Bear Stearns, Enron, and Some Confusion About Trust
Is there such a thing as an inherently trust-based business? Houston Attorney Tom Kirkendall, who writes a blog called Houston’s Clear Thinkers, seems to think so.
In a provocatively titled post called That Pesky Trust-based Business Model, Kirkendall writes:
"The fact of the matter is that Enron was — and Bear Stearns and AIG are — trust-based businesses that fundamentally depend on the trust of the markets to sustain their value. Once that trust is lost, such companies lose value quickly and dramatically. "
I’m not so sure about that. Presumably he means most financial businesses are leveraged—they lend out, or put to work, considerably more money than their base capital. And as long as people trust them, it works If they lose that trust, well, that’s when you get a run on the bank. That’s what I understand Mr. Kirkendall to mean, anyway.
But try shouting "roaches!" in a restaurant. What happens to Wendy’s stock price if someone finds a finger in a bowl of chili? What happens to a pharmaceutical company if someone finds a tainted pill bottle? What happens to a toy company if it’s found to have imported toys made of hazardous materials? What happens to a securities-rating agency when AAA-rated securities turn to junk in months?
I haven’t thought this through fully yet, but the idea that some businesses may be structurally more "trust-based" may be a distinction without a difference—or at least one of degree only.
What is clear to me is that all businesses can be run in a trustworthy manner—or not.
For example, when the CEO of Bear Stearns, Alan Schwartz, said on CNBC on the morning of March 12 that the firm’s liquidity was fine, a Bear Stearns shareholder might reasonably “trust” that the firm wouldn’t lose billions and implode in about four days.
Back to Kirkendall, who goes on to say:
Although unfortunate for the owners of such companies, such a dramatic loss of wealth does not necessarily mean that any criminal conduct caused or was even involved in the loss. Rather, such loss is simply one of the risks of investing in a company based on a trust-based business model.
Granted criminality is not the only warranted deduction. There is also venality that hasn’t been outlawed. And, most common of all, garden-variety incompetence with its handmaiden hubris.
Here’s what mega-investor Saudi Prince Alwaleed had to say just a few months ago about former CEO Chuck Prince’s similar situation at Citibank:
You cannot come to the public and say that this normalization is expected in the fourth quarter and then three weeks later, not three months later, you come and say there is an $11 billion writeoff. This is unacceptable. That’s when the events changed completely. My backing was withdrawn dramatically.
You should never commit to something that you can’t deliver. Never…I am extremely disappointed with Chuck Prince and I believe that Chuck Prince let down the shareholders completely.
Both CEOs Prince and Schwartz said one thing, clearly and confidently—and were very quickly proven either liars or incompetents. Schwartz just got there a lot faster.
Alwaleed considers this patently unacceptable. Kirkendall considers it “simply one of the risks.”
But where is Kirkendall going with all this?
The sooner we all recognize and understand this risk — and avoid the mainstream media’s promotion of myths about them — the quicker we can put a stop to injustices such as this while advancing the discussion of how best to hedge the risk of such potential losses.
I’ll save you the trouble of clicking through the links. The “myths” he is talking about are that "myth" that Enron was about criminal behavior, rather than prosecutorial misconduct. Enron investors could have and should have shorted Enron (true enough). Kirkendall seems to think this is all part of a conspiracy, that Skilling has been unfairly demonized. He says, “I continue to hope that Jeff Skilling’s unjust conviction and sentence are reversed on appeal, not only for his and his family’s benefit, but also for ours.”
O-kay. That’s one view. Here’s another, from someone with standing:
Jeff was indeed the "smartest guy in the room" and a micro-manager to boot—which certainly made it clear to me that the idea that he was unaware of details of his subordinates’ affairs was utterly absurd. Likewise the idea that he was ignorant of the shades of gray and then black concerning the border between legal and illegal market manipulation insults his intelligence. So I guess I conclude "beyond a shadow of a doubt" that the prosecutors and the jury got it right.
That’s by Tom Peters. Tom knew Skilling because he worked with him. Read Tom Peter’s full post on Skilling, Lay and Enron here. It’s enlightening not just about Enron and ethics, but about what a real trust-based business looks like. Tom believes in Cowboy Capitalism. He also believes that those in charge bear some responsibility to those who entrust them with their money. Tom Peters, in my book, does Clear Thinking.
It strikes me as disingenuous at best to describe some business models as "trust-based," and to then use that as a facade for an argument against the accountability of those who are chosen precisely for their ability to navigate treacherous waters and who are paid handsomely for their doing so. If there is no line to cross, then there is no such thing as ethical behavior. And if there is a line, someone’s likely to try crossing it. C’est la vie.
The key issue isn’t whether a business model is "trust-based." It’s whether we can put our trust in the people running the business.
You will note a sidebar to this: saying that everything is fine on Wednesday and having your company sold out from under you on Friday means you clearly don’t have a clue as to what is happening in your own company!
It’s not just the trust in the people that matters, but also whether these people are even competent enough to understand the dynamics of their company before they speak.
Not being competent blows the trust almost immediately; the rest is simply dessert.
As always, Charles, another great post.
I couldn’t agree more, Scot.
Actually, come to think of it, I could.
There’s one thing worse than incompetence, and that is being unconsciously incompetent. It’s one thing to be running around with a loaded weapon; it’s quite another not to even know it.
Unless these people were consciously criminal (possible, though I’m not convinced), they actually thought they knew something–when they didn’t.
That’s bad enough in the day to day world. When a CEO does it, it’s way worse–because by any definition of the word, that is the person who is supposed to be the one in charge, the one at whom the buck stops, the one accountable for all others.
Unconsciously incompetent–not good.
As you point out, there is an element of trust to all businesses, both in the markets and the financial system. We’d still be living under a barter system otherwise. The “clear thinking” forgets that all service industries are inherently trust based. You mention the restaurant example, but also consider every thing from a doctor’s medical advice to getting a haircut – as soon as your customer thinks something might go horribly wrong, your business is at risk of dying. To be fair, the thing that is unique about finance is the speed at which all your customers can react, rather than just the people in the room.
But unlike justice (and market mechanisms), trust should never be blind. Therefore a CEO’s most important job is to maintain that trust. Misleading the public to the extent cited in your examples is both an abuse of trust, and behaviour as negligent as might be found in a medical malpractice suit. Talking about “criminal conduct” is a strawman argument – it is also possible to be found guilty in civil courts. I wonder whether there shouldn’t be a mechanism to impose punitive damages upon a CEO or other executive in such clear cases of misleading the public, and actually being the cause of the loss of trust rather than merely being its innocent victim