The Question of the Leadership Crisis in the Industry - Case Study Example

Is Leadership Responsible for 2008 Financial Services Meltdown? Introduction Leadership is the process of social influence in which one person can enlist the aid and support of others in the accomplishment of a common task. A leader with vision in his long term approach and intuition differentiates himself from the rest. In a democratic type of structure in a business institution, the system of collective leadership is prevailing. There are so many factors attributed to systemic failure. For example, the stock options are given to the executives apart from the salaries and benefits. These employees have vested interest in inflating the stock prices, so that they can exit at an appropriate time, leaving the genuine investors at lurch. Schwartz (2010) writes “the rules of the game are rigged and that no matter what these guys do, they always come out ahead… AMERICAN EXPRESS doled out another rich options package, even as it cut 4,000 jobs last year and got financial help from the government in the financial crisis.” So there is a question of conflict in the interests. However, the question of leadership crisis in the industry as whole calls for thorough analysis with reference to the causes and the factors involved at the industry as well as the government level before coming to any conclusion. Genesis Arrighi states “the concentration of economic power on wall Street, the stagnation of incomes for all but the rich, the structural trade deficit, the military overreach, the switch from being the world’s biggest creditor nation to its biggest debtor add up to a simple conclusion: We are in the twilight years of the long American century”. The crisis as many believe has not spilled over from Wall Street, though Wall Street is the nucleus of the crisis. However, ignoring the basic issues which catapulted into a catastrophe, by blaming leadership seems to be little farfetched and out of context. Regulations and controls have been a source of great concern in a capitalist society, and we expect governments to come to our rescue when the situation is out of control. Knowledge@Wharton (2008) states “regulatory efforts to encourage competition between Fannie Mae and Freddie Mac were misguided because they intensified the pressure on entities that were not completely free-market vehicles. Leaders either did not understand or were unable to balance the goals of a "public-private hybrid" Orts notes. "It might be more sensible to have a clear division between public and private organizations in order for them to focus on a clear mission”. The ideological conflicts, excess leverage in financial sector, poor risk management and neglect of Corporate Social Responsibility have rudely shaken the fundamental concept of ‘free enterprise’. Causes/factors leading to the crisis The causes/factors leading to the crisis are multifarious, and it has evolved into the system over a period of time like cancer and exposed, with the meltdown in financial services sector. Savings & consumption Savings should be the basis for social welfare and corner stone for investment. Money saved is meant for future consumption. Marks and Scherer (2010) state “Americans have stopped saving for a rainy day. Instead, they are living paycheck to paycheck, depending on credit cards to get them through emergencies, and hoping that the rising value of their homes will give them a retirement nest egg”. Subprime crisis and Debt culture The financial structure in the country is made up of borrowings. The staggering level of debts by the individuals and corporations makes the economy vulnerable. One corporate failure acts as a lighted match to a train of gunpowder. Every asset becomes Non Performing Asset, and the flow of capital is arrested. The fundamental principle ‘Liquidity’ in the banking system becomes casualty, more so out of fear and suspicion. The bank finance is locked up to a major extent in subprime mortgages and housing development projects. Pittman (2008) states that “Without the government money, Goldman, Merrill Lynch & Co., Morgan Stanley, Deutsche Bank AG and other firms could have become some of the biggest creditors in a bankruptcy filing by AIG, the worlds largest insurer, because of its billions in losses on subprime bonds and corporate debt.” Probably the process of the bailout plan has been quicker, because Henry Paulson, the Treasury Secretary had been the Chairman of Goldman Sachs earlier. The top 25 in Subprime is given in Appendix I. Dunbar and Donald (2009) state “At least 21 of the top 25 subprime lenders were financed by banks that received bailout money—through direct ownership, credit agreements, or huge purchases of loans for securitization”. Non plan expenditure The governments’ spending on non-plan expenditure has been increasing continuously in the past few decades. Increased allocation to plan expenditure act as a catalyst for the economic development and improving the infrastructural facilities. Monetary policies Monetary policies of the Central Bank of a country, and its system of monitoring over financial services sector particularly deserve special mention in the scheme of things. Einhorn (2009) states “Ben Bernanke and Tim Geithner have become the quintessential short-term decision makers. They explicitly "do whatever it takes" to "solve one problem at a time" and deal with the unintended consequences later. It is too soon for history to evaluate their work, because there hasnt been time for the unintended consequences of the "do whatever it takes" decision-making to materialize”. Deficit spending Deficit spending in the countries has resulted into hyper inflation. Earlier it had been forecasted that the future generations would suffer the consequences. However, the consequences are rattling us now and many investors have lost everything they had, thanks to the financial crisis. Slow down in economy, decreasing tax revenues and the impact of bailout package would significantly contribute to the budget deficit. BPO, Environmental issues and production outsourcing Outsourcing is not just about call centers, and it encompasses several other areas. The advent of Internet and developments in information technology has pitted the work force of the developed countries against the people of the developing countries such as India, Malaysia and Philippines where the education level is good and English is predominantly used. The US and western countries have been shifting their manufacturing facilities due to environmental concerns and green house gas emissions to the underdeveloped or developing countries fearing compliance with the Kyoto Protocol sooner or later. This involves flight of capital as well as employment opportunities to these countries. Current Situation According to Trading Economics (2010) “The Gross Domestic Product (GDP) in the United States expanded at an annual rate of 2.50 percent in the third quarter of 2010. From 1947 until 2010 the United States average quarterly GDP Growth was 3.31 percent…”  The performance of the largest economy in the world has its repercussions in the world economy. Realty Trac states that foreclosure activity for July, 2010 is at “near-record levels of bank repossessions, which increased on a year-over-year basis for the eighth straight month.” Reduction in interest rates and stimulus packages can only act as a catalyst in the revival of economy within a reasonable limit and cannot be sustained for a longer period of time. There are limitations for reducing the interest rates further as it will affect the pensioners, whose population is growing. Enforcement of controls and regulations in the financial sector should not take a back seat, and semblance of stability could be misleading. Restructuring in the sector is important in terms of capital adequacy and risk management, and the system fine tuned for to diagnose the symptoms at an early stage for taking necessary action. Stability in interest rate structure and exchange rate is a pre requisite for the growth and development of the economy. Conclusion Though the Complacency on the part of the banks is very glaring and evident, the causes being external were not under the control of the industry stalwarts. Knowledge@Wharton (2008, p.1) states “Greed reflects a failure of leadership; turning your head to ignore the high risk because you are making big earnings today certainly shows a lack of leadership. How many people on Wall Street have been subject to less than robust oversight by their organization because they were producing such big contributions to the firms earnings? Allowing your organization to be a party to contributing to this scheme -- even if you know that you will not be directly affected -- is not a mark of leadership. It is a sign of greed”. The system of rewarding the executives with bonuses and stock options only aggravated the problem. It could have made them succumb to greed and avarice, but, the crisis can’t be attributed to leadership factor alone. The financial structure built on excess leverage, complicated financial instruments and cross holdings is bound to collapse like a castle of cards sooner or later. The central banks and the governments had failed to discern the dangerous patterns in the financial sector and taken steps to plug the loopholes. Appendix I The Top 25 in Subprime 1. Countrywide Financial Corp. Amount of Subprime Loans: At least $97.2 billion 2. Ameriquest Mortgage Co./ACC Capital Holdings Corp. Amount of Subprime Loans: At least $80.6 billion 3. New Century Financial Corp. Amount of Subprime Loans: At least $75.9 billion 4. First Franklin Corp./National City Corp./Merrill Lynch & Co. Amount of Subprime Loans: At least $68 billion 5. Long Beach Mortgage Co./Washington Mutual Amount of Subprime Loans: At least $65.2 billion 6. Option One Mortgage Corp./H&R Block Inc. Amount of Subprime Loans: At least $64.7 billion 7. Fremont Investment & Loan/Fremont General Corp. Amount of Subprime Loans: At least $61.7 billion 8. Wells Fargo Financial/Wells Fargo & Co. Amount of Subprime Loans: At least $51.8 billion 9. HSBC Finance Corp./HSBC Holdings plc Amount of Subprime Loans: At least $50.3 billion 10. WMC Mortgage Corp./General Electric Co. Amount of Subprime Loans: At least $49.6 billion 11. BNC Mortgage Inc./Lehman Brothers Amount of Subprime Loans: At least $47.6 billion 12. Chase Home Finance/JPMorgan Chase & Co. Amount of Subprime Loans: At least $30 billion 13. Accredited Home Lenders Inc./Lone Star Funds V Amount of Subprime Loans: At least $29.0 billion 14. IndyMac Bancorp, Inc. Amount of Subprime Loans: At least $26.4 billion 15. CitiFinancial / Citigroup Inc. Amount of Subprime Loans: At least $26.3 billion 16. EquiFirst Corp./Regions Financial Corp./Barclays Bank plc Amount of Subprime Loans: At least $24.4 billion 17. Encore Credit Corp./ ECC Capital Corp./Bear Stearns Cos. Inc. Amount of Subprime Loans: At least $22.3 billion 18. American General Finance Inc./American International Group Inc. (AIG) Amount of Subprime Loans: At least $21.8 billion 19. Wachovia Corp. Amount of Subprime Loans: At least $17.6 billion 20. GMAC LLC/Cerberus Capital Management Amount of Subprime Loans: At least $17.2 billion 21. NovaStar Financial Inc. Amount of Subprime Loans: At least $16 billion 22. American Home Mortgage Investment Corp. Amount of Subprime Loans: At least $15.3 billion 23. GreenPoint Mortgage Funding Inc./Capital One Financial Corp. Amount of Subprime Loans: At least $13.1 billion 24. ResMAE Mortgage Corp./Citadel Investment Group Amount of Subprime Loans: At least $13 billion 25. Aegis Mortgage Corp./Cerberus Capital Management Amount of Subprime Loans: At least $11.5 billion Source: Center for Public Integrity and Home Mortgage Disclosure Act data References Arrighi, G. The Long Twentieth Century : money, power, and the origins of our times, London, Verso. Dunbar & Donald (2009), America’s Economic Collapse Billion Dollar Bailout Banks Financed the Subprime Industry and America’s Economic Meltdown, 18 May 2009, http://www.thecuttingedgenews.com/index.php?article=11323&pageid=&pagename= Einhorn, D. (2009), Greenlight Capital, “Liquor before Beer…In the Clear”, Value Investing Congress, 19 October 2009, Scribd, http://www.scribd.com/doc/21311124/Einhorn-Vic-2009-Speech Knowledge@Wharton, (2008), Opinion: Greed Reflects a Failure of Leadership, 20 June 2008, Wharton School of the University of Pennsylvania, http://knowledge.wharton.upenn.edu/articlepdf/1987.pdf?CFID=33276759&CFTOKEN=27457828&jsessionid=a8308824c68b5b4d73f718627b7919245145 Knowledge@Wharton (2008), Eyes on the Wrong Prize: Leadership Lapses That Fueled Wall Streets Fall, 17 September 2008, Wharton School of the University of Pennsylvania, http://knowledge.wharton.upenn.edu/article.cfm?articleid=2048 Marks, A. and Scherer, R. (2010), U.S. savings rate falls to zero, Christian Science Monitor, MSN Money, http://articles.moneycentral.msn.com/Investing/Extra/USSavingsRateFallsToZero.aspx?page=2 Pittman, M., 2008. Goldman, Merrill Collect Billions After Feds AIG Bailout Loans, 29 Sep 2008, Bloomberg, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aTzTYtlNHSG8 Realty Trac, 2010. Foreclosure Activity Increases 4 Percent in July, http://www.realtytrac.com/content/press-releases/foreclosure-activity-increases-4-percent-in-july-5946 Trading Economics (2010), United States GDP Growth Rate, http://www.tradingeconomics.com/economics/gdp-growth.aspx?Symbol=USD Read More