Corporate Strategy and Policy Design

Let’s take a look at the corporate strategy of the large financial institutions that played an instrumental role in bringing on the financial crisis. The chief executives at these companies tended to favor an aggressive leadership style, which for a long time led them to aggressive growth; as they acquired companies, the largest companies became ‘financial supermarkets’ with a whole range of services. These financial institutions grew and grew, but eventually reached a point around 2004 where their growth stopped. The leadership of many of these companies started to be criticized for not integrating their acquisitions well. And so chief executives responded by making their companies more governance-oriented, with new constraints for things being signed off by teams. These new protocols and procedures made the financial institutions stabilize and stop growing, but they didn’t prevent the financial crisis, and the whole sector is now suffering as banks (and individuals) are unable to pay back all their creditors.

The crisis wasn’t the result of transnational collusion, intentional Ponzi-type schemes, or a failure of leadership as the media has interpreted it. The bankers weren’t bad people per se, but they shared some assumptions that turned out to be wrong. The crisis comes as the result of an intentional strategy that placed too much trust in complicated financial models; it was the result of policy design.

It is no secret that in 2006 the amount of derivative positions in the market was $596 trillion dollars, compared to a global output of $49.6 trillion dollars. All major governments and banks had this data, that the $50 trillion dollars of wealth created that year had been sold on by a factor of twelve. Sooner or later someone was going to say, “Can I have my money back?”

This overextension occurred in part because the demand for quick wealth creation and returns (from shareholders) and large bonuses (from bankers) was so large, and the investment banks provided a means to achieving these quick returns. Even if they could have transitioned to more traditional and conservative ‘slow’ banking before the crisis, the shareholders and bankers wouldn’t have wanted the decrease in wealth it would have entailed.

This borrowing mentality stemmed from Reagan (and Thatcher)-era economic policy, when the government began borrowing to a massive extent, greater than it ever had before, in order to fuel faster growth. It became an economic assumption that this borrowing was fine, and the political economy in the US and UK (including Labour Party reforms, but the political affiliation didn’t matter) became dependent on this economic assumption; they became dependent on financial services being profitable.

Let me expand on this economic assumption that all the borrowing was fine—it was based on short-term risk models and thus the assumption that the wealth being created would continue to grow. No one questioned where this growth could come from – in actuality, it was based on betting, derivatives, and other risky behaviours – and the financial models turned out to be unable to accurately assess the risks of a general loss of faith in the market. It didn’t take into account that people don’t always act rationally. They had assumed that incentivising supply (i.e. government offering companies tax incentives and subsidies in the hopes that these benefits on the supply side would trickle down to the rest of the economy) would create demand, which contrasted with the Keynesian view of designing policies that create demand through reducing income tax and keeping people employed.

Some leaders at the recent G20 summit share a fear that the Anglo-American equity form of financing could collapse; this would have great political implications. We’re now seeing a meeting of corporate strategy and policy design; the current solution proposed for the crisis is greater regulation. This won’t work, because it slows down the marketplace in the wrong way. So how should the G20 be moving forward?

One way to get out of the crisis would be for the Euro zone, with its relatively stable currency and surplus wealth, to consume more, thereby helping to reduce the deficit in other (primarily Anglo-American) countries. If the Euro zone did start to consume more right now, they would have more buying power than before, and would get good value for what they purchased. However, getting the Euro zone to consume more would require them to break the protocols that allowed them to have sustained growth without class problems in the past—it would make them take on more of an Anglo-American model, which they (for the most part) don’t want to do. Smaller countries are considering breaking these protocols, but if they consume more, the essence of their success is undermined further as they slip into the Anglo-American system.

What will emerge is a slow, insidious way of thinking whereby certain countries will say they don’t want any hint of an equity-based financing system for sourcing wealth in their societies. These countries could align and, refusing to purchase any Anglo-American debt, we might even see the emergence of a United States of Europe, with its own foreign policy, banking system, continental army and the removal of NATO. Such a regional bloc could be rich compared to the rest of the world.

We haven’t yet seen the policy design implications of a stronger European bloc or a riled-up China, who have said they’ll support their allies and their centralized long-term financing system against Anglo-Americans. The intentional strategy that led to the financial crisis is now redesigning boundaries, and we have yet to see where these boundaries will settle.