Demonising Wall Street

From the Economist:

At a hearing in February a Congressman addressed JP Morgan Chase's boss, Jamie Dimon, as "Mr Demon". Deliberate or not, it captured the mood.

I guess you could say that, on Wall Street, such CEOs come a Dimon-a-dozen.

Incidentally, Oliver Stone is planning a sequel to his movie,"Wall Street", that features an institution resembling Goldman Sachs. It is due in cinemas next spring. Hopefully, with the recovery gaining ground by then, it will run to full houses.

Reforming b-schools

The debate continues. The Schumpeter column of the Economist has some suggestions:

So what should business schools do to improve their performance? More history classes would help. Would-be business titans need to learn that economic history is punctuated with crises and disasters, that booms inevitably give way to busts, and that the business cycle, having survived many predictions of extinction, continues to prey on the modern economy.....

History courses aside, business schools need to change their tone more than their syllabuses. In particular, they should foster the twin virtues of scepticism and cynicism....

The original sin of business schools is boosterism. Professors are always inclined to puff the businesses that provide them, at the very least, with their raw materials and, if they are lucky, with lucrative consultancy work.....Business schools need to make more room for people who are willing to bite the hands that feed them: to prick business bubbles, expose management fads and generally rough up the most feted managers. Kings once employed jesters to bring them down to earth. It’s time for business schools to do likewise

What to make of these suggestions?

History lessons? You mean to say the people who ran Bear Stearns and Lehman had not heard of booms and busts? Scepticism and cynicism? You could argue that the latter has a tendency to triumph over the former. Why be sceptical about financial engineering products when you can make money at somebody else's expense? B-schools do not need to foster cynicism. Their faculty and students have this quality in abundance.

I agree with the third point, about boosterism at b-schools. Faculty writing great stories about organisations that provide them the material, consultancy, and, in some cases, chair professorships. This is a serious governance issue for the boards of b-schools, it is not a matter that concerns only faculty.

Sibal takes on the IITs

NDTV had a debate featuring the president of the IIT faculty federation, Dinesh Mohan, professor at IIT Delhi and Mohandas Pai of Infosys. I had meant to report this on my blog but Abi has pre-empted me with a detailed account.

There are just a couple of other points made by Dinesh Mohan that I would like to highlight. Mohan said he had taught in European and American universities and that the degree of autonomy he had at IIT Delhi was far more than was available in those places. So much for the talk of infringement of 'autonomy'. Yes, Sibal knocked the stuffing out of the IIT faculty's arguments with the strident declaration that the protest was not about 'autonomy' but money.

Mohan made another point that I had made myself in my post on the Yash Pal report: partly, the faculty shortage at elite institutions is the result of senior faculty not being receptive to quality talent coming in.

Let me add: both the IITs and IIMs have used the 'autonomy' argument to gain public sympathy whenever they are at the receiving end of criticism or when government has attempted to look closely into their affairs. As somebody who has been part of the IIM system, I can vouch for what Dinesh Mohan has said: you cannot have greater academic freedom than is available currently in the IIM system. At no point has government made the remotest attempt to infringe such freedom. Moreover, there is virtually no funding constraint on academic exploration, the problem that cripples research at universities.

I do believe that the IITs and IIMs offer the fullest scope possible for faculty to develop themselves as academics. Not only that, we are free to express ourselves on matters of public policy and often find ourselves taking positions contrary to those of government or public authorities and even criticising government. We must give government credit for making this possible.

My greatest fear is that it is the withdrawal of government from these institutions that will threaten academic freedom because then academics would become more subject to the control of management and the boards. Boards in which government representatives are present have never prevented us from expressing our views. But boards in which government is absent and that are run by people from the private sector well may.

Being part of government makes for true academic autonomy in other ways: you have job security; the institutions come under the writ jurisdiction of High Courts, so there is easier recourse against mala fide actions of management; and then there is the whole range of supervision and protection afforded by coverage under CAG, CVC and the RTI Act.

I come back to my old argument: putting in place a governance structure with checks and balances that will adequately substitute the benefits conferred by government presence cannot be done overnight; it has to be a slow and gradual evolution and it has be fully tested before we can contemplate government withdrawal. A governance vacuum in the IITs and IIMs caused by precipitate government withdrawal is for me the ultimate nightmare.

Bonus for IIT faculty

IIT and IIM faculty have been asking for more...... well, not quite like poor Oliver. IIT faculty have planned a hunger strike for September 24. Indian Express reports that IIT directors are seeking to head off the crisis by offering a performance-linked bonus:

Directors of the Indian Institutes of Technology (IITs) are fine-tuning a Performance Related Incentive Scheme (PRIS) which they are expected to place on the table later this week to defuse the stand-off with protesting faculty across all seven IITs.

Under this, an incentive equivalent to “two to four months of salary” could be offered annually to faculty depending on their performance which will be quantified on key indicators.

This is a terrible idea. There is a sufficiently large literature on incentives that casts doubt on the efficacy of these even in a corporate context. In academics, such schemes can play havoc with the very culture of academia.

Leave aside the measurement aspect. You produce high quality work in academics because you are driven by intellectual curiosity- not because you hope to get two months' bonus. Pecuniary rewards can come in other, more satisfying ways- sponsored reserach, consultancy, high value awards for outstanding work, royalty on books, patents, etc.

How many great academic institutions in the world have performance-linked bonuses? Top academic institutions have variable increments that are linked to performance. Your base salary itself can move up sharply based on work done- and that translates into extra pay over the rest of your career. There is nothing like extra pay for a given year- which is what bonuses are about.

The Sixth Pay Commission had suggested the cautious introduction of performance-linked incentives in government. The suggestion has not taken off because of the difficulty in implemting such schemes in government. Why should government make an exception in the case of government-run academic institutions?

I am surprised that IIT directors should have thought up such a scheme.

B-schools after the crisis- business as usual?

There was much talk in the early months of the present crisis of b-schools doing deep introspection into their goals and pedagogy and coming out with a radical revamp. What has actually happened? Not much, according to the Economist. Even as the world recovers from the crisis, b-schools, it appears, will carry on as usual, with some cosmetic changes to take into account the crisis.

Most (b-schools) have settled for modest adjustments. Columbia Business School in New York, for example, set up a faculty committee that delved into every aspect of the MBA programme. But it is introducing just two new modules—on the future of finance and the collapse of the auto industry. At Thunderbird School of Global Management in Arizona, too, there is to be no ripping up and starting afresh. Instead, students on the Global MBA course are to be brought together at the end of the programme for a final module on global citizenship.

Instead of radical change, there will now be attempts to incorporate the crisis and its lessons in various courses, as required. That is normal. The East Asian crisis is part of courses in economic development. LTCM is standard fare in courses on financial institutions and markets.

Randall Kroszner, a former governor of the Federal Reserve and an economics lecturer at Chicago University’s Booth school, agrees that his MBA students will notice a change of emphasis, if not a radical new curriculum. “If I just taught my money class as I did four years ago I wouldn’t have the same emphasis on the housing market or the inter-connections between the banking and non-banking financial systems. I touched on it, but one would be foolhardy not to put a new emphasis on it.”

Monetary policy is another example. Five years ago, the theoretical possibility of a zero lower bound on interest rates may have been mentioned in passing, but most students saw it as such a low-probability event for most developed countries that they didn’t pay it much attention. Now it is a real issue that affects business decisions.

Anthing else? Well, there is talk of greater focus on "soft skills". But this can only give those familiar with b-schools a sense of deja vu......

Bank consolidation

There is a revival of talk about bank consolidation. The chairman of SBI, Mr O P Bhatt, wants Indian banks to grow bigger. Mr Bhatt has been quoted as saying: “The size of Indian banks is not good enough, we need to consolidate....Even SBI is not large enough to serve Indian corporates”. Mr Bhatt thinks there should be at least two to three banks bigger than SBI and half a dozen banks the size of SBI in the country.

I have been sceptical about bank consolidation in India for quite some time. I reiterated my doubts in my recent ET column, Beware of bank consolidation. Earlier, my concern was about the HRD issues: did management of Indian public sector banks (PSBs) have it in them to manage mergers? Making a success of mergers has been a challenge to top management even in advanced economies where there is freedom of hire and fire. In India, where this is difficult and so is closure of branches, I would reckon that mergers would stretch top management for several years. It would prove a major distraction from other tasks that need urgent attention.

Now, after the recent financial crisis, I have an additional concern: the systemic risk posed by largeness. Better, on balance, to have a number of small banks competing with each other instead of having a few 'systemically large' institutions- except where banks are so small as to lose out on scale economies. The larger the bank, the greater the difficulty in managing it. Moreover, consolidation can work to the detriment of the customer. Lastly, you have to make out a case for merger, saying: look, I have made the most out of my present size, I need to get larger in order to sustain earnings growth.

I doubt that many PSBs can make this case. They have failed to get the most out of their existing size. As for SBI itself, it is large as it is. It doesn't have to get larger by gobbling up its subsidiaries, many of which have done better than SBI.

Incidentally, I read in one paper that SBI's proposed merger with State Bank of India has been held up by the finance ministry because of concerns about the malign effects of consolidation.

Small banks, manageable banks

I wrote earlier that we needed banks that idiots could manage and this meant that banks should not become too large or complex. The Economist carries a profile of a successful East European bank wherein the banker talks about the virtues of being small. The bank is Erste Bank,Austria's second biggest. Its CEO says banks should stay small because they can't attract the best talent, only mediocre people.

People who want to make a lot of money fast go to work in investment banks, but people who work in commercial banks are pretty average people," says Mr Treichl in an office so understated that it almost seems calculatedly so...."We should not think we can invent something brilliant. If we could we would be working somewhere else,"he says of the exotic credit derivatives that spread risk, like a contagion, through the financial system.

The banker also points to the difficulties in managing large banks, sprawled across several countries.

If you run something like Citi how the hell do you know what's going on in Poland if you only go there every three years?" he asks. "This is very much a people business. I need to touch and smell and feel what's going on."

Very true. But I would question the presumption that because investment banks attract brighter people, they can afford greater risks. If this were true, then Lehman, Bear and others would not have gone under. The problem is two fold. First, firms that are beyond the capability of even the brightest to manage because of their sheer size. Then, the problems of excess leverage, which create incentives to take excess risk that even the brightest are not immune to. Greed is not something that bright people are free from.

Should IITs and IIMs become universities?

Yes, says the recent Yash Pal committee on higher education. I say: no. The IITs and IIMs have serious work to do in their respective fields, engineering and management, and cannot afford to fritter away energies in diversifying into unrelated fields. More on this in my ET column, IITs and IIMs:Yash Pal is wrong.

The Yash Pal committee also takes too benign a view of governance at IITs and IIMs. On the hierarchy of governance, the committee places universities, IITs and IIMs in an ascending hierarchy. Now, it's true that IITs and IIMs have done a better job than universities. But that doesn't mean they have no governance issues. The IITs and IIMs have become high quality teaching institutions, thanks, in large measure, to generous financial support from government and the benefits of exclusivity in a highly uncompetitive Indian market for higher education.

I argue in my column that, to progress further, they need substantial improvements in governance and accountability. The composition and performance of their boards is one area that cries out for reform. The Bhargava committee noted that the IIM boards tended to reduce their roles to one of providing routine administrative approvals.

The most important function of a board is to lay down performance objectives for top management and to measure performance against objectives. How many IIT and IIM boards can claim to have done this? Somewhere along the line, many have forgotten that boards don't exist in order to approve canteen contracts.

I would add: there are limits to the effectiveness of board monitoring. We have seen this in the corporate world and must not expect anything different from academic board. The difference is that companies are subject to the discipline of the market place in a way in which academic institutions are not- certainly not, institutions of higher education in India.

America has a reasonably competitive market for higher education.Yet, it has state universities of high quality. In India, the government cannot afford to withdraw from public institutions until a more competitive market has evolved. For the same reason, board monitoring at the IITs and IIMs will not suffice. There must be periodic, external audits commissioned by an Appointments Committee for Higher Education that I propose.

The Bhargava committee provided an overview of the functioning of the IIMs. The government must now ask for detailed, institute-specific audits for the older IIMs and IITs. These audits must be based on extensive interactions with all stakeholders, not written documents provided by the institutions. There are private schools in the west that have subjected themselves to such an audit on their own. One b-school I know has benefited enormously from external audit is Toronto's Rotman School of Business which has moved up in the international rankings quite a bit over the years.

Do we need mega banks?

I had a post earlier on the problems posed by large banks and I proposed then that we may need to impose a regulatory cap on bank size.

I find that this proposal is being mooted by some very illustrious names and indeed is gaining some momentum- although I doubt that large banks, with their political clout, will allow the proposal to fructify. In an article in ET, Joseph Stiglitz writes:

We need to break up the too-big-to-fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others. And, if we don’t break them up, then we have to severely limit what they do. They can’t be allowed to do what they did in the past — gamble at others’ expenses.

Much the same is echoed by Henry Kaufmann, a much respected figure on Wall Street. In his book reviewed in the latest Economist, Kaufmann is quoted as warning against the dangers of consolidation forced on the financial sector in the wake of the crisis and the problems posed by large banks:

Driving the weak into the arms of the strong may have been expedient, but it swelled the oligopoly of financial conglomerates deemed too big to fail.

Mr Kaufman draws a convincing link between this consolidation and greater market vulnerability. He sees two possible roads to reformation: dismantling the monsters or curbing their riskier activities to the point that they become public utilities, too safe, rather than too big, to fail.

So, if you can't limit the size of banks through regulatory fiat, then you have to limit the nature of their activities. My own view is that the former is,perhaps, the lesser evil. But, a former deputy governor of the Bank of England, John Gieve, quoted in FT, thinks the latter is preferable:

Sir John (Gieve) doubts that policymakers can set an optimum size for financial services, but suggests the industry could be subject to the sort of economic regulation applied to other utilities, such as telecommunications.