Concentration of power: a peril to corporate integrity

Citation

Ali, A.J. (2010), "Concentration of power: a peril to corporate integrity", Competitiveness Review, Vol. 20 No. 4. https://doi.org/10.1108/cr.2010.34720daa.001

Concentration of power: a peril to corporate integrity

Article Type: Editorial From: Competitiveness Review: An International Business Journal, Volume 20, Issue 4

In 2008, we wrote that the “the wink-and-nod” era in business practice has led to serious deceptions and frauds and weakened the ability of the market system and existing mechanisms to deter bad practices and corruption. It is this culture that has made it permissible for executives and other senior managers to deceive the public and regulatory agencies with no regret. These executives place their fame and interest ahead of corporations and society, thereby threatening market stability while deepening economic tragedies for millions of people across the globe.

In its editorial, “After Goldman,” The New York Times (2010) stated that current financial practices by major banks can “bring down the system” and called for a restoration of what has been lost in the current financial crisis, the “public confidence in the integrity of financial markets.” Likewise, the Washington Post (Samuelson, 2010) called for a profound change in the Wall Street culture which increasingly tolerates deceptive or dishonest behavior.

The Post indicates that there has been a paradigm shift in Wall Street. Previously, Wall Street’s executives used to think of themselves as “arbiters of capital, helping to allocate society’s saving to productive uses.” But major firms on Wall Street have moved away from this model and have started to view themselves as “captains” of the market, “navigating it – for themselves and sometimes their clients – for maximum gain.”

Motivated by “maximum gain” and disregarding public concerns and interests and, more importantly, regulators, major financial institutions, especially Goldman Sachs, induced their clients to buy a mortgage-related investment without them having any knowledge that the investment was devised to fail (Sorkin, 2010). These financial institutions have benefited greatly from being the captains of the market and increasingly have focused on trading and proprietary investments. The Post reported that about 80 percent of Goldman’s revenue for the first quarter of 2010 (totaling $12.8 billion) came from trading accounts and only 20 percent came from traditional underwriting, financial advice, and management accounts.

Goldman Sachs invented the synthetic collateralized debt obligation (CDO) deal. This design involves betting rather than investing. In inventing synthetic CDO, Goldman Sachs was motivated by a philosophy that “if buyers and sellers can be found, we’ll create and trade almost anything, no matter how dubious” (Samuelson, 2010). Practically, synthetic CDO is an instrument for betting on the housing market. The value of such an instrument is linked to a series of mortgage bonds. According to released documents by a US Senate Subcommittee, Goldman Sachs, in 2007, cheered the decline in the housing market because it, as one of its executives stated at the time, “Sounds like we will make some serious money.”

For many years, financial institutions like Goldman Sachs have gained economic and political power to a point that no other industry has ever reached. One may argue that this is an outcome of a natural industry evolution. That is, as the manufacturing and agricultural industries’ shares in the economy fell dramatically and that of the service sector experienced a rapid increase, the financial sector ascended. However, this argument may be challenged. This is because the unparallel clout of the financial institutions is the outcome of deliberate and thoughtful strategies to influence legislators and government agencies to mold the rules and profoundly change the political environment in Washington to be supportive to the demands and priorities of the mega financial institutions.

These institutions have capitalized on two important but interrelated factors in strengthening their power and seizing opportunities. The first factor is networking with influential politicians, thereby establishing a sophisticated web of relationships with senior government officers and legislatures. These institutions have also capitalized on their wealth by generously contributing to politicians who seek cash for their political campaigns and aim at strengthening their chances for reelection. The Wall Street Journal (April 20, 2010) reported that recently John Paulson of Goldman Sachs held political fund raising events for top politicians in both the democratic and republican parties. The journal reported too that, since 1989, Goldman Sachs’s political action committee and its employees donated $31.6 million to politicians.

Writing in The New York Times, Wyatt and Lichtblau (2010) reported that the financial sector sent more than 1,500 lobbyists, executives, and others to the Senate Agriculture Committee which was scheduled to take up legislation to rein in derivatives. The reporters indicated that in the current election cycle, members of the Agriculture Committee received $22.8 million from institutions and individuals affiliated with financial and related industries – two-and-half times what they received from agriculture contributors. Faced with widespread public discontent and disapproval and an administration seeking to overhaul financial regulations, the financial institutions and their lobbyists have flexed their muscles to prevent profound changes in existing laws.

Political commentator, Scheer (2010), stated that “Never in US history has one company wielded such destructive power over our political economy, irrespective of whether a Republican or a Democrat happened to be president.” In general, the mega six banks – Goldman Sachs, Morgan Stanley, JPMorgan, Citigroup, Bank of America, and Wells Fargo – have assets equivalent to 60 percent of the US GDP; in 1990 its was 20 percent (Moyers, 2010). It is this economic clout that is translated into political capital forcing its way into Washington’s corridors of power.

The second factor is the ability of senior executives at megabanks to move in and out of the federal government with remarkable ease, thereby making it possible for these banks to have their views translated into policy directives. For example, senior executives at Goldman Sachs in recent years have become treasury secretaries (Henry Paulson, during the George W. Bush administration; Robert Rubin, under President Bill Clinton), White House Chiefs of Staff (Joshua Bolten, 2006-2009), Chairmen of the Commodity Futures Trading Commission (Reuben Jeffery, 2005-2007; Gary Gensler, May 2009), Chairmen of the Board or President of the Federal Reserve Bank of New York (Stephen Friedman, 1990-1994; Bill Dudley, January 2009), etc.

Some of these individuals were instrumental in persuading President Clinton to sign off on the Commodity Futures Modernization Act. Fortune (September 30, 2008) magazine reported that under pressure from Wall Street, Congress in 2000 passed a bill which prohibited all federal and most state regulation of the credit default swap and other derivatives. Senator Phil Gramm, a co-author of the bill, at the time, argued that the new law “protects financial institutions from over-regulation […] and it guarantees that the United States will maintain its global dominance of financial markets.” Likewise, it was Henry Paulson of Goldman Sachs, then Treasury Secretary, who introduced the bailout schemes during the Bush administration after the financial crisis erupted in 2008. Both actions could not have been introduced without the lobbying of the megabanks and the willingness of politicians to be responsive to megabanks’ concerns and demands.

In the USA, as in other countries, the financial sector elites have emerged as the most powerful actors in dictating economic policies. The interests of these actors intertwine with public policymakers. According to The New York Times, this has created a belief that “Wall Street’s financial interests [has] coincided with Washington’s regulatory interests.” It is this very reason which makes it possible for such elites to be in and out of the federal government. Subsequently, these actors have been a powerful force in reshaping the culture and practices on Wall Street.

The recent financial crisis, while underscoring the urgency to overhaul the financial regulations, has led to a regrouping of the mega financial institutions. Indeed, the bailout has strengthened the big banks. Consequently, it has emboldened these banks and encouraged them to recklessly pursue their interests with no regard to public good.

Undoubtedly, the concentration of power weakens the free market economy, deepens mistrust among market actors, and profoundly shakes the faith in market institutions. Certain measures are needed to regulate uninhibited risk, limit the size of megabanks, establish boundaries for responsible conduct, safeguard customers, and, more importantly, provide guidelines for recruiting senior bank executives to serve in higher places in government. These steps may gradually change the culture in Wall Street and align it with that of the main street.

Abbas J. Ali