For the past year, as the nation has engaged in a heated debate about how we got into the current financial mess and how we're going to get out of it, there's been one group noticeably missing from the conversation: leaders of the big Wall Street firms. At a time when it was most needed, industry leadership has been nonexistent.
Until now. In a speech last week in Washington to the Council of Institutional Investors, Lloyd Blankfein, the chairman of Goldman Sachs, took the first trip through the public confessional, acknowledging that "the past year has been deeply humbling" for an industry that held itself out as expert but took actions that "look self-serving and greedy in hindsight."
Explaining why the industry failed to understand the risks it was taking, Blankfein identified the kinds of rationalizations that people latched on to: the growing strength of emerging markets, the plentiful supply of liquidity and the availability of new risk-hedging instruments. He acknowledged that too much faith was put in risk models that turned out to be badly flawed and that the size of the firms and the complexity of the financial instruments had been allowed to grow faster than the "operational capacity to manage them."
To make sure it doesn't happen again, Blankfein called for stepped-up regulation of banks and even hedge funds. He also laid out spot-on guidelines for industry bonuses.
Okay, so it's not exactly up there with the confessions of St. Augustine, but it's a start.
There are some glaring factors, however, that Blankfein, like other Wall Street leaders, tends to overlook.
The most important is culture — in the case of Wall Street, a culture that not only tolerates but almost celebrates taking advantage of customers. Here is an industry in which brokers traditionally get their start making cold calls to strangers, offering bogus stock tips, and investment bankers cut their teeth peddling bad merger and acquisition ideas to corporate clients. It is an industry in which the majority of money managers consistently underperform the broad market averages, analysts and strategists are almost always bullish, and firms rarely run into a security that can't be brought to market. These days, the trading culture has supplanted the investment culture on Wall Street.
Until it deals with this blind spot, it is likely to careen from one crisis to another.
Blankfein also makes the common mistake to think that the problem with compensation has only to do with how the pay is structured and not with the overall level of pay. No matter how it is structured, pay at such astronomical levels has a tendency to inflate egos and tempt people to take undue risks of all sorts, ethical as well as financial.
Of course, the industry has a lot of money to lavish on the political process in ways that undermine regulation. There are regulators in Washington who have been reluctant to rein in the industry out of fear that they would be thwarted by the White House, the Treasury and key members of Congress acting under pressure from the industry.
It's all good for Blankfein to call for better regulation. But regulators are unlikely to do much better during the next bubble unless we can find better ways to insulate them from Wall Street's out-sized political influence.