unless the folks at the very top feel the consequences, then the wrong people will learn the lesson about not protecting passwords.

What do you get when conflicts are ubiquitous?

You get people who wake, as if from a dream, to realize that what they've been doing has (a la Arthur Andersen) come 180 degrees away from the firm's original culture (see Greg Smith's NYT op-ed, here) and what they've been facilitating hasn't been nearly as clean as it should have been (see Andrew Ross Sorkin's NYT Dealbook columns here and here).

Greg Smith's "Why I Leaving Goldman Sachs" includes this paragraph:

It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization. I am sad to say that I look around today and see virtually no trace of the culture that made me love working for this firm for many years. I no longer have the pride, or the belief.

Mr. Smith is right about the importance of leadership in a firm's culture.  It matters that a company's officers and directors reward the right behavior and punish the wrong behavior.  But what I liked most about Mr. Smith's op-ed is that it recognizes that culture isn't up to the C-level suite and the board alone.  Senior people have to reinforce the culture all the way down the line.  They have to watch what their people do and say (and reinforce the right behavior).

As I've said before, the problem isn't that all people are evil.  It's that all people are human, and humans have an unlimited capacity to fool themselves into thinking that what they're doing is the right thing to do, even when it isn't.  When senior people rationalize their behavior, a company's decline isn't far behind.

As for the board, it can start thinking about how to turn around this very important company, or it can continue down the same path.  I'll be interested in watching what happens.

Conflicts of interest redux.

Andrew Ross Sorkin wrote a great piece in yesterday's New York Times about the "heads I win, tails you lose" approach that Goldman Sachs seems to have used in the El Paso-Kinder Morgan deal (here). 

Lots of people think that mere disclosure of conflicts will cure each and every one of them.  Sure, disclosure will cure some, especially with sophisticated clients.  But even with the most sophisticated clients, disclosure is a tough thing to get right.  Disclose too little, in consideration of each client's confidential information, and the consent to the conflict isn't very "informed."  Disclose too much, and the clients' confidential information goes out the window.

I'm going to guess that most of the time, the disclosure is too little, not too much.  And that's not just right.

Best quote in an op-ed referencing Nozick.

John Kay's piece in the Financial Times (here) includes this wonderful paragraph, which applies to corporate pay and the pay of estate professionals in bankruptcy cases:

And again, problems arise when people voluntarily hand over money that is not their own. John Kenneth Galbraith once described executive pay as a warm personal gesture by the beneficiary to himself. In today’s world of remuneration committees, it is more often a warm personal gesture by friends to each other. 

Perfect.

Interesting article.

Forwarded to me from my buddy Marc Stern (article here).

Not just one but two great op-eds.

The first, from Nassim Taleb, in today's New York Times, points out that bonuses are not the best idea when it comes to bankers taking on too much risk (here); the second, from Joe Nocera, showed up in today's Las Vegas Sun but isn't on the Sun's web page.  It is on the New York Times's webpage (here).

Both op-eds remind us that it's important to pay attention to the facts:  study the behavior of people whose compensation isn't linked to the prudence of their decisions (Enron, anyone?) to see if bonuses make sense; pay attention to the the factors pushing people toward strategic defaults on their mortgages and try to think of sensible solutions (reductions of principal) as a way out of the mess.

What doesn't work?  Ignoring the facts.  For example, check out Andrew Ross Sorkin's column today on the continuing saga that is the H-P board (here).

Boards that don't pay attention to actual performance before awarding incentives?  Check.  Bonuses not linked to actual performance?  Check.  Reasons why underperforming boards need to consider different ways of finding good new board members?  Oh, about a few trillion.

That "boom" you hear? It's MF Global Holdings going down, thanks in part to bad decisions concerning compensation.

See Joe Nocera's column describing Corzine's compensation here.

It's easy to get too cozy to clients.

See Floyd Norris's report in today's New York Times (here).  Seems as though some Deloitte folks were taking the word of the execs of the companies they were auditing, rather than doing some digging on their own.  So much for learning from Enron (see yesterday's Wall Street Journal report on Enron 10 years later, here).

Why don't we learn from our mistakes? Well, I have some theories.  I think that we combine a failure to pay attention to history with some common cognitive mistakes that even the smartest among us make, and we get the same-old, same-old.

Stop me if you've heard these phrases:

"I know these guys.  They wouldn't lie."

"If there were really a problem, someone would have told us by now."
"I am not getting too close to my clients."
"Everybody does it."

So I'm not particularly surprised by this Deloitte issue, or by Andrew Ross Sorkin's report on what may be massive overvaluing of Groupon by Goldman Sachs.

It's enough to make one an avowed pessimist.

Want a healthy company? Reward failure.

See here, from today's Wall Street Journal.  Organizations that give people room to mess up and (this is the important part) learn from their mistakes will do better than ones with incentives that encourage either (1) hiding mistakes or (2) avoiding risk.

I have always learned more from mistakes than from successes.  My dad's a chemist, and he always cautioned me to question results that agreed with my hypotheses.  We don't tend to examine our successes.  We should, but we don't, because we like the results.  But we should also examine our failures to figure out (if we can) what happened.

And it's not just giving people room to mess up that matters.  It's rewarding those mistakes publicly because the people who made them were trying to do something good and have learned something from the effort.

OK, it's not a scandal (yet).

My buddy David Smith, who does really interesting research over at the University of Virginia (see here), pointed me to this article about Nevada's corporate climate, especially the shell-friendly regulations (here).  And I quote:

At the same time, Nevada is attracting an outsize number of companies with shaky financial reporting, according to a study published in March by Michal Barzuza and David C. Smith of the University of Virginia.

Want to read that research?  Click here.

Dear HP Board: Perhaps you need some new blood?

See here and here.  Doing the same thing over and over and expecting different results hasn't worked so well for you, has it?  Perhaps you should consider using someone who studies why smart people do dumb things.

UBS and the wrong checks and balances.

Kim Krawiec has a great post over at The Faculty Lounge (see here) about the UBS rogue trading scandal and the patterns of behavior that make such high-stakes exposure possible.

"Too good to be true" never is.

In yesterday's Wall Street Journal, Michael Rothfeld reported (here) that Société Générale may have ignored a red flag on Allen Stanford's account.  He writes: 

     At issue is a Swiss bank account held by one of Mr. Stanford's companies at SG Private Banking (Suisse) SA, a Société Générale subsidiary, that was allegedly funded with investors' money and used to make payments into Mr. Stanford's personal accounts and for bribes to his Antiguan auditor. Prosecutors in the criminal probe are examining whether Société Générale failed to follow due diligence procedures or to ask questions about irregular banking activity, the people familiar with the matter said.

I've been working on a mini-essay for an upcoming conference on the intersection of white collar crime and bankruptcy law (see here), and this whole issue of why smart people can ignore red flags fascinates me.  I'll be following this story.  More on the conference as we get closer to the event.