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John Fullerton

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Financial Statesmanship for a New Economy

Posted: 03/21/2012 3:30 pm

Reactions to departing Goldman derivatives salesman Greg Smith's "Why I am Leaving Goldman Sachs," which appeared as an op-ed in the New York Times last week, have ranged from the hyperbolic -- Robert Reich's "If you took the greed out of Wall Street, all you'd have left is the pavement" -- to the addicted -- Mayor Michael Bloomberg's "we need their taxes" (my paraphrase).

Both views are problematic, as I will address. But first, some historical context:

Wall Street has always been rife with conflicts of interest. Avoiding all conflicts of interest would destroy the lucrative integrated banking business model, so Wall Street has long proclaimed "we don't avoid conflicts, we mange them." Clearly, that no longer works.

During the nearly twenty years I spent at JPMorgan (previously known as the Morgan Guaranty Trust Company of New York), the strong and principled leaders on Wall Street -- names like JPMorgan's Lew Preston and Dennis Weatherstone, Goldman's John Whitehead and John Weinberg, and Lazard's Felix Rohatyn -- acknowledged these conflicts and took great pains to manage their firms' affairs in such a way as to avoid even the appearance of conflicts of interest in their dealings with clients, regardless of the forgone revenue opportunities. These leaders were financial statesmen, role models for a generation.

I stayed at what we now call "the old JPMorgan" (prior to the merger with Chase in 2001) for nearly two decades because of culture. It was far from perfect, but the firm had a special culture that demanded integrity and valued teamwork. "Only first class business, and that in a first class way" was a famous saying of J. P. Morgan, Jr. It is interesting to read the full context of this statement, still posted on Morgan's website to this day.

I wonder what happened to the belief that banking is a profession, as Morgan believed, rather than "just a business" as it is today. There was an arrogance about the culture of integrity at the firm when I had the privilege to work there, but it was real. I think it was also quite unique on Wall Street. But in fairness, we were served a lot of Kool-aid.

When I started my career in the 1980's, JPMorgan Chairman and CEO Lew Preston had a saying that was etched in the minds of all of us young bankers and was passed on for years after Lew's departure in cult-like fashion:

"When we make errors, let us be sure they are errors of judgment, not errors of principle."

There are no financial statespeople like Lew Preston or John Whitehead on Wall Street today, able to see that the colossal firms they oversee have become too big and complex to manage or govern. They systematically exploit conflicts of interest to the extent they can get away with it, as a central component of their business models. As society fully understands, these firms are incompatible with a resilient financial system that serves the long-term needs of the real economy. The servant has become master, confusing means with ends.

But this does not mean that there is nothing on Wall Street above the pavement but greed, now or in the past, as Robert Reich suggests. There are many smart, hard working, honest people working in a system they did not create, nor particularly like. Some will walk away when they feel they can. Some like Greg Smith will leave with a bang. Many will carry on oblivious to the inevitable consequences of the system.

There is no going back, too much has changed. And much of what's currently wrong has always been there, yet on a smaller scale and therefore less dangerous to society as a whole. Looking forward, I can imagine three potential outcomes:

Financial Statespeople emerge into leadership positions on Wall Street and lead these firms to a sustainable position serving the real needs of an economic system in profound need of transformation. In a letter exchange I had with Lloyd Blankfien back in 2009, I offered up such a proposal for Goldman in what I called the "Goldman Sachs Historic Restructuring Speech". While I never expected Blankfein to have the courage to follow my (unsolicited) advice, I also never could have imagined that he would subsequently embarrass himself and the entire industry trying to defend a truly sinister transaction like "Abacus" in front of the US Congress.

A second outcome where governments restructure the industry by placing hard lines that eliminate the biggest conflicts of interest while downsizing the speculative casino to the safe side show it should be appears equally unlikely at this time. But it remains a possibility, even if politically unlikely given Wall Street influence in Washington.

The third and unfortunately most likely outcome is that the bankers win in the short term and we continue to subsidize what are otherwise unsustainable business models and the bonuses they throw off, making it hard if not impossible for healthy alternatives to emerge at a scale that matters. In fact, the regulations imposed will have the perverse affect of making it even harder for new entrants to compete away the business of the entrenched due to the high compliance costs that only the giants can absorb. In this scenario, we inevitably drive headlong into the next financial crisis with further economic violence done to people in the real economy.

Which finally brings us back to Mayor Bloomberg's "we need the tax revenues" reaction. Bloomberg has been a good mayor in my opinion, perhaps a great mayor. He is a strong leader. Yet his response reveals how much trouble we are in, particularly looked at from a financial center like New York (or London), but also true when looked at from the unsustainable underfunded pension obligations of many states in the union. We have become addicted to speculative finance to achieve unsustainable financial returns to keep the entire system from imploding under a mountain of unserviceable liabilities right at the time when resource constraints will make it harder for the developed economies to grow out of these debts, debts made far worse by the inevitable crashes that the unsustainable system perpetuates.

It's time for financial statesmanship to emerge on Wall Street. Surprise us.