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Dylan Ratigan is well positioned to author a book, designed to be an enjoyable and informative read by normal humans, on the ongoing financial crisis. He is the wunderkind who became Global Managing Editor for Corporate Finance of Bloomberg, the premier news service that specializes in finance, at an exceptionally young age. He was at CNBC while that network was hyping the housing bubble as a non-bubble offering fantastic investment opportunities.
Now an anchor for MSNBC, Ratigan is a fierce critic of prominent politicians in both parties for what he views as their destructive policies and slavish efforts to aid the wealthiest and most politically powerful at the expense of the best interests of America and its people. He is passionate about these subjects and far less predictable than many of his peers because he is not a political partisan.
In finance, the most important question is why we suffer recurrent, intensifying financial crises. That question is really two questions. Answering it requires that we determine what causes our crises and why we fail to learn from these crises, but instead make the incentive structure ever more perverse after each crisis. Anyone from a finance background is likely to conclude that perverse incentives cause financial crises, so I was surprised by Ratigan’s choice of book title (“Greedy Bastards”). I think that greed is unlikely to have changed greatly over the last quarter century in which the U.S. has suffered three recurrent, intensifying financial crises.
I don’t call people bastards, even the self-made ones, because my mother reacted poorly to Speaker Wright referring to me as the “red-headed SOB.” Ratigan’s view on these points turns out to be similar to mine. He argues that the issue is not greed, but perverse incentives. When CEOs have incentives adverse to the public and their customers they tend to act on those incentives and harm the public and their customers. This observation is one of those essential points so often overlooked by writers about this crisis. A CEOs’ principal function is creating, monitoring, and adjusting the corporation’s incentive structures. There is a massive business literature on this function and CEOs uniformly believe that incentive structures for officers and employees are critical in shaping their behavior.
There is only one (disingenuous) exception to this rule – when officers and employees act criminally because the CEO has created perverse incentive structures. Suddenly, the CEO is shocked that his officers and employees acted criminally in response to the CEO’s incentive structures that encourage criminal conduct. Ratigan focuses on precisely this exception. Anyone that has had the misfortune to listen to compulsory business ethics training by his or her employer will have learned that the key is the “tone at the top” set by the CEO. True, but that always ends the discussion. No employee is going to be trained by his employer as to what to do when the tone at the top set by the CEO is pro-fraud.
As Ratigan demonstrates, our most elite financial CEOs typically created and maintained grotesquely perverse incentive structures that encouraged their officers and employees as well as “independent” professionals to act criminally in a manner that harmed customers, the public, and shareholders – but made the controlling officers wealthy. Is there any CEO of a lender incapable of understanding that when the loan officers and brokers’ compensation depends on volume and yield – not quality – the result will be catastrophic? Is there any CEO of a lender incapable of understanding that if the loan brokers’ fees depend as well on the reported debt-to-income and loan-to-value ratios and the broker is permitted to make liar’s loans the result will be that the brokers will engage in endemic, severe inflation of the borrowers’ incomes and their homes’ appraised values? Is there any reader that doubts that the CEOs intended to produce precisely what their perverse incentives were certain to produce? A CEO cannot send a memo to 50,000 loan brokers instructing them to inflate appraisals and use liar’s loans to inflate the borrowers incomes’ but he can, and does, send the same message through his compensation system. Each of these perverse incentives produces precisely the result that the CEOs expected and desired.
Ratigan gets right two of the essentials to understanding why we suffer recurrent, intensifying financial crises. First, cheating has become the dominant strategy in finance. Second, cheating is dominant because finance CEOs create such intensely perverse incentives that fraud becomes endemic. The Business Roundtable (the largest 100 U.S. corporations), had to react to the Enron era frauds. It chose as its spokesperson a CEO who embodied the best of American big business. This was the response he gave to Business Week when their reporter asked why so many top corporations engaged in accounting control fraud:
“Don’t just say: “If you hit this revenue number, your bonus is going to be this.” It sets up an incentive that’s overwhelming. You wave enough money in front of people, and good people will do bad things.”
How did the CEO know about the “overwhelming” effect of creating incentives so perverse that they would routinely cause “good people [to] do bad things”? He knew because he directed and administered such a perverse compensation system. An SEC complaint would soon identify that compensation system as driving accounting control fraud at his firm. His name was Franklin Raines, CEO of Fannie Mae.
What Ratigan does in this book that differs so importantly, and accurately, from nearly every other account of the crisis by a prominent writer is to say in plain English that our most elite financial institutions caused the crisis, that they did so because their controlling officers caused them to cheat, and that the senior officers cheated their own shareholders for the purpose of becoming wealthy.
Ratigan shows that the self-described “productive class” is actually a group dominated by “greedy bastards” who win by cheating. As George Akerlof and Paul Romer said in their famous 1993 article (“Looting: the Economic Underworld of Bankruptcy for Profit”), accounting fraud is a “sure thing.” Ratigan shows that while looting begins with accounting fraud it ends with tax fraud, political domination and scandal by the wealthy frauds, and crony capitalism. Indeed, Ratigan shows how far we have fallen since 1993. Fraudulent CEOs who control systemically dangerous institutions (SDIs) can now become wealthy by looting, cause the SDI to become insolvent, get bailed out by their political lackeys, resume looting, pay virtually no federal income tax, and do so with nearly complete immunity from prosecution. He shows that rather than being “productive”, the greedy bastards are destroying America’s middle and working classes, hollowing out our economy, and destroying wealth and employment.