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Corporate Governance Viewpoints

Days of Reckoning

by Sir John Stuttard


Sir John Stuttard has spent his career with accountants, PricewaterhouseCoopers, of which he is now a vice-chairman. He has focused on auditing, acquisitions, stock exchange listings, and privatizations for UK, US, and Scandinavian companies. He was made a Knight, and then a Commander, of the Order of the Lion of Finland, and has been Chairman of the Finnish–British Chamber of Commerce. He served in the Cabinet Office for two years and spent five years in China as PwC executive chairman. He has also been a director of the China Britain Business Council. He is currently a trustee of Charities Aid Foundation and of Morden College, a governor of King Edward’s School, Witley, and on the board of other charities. He served as Sheriff of London in 2005–2006 and Lord Mayor in 2006–2007.

The Blame Game

When something goes wrong, regrettably, I’m afraid it’s human nature to point the finger at someone else. All too rarely does one admit responsibility and a share of the blame.

Back in the late summer of 2007, when it was clear that many financial institutions were facing difficulties, the first group to be attacked was the credit rating agencies. In September that year, European Union Commissioner Charlie McCreevy criticized credit rating agencies such as Moody’s and Standard & Poor’s for their conflicts of interest and poor methodologies. European Central Bank president Jean-Claude Trichet joined in.

Then the focus switched to the regulators, particularly after Northern Rock in the United Kingdom had to be bailed out by the government. It was unusual and refreshing, therefore, to witness the United Kingdom’s Financial Services Authority publish two separate internal reports criticizing itself for shortcomings caused by frequent changes in senior staff, inadequate review and discussion of findings, and failure to engage properly with Northern Rock.

Towards the end of 2008 and during the first two months of 2009, the criticism has been directed at bank executives, with their large bonuses, and to the nonexecutive directors who, it is alleged, should have exercised better corporate governance.

So who actually is to blame for what happened and what needs to be done to limit the possibility of it happening again? To begin with, we should all have seen it coming. Large trade surpluses in China and the Gulf countries generated huge foreign exchange reserves, which were typically invested in US Treasury bonds and Eurobonds, leading to inflated credit in the global financial system and the lowering of real interest rates.

This cheap, available money led to an extension of credit around the world. At the same time, investors were searching for higher yield and financial institutions became even more imaginative at creating new financial instruments. Financial activity exploded with, for example, the value of outstanding credit default swaps increasing from almost nothing in 2000 to over US$60 trillion in 2007. Gearing by financial companies increased tenfold in the period 1987 to 2007 and household debt doubled.

Was it surprising, therefore, that the bubble eventually burst? When there is too much credit in the system and when the price of borrowing does not reflect the intrinsic risk, there is bound to be a day of reckoning. And the fallout has been simply devastating for many.

Our global institutions, our governments, and many economists seemed content to allow agreeably high levels of economic growth to continue without spotting the thunder clouds gathering. And the media, usually so quick to criticize, didn’t blow the whistle either. We were all riding on a cloud of hubris.

The Role of the Regulators

And what of the regulators? A major problem is that our financial companies have become global, whereas financial regulators are, for understandable national reasons, predominantly national. And they each have their own structures and methodologies when it comes to regulation, just like different religions.

For example, in the United States there are many regulators for different parts of the financial sector and there is an insurance regulator in each state. In Britain, there is just one, the FSA, and in many other countries, such as China, there are three.

But the philosophies and methodologies are also very diverse. The French, the Germans, and the Chinese are very prescriptive. Their form of regulation is rules-based. Yet, America was very liberal and flexible in its approach. In his book The Age of Turbulence, completed in June 2007 when the crisis was brewing but not yet fully upon us or recognized, Alan Greenspan, formerly Chairman of the Federal Reserve, wrote: “Public sector surveillance is no longer up to the task,” and “We have no sensible choice other than to let markets work.”

I was concerned to read this. While the capabilities of financial regulators to provide oversight have indeed diminished in recent years because of the complexity of financial markets, regulators are appointed by governments to protect people and to protect economies from systemic failure, as well as fraud.

But then much of the blame must be laid at the door of those banks that took the greatest risk or did not test their strategies and their business models, or made acquisitions at high prices. Lehmans is no longer with us and others such as the Royal Bank of Scotland are, effectively, in state ownership. Bankers have apologized. The finger has also been pointed at nonexecutive directors for allowing such risks to be taken on their watch.

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