Lessons from the crisis
The global credit crisis has seen governments worldwide intervene to prop up various parts of their economies. In the UK many banks would not be standing if it weren’t for the massive support of tax payers, but do the loans, guarantees and investment pledged mean bankers have to toe the line with government policy?
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The car industry, both in Britain and the US, is going cap in hand for state help in the face of dramatically plunging sales, but what strings will be attached to that aid? Chris Higson, Professor of Accounting at London Business School, contemplates the full and daunting implications of growing government intervention and what we have learned so far.
Bail-outs don't alter fundamentally uncompetitive businesses
Unprecedented government intervention has been one of the most striking features of the ongoing financial crisis afflicting the world's economies. Some of the most spectacular sums have been used to rescue the ailing American auto industry. In return for investment, companies are being told to create greener and cleaner models. The connection which the American and other governments are making between aid to the auto industry and environmentalism is very neat and is likely to work to some extent. The requirement to invest in green models is going to change behaviour. But there is an even more fundamental challenge. It's easy to forget that General Motors and the other big US auto manufacturers were actually failing businesses well before the recession. For example, GM in the third quarter of 2007 reported a $40 billion loss. Even with government help, it's very unclear what the future of those companies is. Indeed, government help may be akin to putting a band-aid on a terminal patient. GM simply cannot be transformed into Toyota. After all, the car in front has been a Toyota for much of the past two decades and GM has been largely powerless.
One plus one does not automatically produce two
Even larger band-aids in the form of government loans have been handed out to a variety of banks and financial institutions. The hope was that this would not only save the businesses but would encourage them to start lending money once again. The reality has been somewhat different. Banks in the UK have been criticized for not increasing lending and, in particular, are being lobbied to support British investments rather than overseas projects. It appears unacceptable that the global ambitions of certain UK banks have meant that UK businesses and individuals now can't access normal bank credit at home. The lesson here is that the needs of one side cannot be assumed to coincide with those of the other side. In this case, banks have, rather late in the day, closed the stable door and become excessively risk averse at the very time when the government and people in business need their support.
Failure starts at the top
A business that goes to the Government for a bail-out is a failed business and it's completely appropriate that CEOs should resign - as we have seen at AIG, Citibank, Royal Bank of Scotland and GM. If one or two of these CEOs turn out to be hapless victims with irreplaceable talents so be it. We've just witnessed an extraordinary failure of corporate governance in the banking industry, and the entrenchment and sense of entitlement that some senior executives in that industry display is quite extraordinary as they stand among the rubble of their businesses with their pensions and their bonuses neatly tucked under their arms. If we're going to mend this failed governance culture, it's essential that these people should start to take the downside as well as the upside.
The problem is always how to distinguish unique and valuable talent getting a fair reward from people who simply garnered some power and are overpaying themselves. So, this goes back to the effective governance question. But also I think, in the case of banking, it would be clarifying and helpful if we could turn back the clock. We need to go back to the age before universal banking where we had two different sorts of organisation, banks doing the everyday commodity business of providing credit and banking services, and a few financial organisations devising complex financial instruments. So, while the banking industry will be at the commodity end of the market, there will be other organisations at the luxury end of the market and they can sell their goods at a suitable price.
We're all Keynesians now
The banking and automotive industries have been bailed out because they are judged to be too important to fail. It has been extraordinary how quickly governments have become, in the wonderful American phrase, shovel ready. In other words, everyone is now a Keynesian. The question must be whether these new habits of intervention will stick after the immediate crisis has receded? Governments don't have the competence or resources to get involved in the detail of managing businesses. There can be no doubt, that the Anglo-Saxon business world has some hard thinking to do. We are surrounded by examples of organisational and governance failure. What next?
Chris Higson (chigson@london.edu) is a Professor of Accounting at London Business School.