Anna Bernasek's Blog

American banks try to pass the buck

2012-01-28T16:35:00.000-08:00

Australian Financial Review

PUBLISHED: 28 Jan 2012

Anna Bernasek New York

What’s on Wall Street’s mind right now? It seems to be regulation. Listen to any banker in the US lately and it sounds like regulation is killing them. But take a look at the evidence.

US banks have just reported earnings for 2011 and, at first glance, there is some cause for concern. Acknowledged leader Goldman Sachs’s net income was cut in half in 2011, compared with the previous year. Bank of America, the biggest bank by assets, barely broke even. Without the benefit of a tax provision, BoA would have lost money.

But digging a little deeper into recent numbers tells another story. Those regulations may not be hurting US banks as much as bankers would like you to believe.

Take a look at the strongest big bank, JPMorgan Chase. Its head, Jamie Dimon, has been an outspoken critic of regulations. Since last summer he has openly feuded with global financial regulators about new international capital standards.

Dimon reiterated his criticism of tighter bank rules at JPMorgan’s earnings announcement last week. “Regulatory policy is completely contradictory to government objectives,” he said.

In particular, Dimon singled out two areas of regulation he believes are bad: bank capital rules and restrictions on trading.

But if regulations are hurting so much, why are JPMorgan’s earnings so strong? For the full year, JPMorgan reported a record profit of $US19 billion. That’s up a healthy 9 per cent from the previous year. But it’s also about 25 per cent higher than in 2006 and 2007, when the market was sizzling and today’s regulations weren’t even on the radar.

To be fair, JPMorgan is bigger than it was in 2007 and has to maintain more capital. But other measures of profitability show the bank is not far from boom-time levels. Pre-tax earnings were 28 per cent of revenue, only a shade less than in 2006-07. In this new era, it is turning out results comparable to its best years.

Dimon may have a point on some regulatory details, but in the big picture he’s not getting hurt. For a well capitalised giant such as JPMorgan, it’s clearly possible to thrive under the new rules.

The picture is not the same at the other big banks. Look at Citigroup, for example. According to its latest figures, Citigroup’s profitability is about half what it was during the boom. But the bank’s profitability fell off a cliff in 2007 when its assets and loans problems came to light. That was well before the new regulations kicked in the following year.

For the past two years, Citigroup has turned out steady and growing profits. The fact that they are about half what they were in 2006 probably says more about the bank’s irresponsible practices from the year 2000 on, than about any recent regulatory burdens.

Then there’s BoA, the asset leader. It seems to have some operational and legacy asset problems as opposed to regulatory constraints. The disastrous acquisitions of Countrywide and, to a lesser extent, Merrill Lynch continue to take their toll.

BoA actually showed paper profits in 2008 and 2009, the worst years for its big-bank peers. But throughout 2010 and again in 2011 BoA printed red ink. That doesn’t look like a regulatory problem, especially compared with JPMorgan’s strong results under the very same rules.

So what about the best of the investment banks? How are they faring?

Like Citigroup, Goldman Sachs’s profits have fallen by half. Unlike Citigroup, though, in Goldman’s case the drop is clearly related to regulation. Remember that, to save its skin during the 2008 crisis, Goldman converted from an investment bank to a commercial bank. That brought a whole new set of capital requirements, which more or less directly explain the drop in profitability.

It’s a simple matter of leverage. In the boom era, Goldman’s leverage was about 27 times its equity. Today that leverage is closer to 13 times, essentially cut in half. Investment bankers may make noises about restrictions on proprietary trading and other issues, but it’s no coincidence that profits have dropped in lock-step with leverage.

Morgan Stanley’s numbers tell a similar tale. Profits for 2011 were off 27 per cent versus 2006, while leverage dropped from 32 times to 12 times. Adjusted for leverage, Morgan Stanley seems even healthier than in 2006. There’s just no sign of regulatory strangulation in Morgan Stanley’s numbers.

While everybody misses the profits, the investment banks’ leverage wasn’t healthy for the financial system. At 27 times leverage, it doesn’t take much of a setback to put a company in intensive care. And it is an integral part of the global banking system, then watch out, everyone’s at risk.

On balance, new regulations are not putting banks out of business. What’s more, the financial world is a safer place for it.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity was published in 2010.

Fed pushes Congress for Housing Policy Action

2012-01-21T06:06:00.000-08:00

Financial Review

Published January 21, 2012

Anna Bernasek, New York

US Federal Reserve chairman Ben Bernanke this month sent Congress a report on the housing market urging more policy action. Since then, a rising chorus of Fed officials has reinforced Bernanke’s message in speeches around the country.

Despite “green shoots” in some parts of the American economy, the Fed remains concerned about the effects of continued weakness in the housing sector. Just how big a problem is the housing market?

Housing prices have fallen on average about 33 per cent from the peak in 2006. The last time home prices fell anywhere near that much was during the 1930s. And by some measures at least, the current crash in housing prices is even worse than what happened in the Great Depression. According to the S&P/Case-Shiller home price index, a measure of national housing prices, the average price of a home fell 24 per cent from 1929 to 1933.

As a result of the recent decline in prices, $US7 trillion in household wealth simply vanished, drastically reducing consumer spending. Today the value of all housing assets is about $US14 trillion. It was close to $US21 trillion at the peak.

Falling home prices have a big economic effect due to leverage. A significant fall can wipe out a home owner’s equity and eat away the value of the bank’s mortgage. Analysts estimate that a 10 per cent fall is the typical threshold for those pernicious effects. With home prices falling three times as much, the impact has been unprecedented.

Lots of people are desperate. The Fed estimates that 12 million borrowers owe more on their mortgages than their homes are worth. That represents about one in five mortgages in the US.

In Florida, Nevada and Arizona, where prices have fallen more than the national average, as many as half of all mortgage borrowers owe the banks more than their homes could be sold for.

It all adds up to a whopping $US700 billion in aggregate negative equity, according to the Fed. To put that another way, it would take a 5 per cent increase in prices just to absorb that shortfall, without any gains going to home owners.

About 3.4 million borrowers with negative equity, amounting to $US275 billion, are late or have stopped making mortgage payments. While the remaining 8.6 million or so are still paying, they might stop at any time. That’s a continuing risk for US banks.

Negative equity creates a series of headaches for borrowers. For starters, banks won’t approve refinancing for borrowers with negative equity so they can’t take advantage of record low interest rates when they need it most. Worse still, it ties borrowers to homes and locations that might not offer the best job prospects so it creates a vicious cycle of falling prices, more negative equity and reduced economic prospects. And to top it off, the worst price declines tend to occur where the job market is not terribly strong.

Although the decline in home prices mostly occurred between 2007 and 2009, more recently home prices have begun falling again. As of October, the S&P/Case-Shiller index of property values in 20 cities showed a decline of 3.4 per cent from the previous year.

What worries the Fed is that it has already used its main tool, interest rates, to try to stimulate the housing market, with little visible effect. Mortgage rates are at record lows, with a typical 30-year mortgage priced under 4 per cent. Yet that seems to have had little impact on boosting demand, which would help home prices.

It seems that the banks aren’t eager to lend. The Fed believes there may be a permanent shift under way in the availability of mortgage credit as banks introduce tighter lending restrictions. Americans who would like to refinance their mortgages or buy properties are finding they simply can’t get a loan.

Mortgage applications are at their lowest level in 12 years and the Fed forecasts that home-loan borrowing in 2012 will decline to its lowest level in 15 years.

If the Fed is correct, new lending standards will further burden the housing market as demand is held back while supply continues to flood the market.

The Fed acknowledges that it lacks a silver bullet to end the housing crisis but it has urged Congress to take three steps.

Since rental markets are strengthening, the Fed has asked Congress to reduce barriers to converting foreclosed properties to rental units.

Next, the Fed wants Congress to reduce obstacles blocking people from getting credit.

And finally, the Fed wants Congress to encourage banks to make loan modifications rather than pursuing foreclosures, which are costly and put more pressure on home prices.

The Fed’s recommendations should come as a welcome relief. They rely on rule changes rather than spending money.

So far, though, the response has been lukewarm at best. More than a few Republican members of Congress have told the Fed it has no business trying to affect the housing sector.

For the sake of the economy, let’s hope Bernanke doesn’t give up too easily.

Drug profits are hard to swallow

2012-01-14T15:24:00.000-08:00

The Financial Review

PUBLISHED: 14 Jan 2012

Anna Bernasek New York

On New Year’s Eve, John Capano, an off-duty federal agent, went to his local pharmacy in the middle-class suburb of Seaford, on Long Island, New York, to pick up some prescriptions for himself and his cancer-stricken father.

What seemed like a perfectly mundane Saturday afternoon errand ended his life. A gunman entered Charlie’s Family Pharmacy demanding painkillers and cash.

After the robber left, Capano tried to apprehend him and shot him in the leg before the pair became embroiled in a scuffle. A retired police lieutenant and an off-duty New York City police officer were next to arrive. In the confusion, Capano was shot dead and so was the robber.

A pharmacy robbery in broad daylight is not supposed to happen in the quiet suburbs of Long Island. Seaford is the kind of place to which people moved to get away from all that.

And while much of the public’s attention has focused on the tragedy of the mistaken shooting, the incident at Seaford highlights the disturbing country-wide increase in abuse of prescription drugs. That has fuelled a rise in crime – and bumper profits for pharmaceutical companies cashing in on the epidemic.

The number of deaths from prescription painkillers soared from about 4000 in 1999 to 15,000 in 2008, the Centres for Disease Control and Prevention report.

That’s still less than half the number of road fatalities in the United States in a typical year. But while road deaths have been declining, deaths from prescription drugs have been increasing at an alarming rate.

The Drug Abuse Warning Network says 86,000 emergency department visits in 2009 were associated with the non-medical use of hydrocodone, among the most abused of all the prescription painkillers. That compares with 19,000 visits in 2000.

Prescription drugs are second only to cannabis as the most abused class of drug in the US.

Perhaps most disturbing of all, as drug abuse in the US extends from illegal street drugs to prescription painkillers, pharmaceutical companies are only too eager to find new ways to meet this growing demand.

Four companies – Zogenix, Purdue Pharma, Cephalon and Egalet – say they are developing a potentially more potent form of hydrocodone that could be 10 times stronger than existing medicines. Zogenix plans to file an application for its product with the US Food and Drug Administration early this year.

Hydrocodone is used in combination with a non-addictive painkiller called acetaminophen. Hydrocodone is an opiate from the same family as morphine, heroin, oxycodone, codeine and methadone. These drugs are highly addictive and people taking them on a regular basis often need to step up the dose to provide the same effect.

If you don’t count the tragedy, that makes for a very effective business model.

Pharmaceutical companies argue that a pure form of hydrocodone will help control pain for people with liver problems, as acetaminophen can be toxic to the liver.

Some doctors are sceptical. They say there is little medical need for stronger painkillers and argue that the profession already has the tools at hand to manage pain effectively.

The market for prescription opiates is big business, and estimated to be $US10 billion a year in the US. The number of people who have taken hydrocodone for non-medical reasons is thought to be close to 25 million, a 2009 National Survey on Drug Use and Health found. That’s nearly 10 per cent of the population.

So far, the abuse of hydrocodone and oxycodone seems to be an American phenomenon. The International Narcotics Control Board reports that the US consumes 99 per cent of the world’s hydrocodone and 83 per cent of its oxycodone. The discrepancy may be the result of loopholes in US law.

As it now stands, patients get up to five automatic refills of hydrocodone compared with one for oxycodone.

Another factor is the growing supply and widespread availability of hydrocodone. The Drug Enforcement Administration (DEA) wrote in a recent report that every age group had been affected by easy access to hydrocodone and the perceived safety of those products by medical prescribers.

In the US, the DEA sets quotas for the amount of addictive painkillers pharmaceutical companies can make. So government agencies have approved the big increase in supply of recent years.

The increasing trend of prescription drug abuse results from many factors: a medical culture that promotes pills over other solutions, ineffectual laws, a ready supply of dangerous products – and big profits.

Washington puts the cost of drug trafficking and drug abuse at $US215 billion a year. The human costs are even higher.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York.

When the world sneezes...

2012-01-07T08:21:00.000-08:00

The Financial Review

PUBLISHED: January 7, 2012

Anna Bernasek New York

As street sweepers clean up after the revelry in Times Square, it’s time to think about what’s in store for America. An election campaign is under way, of course. But for the American economy a lot will depend on what happens elsewhere. Three major global trends are affecting the nation.

The carbon rush

Persistent high energy prices are driving the global frenzy to develop new carbon sources. In the US, there is a spectacular boom in oil and gas drilling as new technology – hydraulic fracturing, or “fracking” – opens up new resources.

Touching 38 out of the 50 states, a mining boom on this scale hasn’t occurred in generations. In the past year alone, the number of drilling rigs in the US rose by 313 to 2007, the highest level since the 1980s and four times greater than in the 1990s. Experts believe it is the start of a great new era in American oil and gas production.

James Hackett, chairman and CEO of one of the world’s largest oil and gas companies, Anadarko Petroleum, predicted late last year that North American oil production could double in the next 25 years.

Hackett has reason to be optimistic. In November, Anadarko announced what could turn out to be the single biggest oil and gas field discovered in the US. Based on preliminary findings, the company believes it has found between 500 million and 1.5 billion barrels of oil, natural gas liquids and natural gas in shale beneath the Wattenberg field in north-east Colorado. Only a few billion-barrel fields have ever been found in the US.

Like a good old-fashioned gold rush, the drilling boom is exciting investors and boosting local economies. In North Dakota, for instance, there’s no sign of the great recession. Unemployment is 3.5 per cent, compared with the national average of 8.6 per cent.

But there’s a dark side to the boom. Fracking threatens local water supplies, and growing oil supply undermines efforts to develop alternative energy sources and combat global warming.

And that may be more urgent than ever. According to the Global Carbon Project, emissions of carbon dioxide from fossil-fuel burning jumped almost 6 per cent in 2010. On a tonnage basis, that was the largest increase in carbon emissions ever recorded.

The debt wave

A wave of debt has washed over governments and consumers. With debt markets now global, one region’s problem affects everyone.

After the 2008 US financial crisis, debt problems now engulf Europe. Buoyed by cheap money, runaway property markets in China or elsewhere could be next to collapse.

In the US, consumers are still working off debt as the government struggles with record deficits. So far economic growth has been too slow to make a significant difference and, as the US muddles along, it remains vulnerable to what happens in Europe and China.

It seems Europe is all but certain to enter recession this year and growth in China is expected to slow as the housing boom cools.

In Europe, ill-conceived austerity measures could keep its economies mired in stagnation for years.

It’s much harder to assess the Chinese situation. Property price increases in China have been similar to those seen in Japan in the late 1980s and in the US in the late 1990s and early 2000s. In cities such as Shanghai and Beijing, house prices rose by more than 30 per cent a year.

In response, the Chinese government has introduced measures, including raising interest rates, to take some froth out of the market. Whether the housing bubble turns into a full-blown banking crisis or not, it adds to uncertainty and has the potential to create more volatility in global financial markets.

So while the US is digging itself out of its own debt crisis, the crisis in Europe and a potential crisis in China may only prolong America’s economic problems.

Social unrest

Scenes reminiscent of the Arab Spring are playing out around the world. Public protests have ignited in cities as diverse as Cairo and Oakland, California.

While there are different reasons why people around the world have taken to the streets – the latest Russian protests sparked by election fraud; the Occupy Wall Street protests focused on income inequality and a lack of economic opportunity – much of the unrest has something in common. Weak employment and stagnant wages fuel desire for systemic change.

Little serious effort has been made to address the concerns of protesters. Here and abroad a generation of young people is at risk of losing their chance at a middle-class life, suggesting we’re likely to see more unrest.

According to the International Labour Organisation, the change in the risk of social unrest in the past five years has been greatest in advanced countries, followed by the Middle East and then Africa.

In an open society such as the US, it’s possible for public demonstration to be channelled into constructive change. But social unrest is a dangerous and unpredictable force. And by the time a nation is faced with significant and prolonged social unrest, it’s a sure bet the government hasn’t done its job. Happy New Year!

Tip: goodwill can lead to profit

2011-12-24T04:50:00.000-08:00

Here's my column in this weekend's Financial Review:

Jack Frost nipping at your nose and bells ringing on Fifth Avenue mark the time of year: ’tis the annual tipping season in New York. That’s when all the doormen, supers, nannies, housekeepers, mail carriers, newspaper deliverers, garbage men and the like get a year-end bonus from their clients.The individual amounts can range from a few dollars up into the thousands. In total, seasonal tips will add up to a substantial chunk of a service person’s annual income.

But deciding whether and exactly how much to tip is entirely up to each New Yorker. For some it’s a matter of conscience. For others it’s a more self-interested calculation, a spreadsheet exercise.

The amazing thing about the peculiar American culture of tipping is that it actually works quite smoothly. There’s absolutely no recourse if an anticipated tip never materialises. Nevertheless, the tips arrive like clockwork. And in New York, it’s been perfected to a high degree.

Perhaps that’s only natural in a city that runs on voluntary payments. The waitress at the lowliest hamburger joint depends on tips for survival. And at the other end of the spectrum, a discretionary bonus is likely to make or break the year for New York’s loftiest banker.

The principle of letting the client decide how much an intangible service is worth, in some cases after it is rendered, has lots of interesting implications for business. As the global service economy continues to grow, entrepreneurs have been testing new business models that reflect the usefulness of voluntary payment schemes.

This month, comedian Louis C.K. became the latest entertainer to experiment with a version of pay-what-you-decide business model on the web.

For $5, fans of Louis C.K. could download a video of his comedy show recorded live at the Beacon Theatre in New York. Or they could watch it without paying anything since he didn’t even try to prevent pirating. Louis C.K. says he chose the low $5 price because it was nearly free. And he wanted downloading to be easy, almost like hitting a link and streaming.

In the first week 175,000 people paid the $5 to download his show. The comedian expects that to top out about 200,000. Assuming that pans out, Louis C.K. will have grossed $1 million. After production costs of $250,000, he estimates making $750,000 in profits from his experiment.

Other entertainers who have tried similar pay-what-you-decide business models include Radiohead, hip-hop singer Niggy Tardust, and comedian Steve Hofstetter.

And it’s not just limited to entertainers. The sandwich chain Panera Bread opened a pay-what-you-decide cafe in St Louis, Missouri, about a year ago. The company found it generated valuable goodwill towards its brand. Perhaps just as important, it turned a profit. Since then, Panera has opened a further two pay-what-you-decide cafes.

From its initial experiment, Panera gleaned an important insight into the behaviour of its customers. The sandwich chain found that roughly 60 per cent pay the suggested price and 20 per cent pay more. Only about 20 per cent underpay for their food.

For some time, small software operators on the web have been experimenting with the pay-what-you-decide model.

The potential for this approach is very large. After all,the entire charitable sector is based on a pay-what-you-decide model. Last year Americans paid almost $US300 billion to charitable organisations. That is the biggest sector by far of the pay-what-you-decide economy.

It could be a lesson for other sectors. Some that are in trouble, such as music and publishing, have struggled to adapt old business models to the ubiquitous online world. So far, much of their effort has gone into devising schemes to protect content from unauthorised, meaning unpaid, use.

This month in a lower Manhattan court, Sony Music and Warner Music joined Universal Music Group’s suit against Grooveshark.

Grooveshark isn’t selling the other companies’ content. Instead, they are streaming it without requiring payment to listeners who (presumably) don’t keep a copy.

There’s just one little problem. Given the state of technology, there’s no way to keep a lid on content. And worse, if you actually happen to succeed in your efforts to discourage somebody from listening to a song, or reading a story, you lose a potential supporter. Illicit users could turn out to be an important source of “word of mouth” advertising. And if the product is good, what’s to say they won’t become paying customers one day.

After all, if nobody pays for the waitress, or the musician, or the corporate executive’s bonus, why should anyone expect them to keep doing their thing?

In the end it all boils down to a matter of trust. And the thing is, people actually like it when you trust them. Letting the customer know that you are confident in the value of what you do, and then trusting the customer to pay fairly for that can build a strong relationship. There’s no better way to communicate your worth or to build a business.

The Australian Financial Review

Obama, Romney, Same Difference

2011-12-17T16:13:00.000-08:00

America Inc: Please read my column in this week's Financial Review

As US businesses close out what looks to be a fairly good fiscal year, there’s plenty of uncertainty about what comes next.

The euro crisis still threatens to slow down the global economy. China’s economy has cooled as dramatically, making it difficult to predict growth coming from Asia. And recent signs of life in the US economy look suspiciously like a mirage that could disappear at any moment. Until there’s real movement in wages and employment it’s hard to believe consumers will be back en masse.

On top of all that, there’s a pretty vigorous competition to challenge for the presidency next year. With so much in play, companies struggle to figure out what they can count on.

On the political front at least, they may have less to worry about. When Americans vote next year, there may not be all that much at stake for business.

Start with the Republican primaries. As the contest unfolds, a parade of potential challengers has captured headlines then faded away. Former Alaska governor and “grizzly mom” Sarah Palin came and went. Self-described business success and reality TV host Donald Trump had his moment in the sun. For a brief time the right was enthralled with former Texas governor Rick Perry, until he couldn’t remember exactly which parts of the government he was desperate to shut down.

Now it’s Newt Gingrich, former House speaker, grabbing the spotlight. Gingrich is an interesting character. A former history professor at a small college who has described himself as a “world historical figure”, he has floated some pretty newsworthy ideas. Recently he made headlines by suggesting poor schoolchildren should be forced to work as janitors in their schools.

Despite the outlandish proposals, though, Gingrich has real leadership experience. He was the prime force behind a Republican takeover of Congress during the Clinton presidency.

But his political success is long gone. He never regained his power or popularity after he shut down the government under Bill Clinton. Since then sordid details of his personal life have come to light. He can count on a segment of the right wing for support, but if he is nominated to challenge Barack Obama it could be a disaster for Republicans.

Gingrich’s momentary popularity has surprised even him. He is only now trying to put together an organisation that could seriously campaign for the presidency, and it’s somewhat late in the game for that.

So that leaves Mitt Romney. Smart, disciplined and well financed, he has the organisation, the résumé and the staying power to earn the nomination. He doesn’t have personal popularity, true, but he can raise money and avoid mistakes.

The smart money is on Romney to get the nomination. If he does, a lot of the political uncertainty facing corporate America goes away. Obama and Romney are more alike than different on most issues affecting business.

Three years into his presidency, Obama is pretty much a known quantity. He’s pragmatic and incremental. And conservative, not in the ideological sense but in his basic character.

The Iraq war was his signature campaign issue and he’s only now winding that down. His biggest policy achievement, health care reform, wasn’t a radical departure from the status quo. And any president who squelches new clean air rules and allows oil drilling over the objections of environmentalists can’t be viewed as rabidly anti-business.

Conservatives label Obama “liberal” but when it comes to corporate America, he’s careful not to rock the boat. Witness the Occupy Wall Street movement. If Obama was really on the side of the “99 per cent”, the movement would not exist; its activists would be out campaigning for him.

While Obama is less of a liberal than he is often labelled, Romney is more of a centrist than he lets on. That’s why the right wing of the Republican party is so loath to elect him. In addition, his record as governor of Massachusetts isn’t exactly pro-business. One of his signature policies was to go after corporate tax loopholes to narrow the state budget deficit.

And then there’s the practical matter of a divided government. Even if Obama or Romney turn out to be more activist than they appear, it’s unlikely they’ll find the legislative support to make big changes. If Romney is elected, the Republicans could also take control of Congress. But experts consider that unlikely at this point, and they give Obama virtually no chance of getting a Democratic Congress. As president, either one would be forced to take a centrist approach.

As the presidential race gets into full swing, the candidates will be forced to promise lots of changes. The reality, though, looks to be more of the same.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity was published in 2010. Her column America Inc. appears each week in the Weekend Financial Review.

America Inc: Heinz meanz big or small beanz

2011-12-09T11:54:00.000-08:00

Please read my column in this weekend's Australian Financial Review called America Inc:

Americans are getting a sense that the nation has split into haves and have-nots. Corporate America already knows it.

Since the industrial revolution, American business prospered on the back of a simple strategy: sell to the growing middle class. That formula produced corporate icons such as Ford, Procter & Gamble, Johnson & Johnson and Avon.

As the middle class grew, so did Corporate America’s reach. Products like Campbell’s Soup and Tide laundry detergent could be found in any home across the nation. So universal were certain consumer products that in the 1960s Andy Warhol famously painted Campbell’s soup, Coke and other household names.

“What's great about this country is that America started the tradition where the richest consumers buy essentially the same things as the poorest,” Warhol said. “You can be watching TV and see Coca-Cola, and you know that the President drinks Coca-Cola, Liz Taylor drinks Coca-Cola, and just think, you can drink Coca-Cola, too. A Coke is a Coke and no amount of money can get you a better coke than the one the bum on the corner is drinking. All the cokes are the same and all the cokes are good. Liz Taylor knows it, the President knows it, the bum knows it, and you know it.”

Today perhaps the only household product Warhol could paint is Google. With the growth of premium products, organic goods and fancy foods, there aren’t many brands appealing to all levels of customers.

Welcome to the bifurcated market. Selling to consumers in the U.S. means picking a side: the haves or the have-nots, the high end or the low. And tellingly, companies are preparing for the change to last.

In the past two years, the trend toward segmentation has accelerated. This is due to greater inequality and an economic recovery weighted towards the top. While unemployment remains stubbornly high at close to 9 percent, the stock market has been very strong. The Dow Jones Industrial Average is up 85 percent since its low back in March 2009.

Some companies are scrambling to capture the high end. Ford is one example. Finding itself on the back foot in one of the fastest growing markets in the industry, luxury cars, Ford is investing heavily to revamp Lincoln, its premium brand. In a much anticipated launch this January, Ford has promised to deliver a luxury vehicle unlike any other on the market. And analysts say the launch is critical to the carmaker’s success.

Focusing on the opposite end of the market are companies like H.J. Heinz, maker of ketchup, frozen foods, baked beans and condiments. Heinz recently announced a drop in earnings largely due to flat sales in its North American consumer products division. As a result, it has changed its strategy and will accelerate product launches targeting consumers at the low end of the income scale, essentially households earning less than $50,000 a year.

Heinz found that more consumers at the low end were buying smaller sizes of products because they came with a lower price tag. To get at this market segment, Heinz will launch a 10 Oz package of ketchup in a stand up pouch at a suggested retail price of 99 cents. In addition, Heinz will sell other products like mustard and beans at 99 cents.

Procter & Gamble, traditionally selling to the middle class is also being forced to change course, repositioning its products away from the middle but toward both the high and low end. For the first time in 38 years, Procter & Gamble launched a new dish soap called Gain with a bargain price.

But those companies already positioned at either end of the spectrum aren’t sitting still. The high end is going more up market and the low end more down market.

This is evident in prices where luxury retailers are raising prices while low-end retailers are discounting heavily. For instance, the most expensive pair of shoes at Saks Fifth Avenue cost a bit over $1,000 a year ago. Since then it’s passed $2,000. Increasing prices for premium products and services are evident in everything from business and first class air travel, wine, jewelry, restaurants, and clothing.

Operating in a market where perceived value is often measured by price, high-end retailers want to make sure they are seen as the ultimate for luxury. After all it’s a lucrative market. The top 5% of income earners accounts for about one third of spending.

At the same time, companies like Walmart, catering to the low-end, have to watch their step. Walmart has to be careful not to be undercut by other discounters such as Family Dollar Stores, a growing low price merchant.

What’s good for companies is good for investors. Two years ago, Citigroup created a stock market index of two dozen or so companies that are best positioned to benefit from the segmentation of the consumer market. Included in the list of companies are Saks and Estee Lauder at the high end, with Family Dollar Stores and Kellogg at the low. Since its formation, the index has outperformed the broader market.

It’s hard to foresee any change in a trend that’s fracturing the American market. It would probably take a sharp drop in unemployment and a convincing rise in wages to reverse the momentum. And the chances of that happening anytime soon are pretty slim.

Obama's job on the line with jobless

2011-12-02T10:49:00.000-08:00

My column in this weekend's Financial Review:

If there’s a single number that could put President Barack Obama out of work it’s the US jobless rate. Since April, the picture has been pretty much the same.

Unemployment has been stuck around 9 per cent and most economists aren’t forecasting big changes for the year ahead. Even the White House predicts a jobless rate of 9 per cent in 2012 with a five-year wait before employment returns to more normal levels.

Despite the grim outlook, there’s no significant jobs initiative from Congress or the Federal Reserve. That seems due to a widely prevalent sentiment that the nation can’t afford a big jobs program. But in all the bickering and feet dragging, something critical has been lost: high unemployment carries a huge cost. Without an understanding of the magnitude of that cost, it’s hard to justify spending on policies to increase employment.

So how big is the cost? Start with how many people are out of work today. According to the official metric, 13.9 million Americans were unemployed in October.

That figure alone provides only part of the story. In addition to the official rate, the Bureau of Labor Statistics tracks what it calls alternative measures of labour under-employment.When these are added to the official rate, a more accurate picture of the unemployment situation emerges.

There are three components of the bureau’s underemployment measure. The first is discouraged workers – people not looking for work at all because they don’t believe there are jobs available to them. This is close to 1 million.

Second, there are people who have been looking for work but didn’t actively do so in the four weeks before the Bureau of Labor Statistics conducted its survey. The bureau calls these people marginally attached to the workforce and there were around 1.6 million in October.

Third, the bureau adds in involuntary part-time workers, people who would like to work full time but can’t find employment or have had their hours cut back. There are about 8.9 million Americans in this group.

The bureau adds these numbers to the official rate to come up with an alternative measure of unemployment with the catchy name U-6. As of October, U-6 was 16 per cent. That means out of a total civilian workforce of 154 million, 25 million Americans were idle or only partially utilised.

The economic cost of that missing output is significant.

While it’s tempting to imagine unemployment at zero, even in the best of times natural changes in industries and movement among the workforce results in some portion sitting idle. There will always be workers who voluntarily forgo an available job because they see better prospects just around the corner. So economists talk about a natural rate of unemployment.

In the last few decades, the natural rate of unemployment in the US has been about 4 per cent. In fact, unemployment was at 4.4 per cent in May 2007. At that time U-6, the alternative measure, was 8.8 per cent. Rounded off, each measure was precisely half the rate today.

Given the average weekly wage of $US795, putting half the jobless and underemployed into full-time positions would increase output by about $US432 billion a year. That represents the direct loss of output, or GDP, from jobless rates twice as high as it could be.

But that’s just a baseline number. The benefit of moving to full employment could be far larger. Economists still use a rule of thumb called Okun’s Law, named after economist Arthur Okun who found a relationship between unemployment and national output in the 1960s. It’s thought a rise in unemployment by 1 percentage point causes real GDP to drop 2 percentage points.

Cutting unemployment in half might lift GDP by $US1.4 trillion a year, three times the increase in wages alone. That is nearly 10 per cent of the total economy. And even that may be just the tip of the iceberg. The value of an additional $US1.4 trillion a year in output over a long term could be something like 10 times that number. A potential $US14 trillion reward awaits if policymakers can shrink unemployment.

None of this considers the human side of unemployment. Diminished health, marital strife, child neglect and social ills are all associated with the stresses of involuntary unemployment. There’s no accepted way of measuring these in dollar terms, but there is little doubt they exist.

Meanwhile, Congress and the Fed dither, apparently relying on an implicit assumption that unemployment really only hurts the unemployed and they may well deserve it. The truth is it’s a huge cost to the whole nation. With next year’s elections drawing closer and no action in sight, job security among Washington’s political class may be at stake.

She is a business commentator for CNBC. Her book The Economics of Integrity was published in 2010. Her column AMERICA INC appears each week in the Weekend AFR.

Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. A former finance reporter for The Sydney Morning Herald, Bernasek has been based in the US since 1999 writing for Fortune Magazine, The New York Times, The Washington Post, and the Huffington Post.

Why U.S. Bankers Can't Sleep at Night

2011-11-27T09:13:00.000-08:00

The Australian Financial Review, November 26, 2011

Anna Bernasek New York

What a difference a month makes. When US banks released third- quarter earnings in October, sentiment was riding high. In stark contrast to their European counterparts, US banks had recovered from the 2008 financial crisis and were poised to gain momentum. But now a looming euro debacle is fuelling fears that again America’s financial institutions are vulnerable.

With the sharemarket under heavy selling pressure this week, financials were singled out for punishment. The mood has soured since November 16 when Fitch Ratings warned it might reduce its “stable” rating for major US trading banks. “Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad outlook for US banks will darken,” Fitch said. “The risks of a negative shock are rising.”

By most reported measures though, US banks are in far better shape today than leading up to the 2008 financial crisis.

Start with capital levels. From the end of 2008 to 2010, common equity increased by more than $US300 billion at the 19 largest US bank holding companies, the Federal Reserve says. Capital levels increased further in 2011 and by the third quarter were at their highest level since 1938. Timothy Geithner, the Secretary of Treasury, says most US banks have reached the new minimum capital standards set out by the Basel III international agreement.

In addition to substantial capital, banks have considerable liquidity as economic softness kept US banks from ratcheting up risk. For the first time, US banks have fewer loans on their books than deposits. Meanwhile, plentiful cheap money has kept profits healthy. The Federal Deposit Insurance Corp reported this week that the industry earned $35.3 billion during the third quarter, up $11.5 billion from a year ago. That puts US bank earnings at their highest level since the second quarter of 2007.

In another sign of health, legacy issues from 2008 have shrunk. The number of problem banks on FDIC’s watch-list declined again in the third quarter to 844. The majority of the troubled banks are small, having combined assets amounting to under 3 per cent of total industry assets.

The rules of the road have tightened. The Federal Reserve’s annual stress test got underway this week. That process will culminate with a pass or fail verdict handed down to major banks early next year. The test is tougher than last year’s to take into account the European crisis.

Banks have been asked to prepare for a “doomsday” scenario of 12 per cent jobless next year, an 8 per cent drop in GDP and home prices down another 20 per cent.

While the European crisis seems threatening, it may also turn out to be an opportunity. As French banks in particular disappear from large syndicated loan deals, US banks are there to step in.

Perhaps the biggest threat is the one that keeps bankers up at night. “Ask any US bank of significance today and you’d find they’re not worried about direct exposure to Europe,” says Tom McGuire, head of the capital advisory group at Barclays Capital in New York. “They’re worried about what happens to confidence. No one knows the downside if the European crisis isn’t resolved.”

If business and consumer confidence vanishes, banks will be hit in their weakest area, loan growth. That would bring earnings under pressure, weakening their entire business model. Instead of being poised for growth, banks would be back to shrinkage. Knock-on effects such as weakness in housing and real estate would affect asset quality, potentially reversing the positive trends.

While bankers seem unconcerned about direct exposure outside the US, industry experts believe it is still a big unknown. Fitch’s downgrade was based on the industry’s exposure to potential losses arising in Europe. Up to now only a handful of banks have released any details. These include Bank of America, which said its exposure to Greece, Ireland, Portugal and Spain totalled $US14.6 billion, while Citibank said its exposure was $US20.6 billion and JP Morgan $US15 billion.

But the amounts do not clarify all the issues. In its report, Fitch criticised the banks for not airing the extent of their holdings of European sovereign debt or their trading positions with European counterparties.

In addition, if the crisis spreads, US banks will find it difficult to avoid. The Congressional Research Service estimates that while the exposure of US banks to Greece, Ireland, Portugal and Spain amounted to $US641 billion, their exposure to German and French banks comes to more than $US1.2 trillion. Combined, that makes up something like 15 per cent of total US commercial banking assets.

As Europe lurches along, counterparty risk could become a big threat. Still an opaque subject, the vast interconnectedness of modern banking nearly brought the global financial industry to its knees during the 2008 crisis.

And no one really knows how big a problem counterparty risk is until it’s too late. After all who can forget Lehman Brothers. On the day of its bankruptcy, Lehman held an investment-grade credit rating.

What keeps U.S. bankers up at night?

2011-11-25T12:33:00.000-08:00

Read my latest column in the Financial Review on U.S. Banking

Can the U.S turn itself around?

2011-11-18T10:24:00.000-08:00

Read my new weekly column on the US Economy and Business for the Financial Review.

Trust is yours to build

2011-10-13T08:22:00.000-07:00

As I was reading about the trust deficit on Wall Street this morning in the NYT business section, I was struck by our conventional notion of trust. We tend to think of trust as something that one has or doesn’t have and it’s almost out of our control. Kind of like the weather. Either it rains or not and we can’t change that. But trust is a company’s most valuable asset and the key to building long term wealth. The sooner Wall Street understands that, the better off everyone will be: banks, financial markets, the public and the entire economy. Canadian financial leaders seem to get it. I just came back from Toronto where I gave a presentation on “The Integrity Opportunity” to the Investment Industry Association of Canada. It was their annual conference and the entire theme was about building trust in the financial industry. Why aren’t our banks and financial institutions talking about how to build trust? Until they do, their economic fortunes will suffer and ours too.

Toyota: a classic case of trust

2011-02-09T11:35:00.000-08:00

The reaction to the announcement that a federal investigation into Toyota found no electronic flaws in its vehicles was revealing. Some commentators tried to pick holes in the 10 month long investigation aided by NASA engineers while others like the NYT editorial column shifted its focus off Toyota to a problem of federal oversight. (Without dealing with its past criticisms of the carmaker in any way) Even a news story in the NYT business section played down the findings saying in the third paragraph of the story: “The findings, reached after a 10 month investigation, neither implicated Toyota nor exonerated it any further than had been the case after the earlier investigation.” (Why write about the findings of the investigation on the front page of the business section then if it isn’t news?) Isn’t the lukewarm response to a long awaited federal investigation really just a barometer of trust in Toyota itself? At least to this observer it appears that Toyota still has a trust problem on its hands in the United States. To be sure, it is a much smaller trust problem than it had a year ago, but it is still a problem nonetheless. It’s an important reminder to any company that relationships of trust are valuable assets that take time to build. In Toyota’s case, rebuilding that trust means a relentless focus on quality and customer satisfaction plus lots of patience. Luckily for Toyota, that means playing to its strengths. After all, those are the same factors behind its global dominance.

Credit unions have a great integrity opportunity for building their business

2011-01-14T10:09:00.000-08:00

Big banks making big profits! That’s the trend we’re seeing at the moment. Yet it doesn’t seem as if the banks are passing on any of those benefits to their customers. High interest rates on credit cards, gotcha fees and penalties are still common experiences for most people. So while big banks are steadily destroying the bond of trust with customers, credit unions have a great opportunity to invest in their integrity and build their business.
With a single minded focus on customer relationships, credit unions can win customers over from banks and keep them. In practical terms that means looking at their fee structure and determining how much they can give up in order to win additional customers. What’s more, operating in an open and fair way with customers, paying attention to customer service and thinking creatively about new products will fill a need that’s not being met by banks. Credit unions are poised to capitalize on the short sightedness of the big banks and have a successful 2011.

Bank of America provides a great lesson for any business

2011-01-10T10:32:00.000-08:00

I read with interest about the behind the scenes work B of A has been doing in response to the possibility that Wikileaks could release embarassing documents about the bank. It reminded me of a quote from the CEO of Best Buy when he said "There's no such thing as an internal memo anymore." It's an important lesson for any company. Don't do something in secret that you wouldn't do in public. It's not worth it. If you do, it's kind of like building a business with landmines that could go off at any time. Simply put: you have nothing to hide when you're creating long term value!

Fertile ground for integrity opportunities may surprise

2010-12-15T08:41:00.000-08:00

There are loads of integrity opportunities at any company. That’s not because companies have little integrity—in order to sell anything you need some integrity—but because there’s no limit to integrity. One clue to sizeable integrity opportunities is whether a firm has a bit of market power. Firms with market power tend not to work on relationships of trust perhaps because they feel it’s unnecessary to their survival. The trouble is market power can change over time and it may be too late to build vital trust.

Think of a company like Verizon Wireless for a moment. Verizon has invested a great deal in its network but not in its relationship with customers. (The same could be said for Microsoft. Both companies have put a lot into their product but not much into relationships with customers.) What happens is that a company can sense its vulnerability (little customer loyalty to the company. It’s all about the product) but instead of doing positive things to build greater trust they end up making it worse by doing things to trap customers. Think of what’s involved when you sign up with Verizon. (I’m with Verizon and I was lucky that my husband took on the frustrating work of signing up)The different plans are difficult to understand (even the people working in the store admit they don’t understand them!) It takes time and energy to work through and sign up. The rebates they offer require lots of paper work (and hope on the part of Verizon that you can’t be bothered and they won’t have to pay out the money). The rebate is sent in the form of debit cards that are clumsy to use and time consuming if you keep track of your balance. On top of all of that, the monthly statements are difficult to understand and the format keeps changing. All in all, it’s a dreadful customer experience! Why would Verizon customers have any loyalty to the company if someone else came out with a better product?

Yet it doesn’t have to be that way. Verizon has a good product and should be building trust with its customers not only about the product but about the service it delivers and the way it values the entire customer experience. If Verizon started trusting its customers and did valuable things to exhibit that trust, it would be a far stronger business than it is today. Other industries are in similar situations. Think of financial services firms or credit cards. There’s a huge opportunity for companies with market power to build stronger relationships of trust with customers. And there’s nothing to lose except fear. If you have a great product, then trusting customers is only a win/win for everyone.

A barometer of prosperity

2010-12-09T09:49:00.000-08:00

The latest survey by Transparency International shows an increase in perceived corruption around the world. Most notably, the survey found that 67 per cent of people surveyed in North America and almost three quarters of Europeans think corruption has increased in the past three years. What’s critical here is the perception of greater corruption. That's because it's probably the most devastating on the economy. Here's what happens when corruption occurs:
1. Economic outcomes are distorted.
2. As corruption is perceived, it changes behavior and creates a self reinforcing cycle of greater corruption. If everyone else is corrupt why should I do the right thing?
3. Finally, valuable bonds of trust that help create efficiency in the economy are broken. If you no longer trust your credit card company, you will spend more time checking through your monthly statements, looking for alternatives, or forgo credit altogether.
It’s no coincidence that a perception of greater corruption goes hand in hand with a decline in prosperity. Long term wealth and widely shared prosperity are created by building relationships of integrity and trust not destroying them.

The Politics of Integrity continued

2010-12-06T08:47:00.000-08:00

When I speak to audiences about the economics of integrity, I often get asked about how integrity relates to politics. While I’m not an expert on the political world I do think there are some similarities (and differences) with the way integrity works in the economy. The biggest difference is that in politics there isn’t a direct financial payoff from acting with integrity as there is in the economy. But I do think there is a payoff nonetheless.

If some smart person were able to measure outcomes, I bet they would find integrity in politics builds trust and that leads to greater political power. Of course, other factors can also give individuals enormous power in politics and clearly that’s where it can get tricky. But in a macro sense, I think there is a direct relationship between integrity in politics and good policies that create a well functioning social and economic system.

If politicians tell lies, mislead the public, and further their interest ahead of the people they were elected to represent, then we’ll get a mismatch of policies that are pretty ineffective and perhaps even harmful. But if our political leaders act with integrity, that is, tell the truth, keep their word, and act in the best interests of the public they are serving, we should get policies that are beneficial to the nation.

A casual observer would probably find little reason to distinguish between Republicans and Democrats on integrity. Wouldn’t it be a striking way for either party to differentiate itself by becoming the party of integrity? Acting with integrity builds trust among the public. The more trust political leaders have, the greater their mandate. It seems to me integrity would be a powerful way forward for any political party to take.

The Politics of Integrity

2010-12-01T09:08:00.000-08:00

Recently I have caught myself thinking a lot about George Orwell’s satire Animal Farm and his masterpiece Nineteen Eighty-Four. That seems to be especially true in relation to the current debate on Bush’s tax cuts. What I am wondering is why we are debating the tax cuts at all? The cuts were bad when Bush introduced them and they’re bad now. Why can’t we let them expire and introduce a new tax policy that makes sense? Change doesn’t mean keeping the same economic policy of the previous administration. Nor does it mean keeping the same economic stewards (Bernanke and Geithner), or fighting in the same wars, or keeping the same head of defense. And change doesn’t mean replacing our troops with private soldiers in Iraq and calling it a withdrawal. Orwell used terms like ‘newspeak’, ‘oldspeak’ and ‘doublethink’ to describe the craziness he saw in governments in his day. Others called it ‘doublespeak’. We used to call it lies. Now we don’t call it anything.

Safe food has a financial payoff for all.

2010-11-29T08:37:00.000-08:00

It’s no coincidence that we’ve been seeing the growth of both the ‘eat locally’ and organic food movements at the same time as shocking lapses in food safety. Who wanted to eat mass produced eggs last summer or feed them to their kids after the horrifying scenes from the henhouses in Iowa? In recent years, Americans have been losing trust in the nation’s food supply and that’s a huge problem. Not just for a population that faces significant health care costs and job insecurity but for the food production industry as well. You’d think that instead of opposing plans to improve food safety, the industry would get on board and find good solutions for all involved. Apparently that hasn’t been the case as Michael Pollan and Eric Shlosser point out in an op-ed in today’s NYT. It reminds me of the way the financial industry opposed financial regulation after the crisis of 2008. When will big business learn that integrity isn’t a cost but an investment?

Fallout from the exploding Rolls Royce engine

2010-11-23T08:11:00.000-08:00

Qantas announced yesterday it had checked 16 engines of its A380 fleet and was satisfied the planes were safe to fly. It would begin to bring back the aircraft into service this weekend after having grounded its flagship fleet for 19 days following the Singapore flight safety incident. Pretty quickly into the investigation, the companies involved announced that leaking oil was probably the cause of the engine exploding. So is that it? Crisis over and everyone back to business as usual?
Not so fast. The incident is revealing about the state of the companies involved. Qantas seems to have emerged from the crisis well. CEO Alan Joyce has been adamant about safety first at the expense of losing money and his approach has helped build trust with the public. Rolls Royce is another matter though. Tight lipped and not very communicative to the public, its announcements have served merely to allow doubt to linger about what’s actually going on at the company, especially in light of other high profile engine mishaps. It may be worth watching what happens next at Rolls Royce. My bet is there could be further bumps ahead.

The power behind rules that enable activity

2010-11-16T09:34:00.000-08:00

Try this thought experiment. Have you ever tried to stop doing some activity, say cutting down on eating junk or watching television? What happens when you make a rule that you won’t do something? It’s a safe bet that after a while you’re not all that successful and you end up breaking your own rule. That’s the problem with a lot of the rules we have in our social and economic system; even in our own households! We tend to set up systems where the rules tell us what not to do instead of what to do. Admittedly, it’s not always easy to create rules enabling activity when there are certain things that we want to make sure never happen—say murder for instance. Yet in many cases it can be done and simply requires a different way of thinking about the problem. For instance, if I want to cut down on junk food I might make a rule that I eat fruit for every snack or with every meal. Or that I’ll only eat nutritious or organic food. If I’m trying to cut down on television then maybe I’ll make a rule that I read a book a week. Next time you find yourself struggling not to do something, make a rule for doing something positive instead. It really can work to change behavior.

How to make rules that work

2010-11-15T08:53:00.000-08:00

Rules are a bit like exercise or a healthy diet. Most of us would prefer to live without yet we know that in the long run we really can’t. Part of what is undermining our confidence in our economic system is that we’re seeing one high profile case after another of rules that have been flaunted or broken. Think of the banks’ failure to follow the rules on foreclosures for instance. One way to restore confidence is to understand what makes rules work and incorporate those insights into the design of our new economic rules.

In that spirit, here are some ideas for what makes a good rule:

1. Must be based on sound principles
2. Should be clear, simple and consistent
3. Works best if it is intuitive
4. Should be designed to be self reinforcing
5. Ideally is enabling of activity not restrictive

Taking Trust to the Next Level

2010-11-10T08:04:00.000-08:00

There’s a typical pattern companies tend to fall into when it comes to thinking about trust. A common question asked might be something like this: how do I get customer x to trust me enough to sign the contract?

But that’s where any thought on the matter usually ends. An extremely valuable follow up question should be: how can I get customer x to trust me more?

When a business starts to think about how to build more trust with its customers, it helps make transactions automatic, more frequent and more valuable. Try it!

A final thought on integrity crises:

2010-11-09T07:50:00.000-08:00

You’re not done until you’re done! A company in the middle of an integrity crisis must keep going until it makes changes on four fronts:
1. What it does
2. What it says
3. The outcome for those who have been hurt
4. What the public thinks

Another integrity crisis blows up!

2010-11-08T09:39:00.000-08:00

It’s hard to imagine a worse integrity problem for an engine maker than having its engine blow up mid air on a passenger aircraft. Yet that’s exactly the situation Rolls Royce is now in after its engine on a Qantas Airbus blew up out of Singapore last week. Of course, it’s not just the engine maker’s problem now but the airline and manufacturer as well.
So what should they do?

There are three key steps the trio should make together:
1. Identify the problem as quickly as possible
2. Release those findings publicly and in real time
3. Ensure the solution is public, understandable to all, and credible beyond any doubt.

So far, Qantas has been handling the crisis well. Its engineers are working closely with Rolls Royce and Airbus to identify the problem. Meanwhile, the CEO of Qantas has grounded its A380 fleet until it is sure there is no safety issue. One analyst estimated that the cost of that decision could amount to $15 million to $20 million in lost revenue a week. Yet Qantas knows its business depends on its safety record. Flying long distances across the Pacific to and from Australia without even one plane crash is not a trivial accomplishment. It has been the result of many people working diligently over decades to achieve such a stellar safety record. It’s another reminder; integrity really is a company’s most valuable asset and worth protecting even if it costs in the short term.

A quick checklist for an integrity crisis

2010-11-04T10:53:00.000-07:00

Here’s a ten point checklist to keep in your bottom drawer in case of a crisis. It incorporates the DNA of integrity and helps build trust with stakeholders.

1. Be honest and open
2. Determine the truth
3. Prevent death or illness regardless of the cost
4. Go see for yourself
5. Reach outside the company for help—ask the leading experts in the field to help find solutions to the problem.
6. Report developments in real time
7. Be generous to those who have been affected. This is not a time to pinch pennies
8. Don’t rest until the problem is fixed
9. Execute organizational changes
10. If someone is at fault, hold them accountable.

Replicating the DNA of integrity to come out ahead of a crisis

2010-11-03T07:33:00.001-07:00

The media focus and coverage resulting from an integrity crisis is a harsh and unforgiving trial. But the really exciting news is that with the right approach it’s possible not just to regain one’s reputation but even to enhance it. When everybody is looking, it’s a great time to impress them.

To do that, you need to appreciate the process that creates trust. Knowledge of the “DNA” of integrity—Disclosure, Norms and Accountability—is the key. Honoring those three concepts allows a company to make smart investments in its relationships with customers and stakeholders.

Start with the single most important one: disclosure. When a crisis hits the last thing anyone feels like doing is admit a problem or mistake and deal with it publicly. Hunkering down, being cautious about what is said to the media or even to staff and following the advice of lawyers is all too common a response. Building trust is not about playing a defensive game. It’s about taking risks and reaching out to people. In times of crisis it’s worth remembering there’s no problem that can’t be fixed so long as there’s not an attempt to hide it. That doesn’t mean disclosure is easy. Facts, details and explanations can be difficult to marshal in the midst of a fast moving crisis. For the manager there’s no better approach than to go and see for yourself. And as you communicate in real time, updates can correct mistakes or erroneous data in an honest and open way.

Next address norms. Crucially, you need to make things right with people who have been hurt. Secondarily, you need to change your product, or process, or staffing in a way that credibly removes the public’s concern. The change should be clear, capable of simple explanation and effectively communicated.

Finally demonstrate accountability. If nobody is at fault, say so. But if there was a lapse, hold him or her accountable. And what if it’s your own lapse? Good luck trying to hide it. A far better approach is to address things in an honest and forthright way.

Is 2010 the year of the corporate integrity crisis?

2010-11-02T10:43:00.000-07:00

Remember Toyota, Goldman Sachs, BP, Apple, Hewlett Packard and J&J? Just to name a few of the big name corporate crises we’ve seen this year. Instead of learning from the mistakes of others, companies seem to react in the same way each time a crisis breaks: by being defensive and denying any fault. In the midst of a corporate integrity crisis, companies tend to limp from one mistake to another. Bruised by an ‘unfair’ media, misunderstood by the public and unappreciated by the market, corporate leaders tend to hold their breath until the crisis is over and hope that the damage isn’t too great.

But it doesn’t have to be like that. Recognizing that integrity is an investment with a financial payoff can be empowering. Smart companies can learn how to build enormous integrity during a crisis and actually come out ahead. And they can do it without calling in the emergency troops, legions of PR and consulting experts waiting to make money from corporate missteps.

So here’s the single most important point for any manager to remember when a crisis hits: you are no longer in the [fill in the blank] business. You are in the trust business. And your job description is now all about building trust.

While there are plenty of examples of how not to handle an integrity crisis there are only a handful of positive role models. And here’s the reason why: how many managers consciously think about how to build trust and really know how to do it systematically?

Podcast for HR execs

2010-10-27T10:34:00.000-07:00

Here's a podcast I did for anyone interested in Human Resources.

Three ideas for good HR

2010-10-12T17:42:00.000-07:00

Integrity has huge applications throughout a firm but it is particularly critical for anyone working in the field of human resources. After all, the whole essence of managing human resources boils down to relationships between people. If those relationships are strong and trusting you create a very valuable asset. Here are three simple ideas based on the DNA of integrity—disclosure, norms and accountability—to help HR execs create value in their organization.
1. Absolute honesty
There’s no such thing as secrets within an organization anymore. If you try and keep secrets you’ll look untrustworthy. It’s a tough message for managers to hear but it’s essential to take on board.
2. Simplify norms
Companies do pretty well on norms. In fact, maybe a little too well! Most companies have plenty of established rules and procedures that are integrated throughout the organization. But to build relationships of trust you need people to internalize simple rules that make sense.
3. Hold everyone accountable to the same standards
The recent case at HP where the board dismissed the CEO for bad behavior is a great point in case. But this is by far the exception rather than the rule. It’s not uncommon to give senior management far more leeway with the rules than everyone else. Yet that doesn’t inspire trust in the organization.

Watch Out for Sticky Relationships

2010-10-08T10:46:00.000-07:00

Some of the largest companies around today actively build sticky relationships with their customers. That means companies try to ‘lock in’ customers in relationships for certain periods and penalize them if they try to ‘get out’. Cell phones and banking come to mind here. It’s a particular type of mentality that wants to lock in short term business but isn’t thinking about building long term value. Quite often, companies ask customers to make a significant investment in the business relationship but do they care whether the customer is having a good experience or not? For any business it comes down to this: are you treating your relationship with customers as an asset that you are actively trying to increase? Or are you feeding off your customer base and essentially dissipating your asset? A kind of churn and burn strategy where you focus on numbers not relationships. If customers have a good experience with your business, why would you need to lock them in? They will keep coming back, again and again and again!

Bush’s Dishonest Tax Policies Come Back to Haunt Us

2010-07-26T19:23:00.000-07:00

The front page of yesterday’s NYT ran a story about an ‘epic battle’ brewing over Bush’s temporary tax cuts. If you recall, the substantial tax cuts on income, dividends and capital gains that Bush introduced in 2001 and 2003 are due to expire by the end of this year.

It wasn’t too hard to see this fight coming. I for one was worried about Bush’s tax gimmickry from the beginning and questioned how easy it would be to allow these tax cuts to lapse. (see one of my past NYT column's for more) Now Bush’s temporary tax cuts are expected to take center stage in the political debate in the fall at a time when we can’t afford to be distracted by hoary old chestnuts like supply side economics and ‘the evils of big government.’ Instead, we need to focus on what matters most to our weak economy: allowing the government to spend on productive investments that will pay off for years.

What's the Biggest Problem Facing our Economy?

2010-07-12T11:06:00.000-07:00

Here's a HuffPo piece I wrote today.

What do Toyota, Goldman Sachs and BP have in common?

2010-06-23T07:45:00.000-07:00

Since The Economics of Integrity came out at the end of February, three huge corporate stories have unfolded, illustrating the phenomenal importance of integrity to a company’s bottom line. Toyota, Goldman Sachs and BP are great examples of what happens when a company’s integrity is called into question. For public companies the market reaction to an integrity breach is swift and the stock is punished. Longer term, though, the costs will also pile up. Think of what faces BP in the future: a bill for damages, the likelihood of more restrictive regulations around the world, less trust from business partners and so on. But it doesn’t have to be like that. If corporations understand the importance of integrity to their bottom line they can learn to protect and promote their most valuable asset. Here are five critical steps to investing in corporate integrity:

1. Keep your promise. Start with your brand since this is your promise to customers. If you promise quality as part of your brand, then make sure you do everything you can to deliver quality. If it’s safety, deliver safety.

2. Make it a win/win for everyone. Make sure what you do benefits everyone involved: shareholders, customers, employees, suppliers and society. If you’re doing anything destructive, stop immediately.

3. Reliability. Go the extra mile to be reliable. Do not cut corners however tempting it may be.

4. Continuous improvement. Focus on how to make the experience and product better for everyone.

5. Feedback. Seek out constant feedback from your employees, customers, suppliers and so on. It’s valuable information to help improve and address problems as they arise.

The Woman behind Integrity in the Workplace

2010-06-09T07:03:00.000-07:00

While doing research I came across the biography of Alice Hamilton. It made me realize that I knew so little about the people behind some of our most important advances in integrity. Hamilton was born in 1869 into a highly educated family. She received her medical degree from the University of Michigan and took a teaching position in Chicago at Northwestern University. It was in Chicago while living at Hull House with Jane Addams that she started her work which transformed the American workplace.

Hamilton began to wonder why so many workers had curious illnesses and often sickened and died. She began to read research on workplace illness which was being done in Europe but at the time not in the United States. She decided to travel the nation, visiting mines and factories to report on the state of health and workplace practices. Her research was considered so remarkable because it was meticulous, impartial and eye opening. She became the pioneer of occupational health and our laws promoting workplace safety today are the direct result of her work. Incidentally, Hamilton was recognized as a trailblazer and hired in 1918 by Harvard Medical School. She was Harvard’s first female faculty member. In 1935 she retired from Harvard and served as a consultant to the US division of labor standards. She died in 1970.

Hamilton is an important reminder that integrity doesn’t just happen by itself. It takes the effort of individuals and governments over many years. The best part though is that the payoff can last for generations.

Does small business sacrifice integrity more than big business?

2010-06-04T07:40:00.000-07:00

At a talk I gave recently, a member of the audience commented that in his experience, a big business was more likely to protect its integrity asset than a small business. As a lawyer for subprime lenders, he found that small lenders were willing to cut corners and operate in grey zones to win business but big lenders simply couldn’t afford to take those same risks. His argument was that a big business understood it had more to lose by exploiting integrity than a small business. It was a provocative idea and quite frankly a distinction that I had never made.

My initial reaction was that size shouldn’t matter. But the more I thought about it the more I determined there was something to it. For one, it’s hard to get big without integrity. So big businesses tend to have a lot of built up integrity. Plus big business can afford to have a long run perspective while small businesses, fighting for daily survival may not.

On the other hand, small business has something that big business doesn’t. Small businesses tend to be run by owners and they have a huge stake in the future of the firm. Big business, on the other hand, is often run by professional managers who don’t have as much invested in the firm’s long run performance.

The temptation to exploit integrity seems to arise when a company is under pressure. If a business can’t figure out how to make money or can’t make enough money to satisfy expectations, there will be enormous pressure to sacrifice integrity for short term money making opportunities, regardless of the future. That could mean that small business often faces greater temptations to cut corners or skirt the law than big business. But the key is whether they cave in to that pressure or not. If anyone knows of studies on this topic I’d love to hear about it. Or just chime in with observations!

How to capture integrity opportunities

2010-06-02T07:02:00.000-07:00

Here's an interview Dan Schwabel did with me on his personal branding blog.

What does good financial reform look like? And where is it today?

2010-05-28T08:52:00.002-07:00

My vote for the best financial reform ever goes to the system of mandated disclosure introduced in 1934 as the centerpiece of the SEC. In response to the worst stock market crash in the nation’s history, lawmakers made a bold and inspiring decision to require full disclosure from publicly listed companies. It was a stroke of genius. Instead of burdening companies with endless rules about how they should or shouldn’t operate, the law required firms to tell the public what they were doing. That way, investors could decide for themselves whether to invest or not. It was a powerful way to rebuild trust in the stock market at a time when it had been broken and it has underpinned trust in the market for decades.

The principle of full disclosure is something that we can all understand. Over time though, that simple and powerful principle has been distorted. The agency itself has gummed up the system of disclosure by introducing rule upon rule of how companies should disclose things and what they need to include and so on. I understand the impulse to clarify but this approach has actually been counterproductive. By introducing endless details in the rules, companies have sought out the help of technicians to make sure they’re in compliance. That can result in situations like AIG where the insurer seems to have complied with GAAP and everything else but it did not disclose the one thing that would have made a huge difference to investors and the market—the fact that it had created an incredibly risky structure that could come tumbling down at any point.

Unfortunately, I believe we’re going to see more cases like AIG if the current financial reform package is any guide. Instead of simple and powerful principles everyone can understand we’re getting lots of technical rules that can be run around. Encouraging good behavior isn’t easy but it starts with the introduction of simple, clear rules that make sense. Once you do that you can hold people accountable to those principles. Anything else just seems to make matters worse.

Interview on promoting integrity and trust

2010-05-28T07:26:00.000-07:00

Here's an interview Barbara Kimmel did with me on her blog Trust Across America

Where’s the Integrity in Financial Reform?

2010-05-27T08:16:00.000-07:00

It’s hard to believe in the integrity of the financial reform package now almost certain to pass into law. That’s not to say there aren’t some positives in the legislation. But without an honest, straightforward approach the reform isn’t likely to do much good. Here are five gaping holes which spell trouble for the future:

1. The root cause of the financial crisis hasn’t been addressed.
In fact, it hasn’t even been acknowledged! While there were plenty of contributing factors to the financial crisis, the central cause of all the panic was the incredible risk financial players were taking with other people’s money. Reasonable limits on risk remain an absolute necessity. Until we take this on, the financial system will remain vulnerable.

2. Solutions are put off until later.
The main effect of the financial reform bill is to give unspecified powers to untested regulators who may—or may not—create effective rules. Rather than taking on and debating the rules, congress has kicked the can down the road to a new group of Washington mandarins. It may all turn out well but we won’t know for some time. In the meantime, the approach isn’t exactly a profile in courage.

3. The temptation to further complexity appears irresistible.
Finance is already an overly complex area of the economy. The proposed legislation does nothing to cut through the fog and clarify the workings of the system. In fact, it seems designed to create an even more complicated matrix of products and rules. That’s not what we need. We lacked clear information about the outrageous risk taking that led up to the financial crisis. Instead we were bombarded with gobbledygook dreamed up by risk takers and echoed by their regulators. If the past is any guide, the industry should be pretty sanguine about continuing to enjoy lax regulation, and more confident than ever that the taxpayer will pay if things go wrong.

4. Politicians are obfuscating the issue.
Congress and the Obama administration are in universal agreement that financial reform is vital to our economy. But they haven’t exactly tripped over themselves rushing to put reform in place. The time to negotiate reform with the entrenched interests of the financial community was when banks and markets were in desperate need of help from the public. That time is long past, and with its passing the opportunity for strong and effective financial reforms has all but disappeared. So when politicians crow about how great this legislation is, or will be when its effects are ultimately able to be seen, keep in mind that the package appears to be designed to have minimal effects.

5. Financial leaders are morally bankrupt.
After so few take so much from so many, mightn’t it be time for a little humility? The enormous risk in the system was no accident. It was knowingly and intentionally created for the short term gain of a relatively small group of financial leaders. But instead of acknowledging the absurdity of continuing these practices, bankers have been spending their time and energy blocking reform.

Is it really too much to ask for all involved—bankers, politicians and the public—to work together for real reform with the main purpose in mind of making the financial system better for everyone?

A Big Thank You to Readers of the Economics of Integrity!

2010-05-25T07:37:00.000-07:00

On Sunday, The Economics of Integrity hit the best seller list in Singapore at number 7! It’s very exciting seeing the book resonate with people around the world. What’s more it’s great to hear from readers about the interesting and important work they’re doing in relation to integrity and trust. I just wanted to mention a few from various exotic corners of the world:

John who is an American, working in China, is developing business initiatives to enhance integrity in commercial dealings between US and Chinese firms.

David Rea, a social scientist in New Zealand, has been working on policy ideas for the New Zealand government to foster greater integrity.

Johanna in Amsterdam has her own business consulting firm and is working on issues like integrity and trust to help her clients prosper.

Carlos who is Spanish and living in Bucharest has been working on taxation policy and is interested in incorporating greater integrity into the tax system.

Thanks to everyone who has gotten in touch with me so far. I really enjoy hearing what you’re working on and sharing ideas!

The Sweet Spot of our Market Economy

2010-05-20T06:58:00.000-07:00

Here are two statements:

Following your own self interest benefits everyone. (Adam Smith)

Acting with integrity benefits everyone. (Conventional morality)

The conventional view is that these two statements are mutually exclusive.
The truth is there is a place where those statements intersect. That place is the economics of integrity and it’s the sweet spot of our economy.

When acting with integrity is in our self interest we get a double payoff: economic growth and societal benefits. This opportunity often exists in the short run but it’s always there in the long run. The only way to create lasting wealth is to act with integrity.

Will Health Care Reform create more integrity?

2010-05-18T11:38:00.000-07:00

Recently I found myself trying to escape from reality by watching a marathon session of Grey’s Anatomy reruns. One episode was so shocking in it’s depiction of our health care system it’s worth mentioning.

A seemingly prosperous man in his late 50s or early 60s is raced to the emergency room after being in a car crash. Unbeknownst to his wife, he lost his job some months back and their health insurance is due to expire at midnight that very day. It turns out the man needs very expensive surgery to save his life. A resident uncovers the health insurance issue and pleads with the chief of surgeons to undertake this mans surgery before the stroke of midnight otherwise the costs could bankrupt the couple. After refusing to put the man ahead of her other patients who were more in need of help, the chief of surgeons turns to operate on him at a few minutes past midnight. But before she starts she asks the resident, who will record the time of operation for official records, to change the clock in the operating room to one minute before midnight.

The audience has a feel good moment and is relived that the Chief of Surgeons turns out to be on the side of the public against health insurers. While I also found myself being sympathetic I wondered what my reaction would be if I worked for a health insurance firm. How would I feel to see doctors cheating health insurers and that practice being legitimized on mainstream TV? What does it tell us when our health care system is portrayed, in a matter of fact way, as so broken that the only humane response is to cheat?

It made me wonder whether health reform enacted by the Obama Administration will do anything to change that. I’m skeptical. But then with so much of the reform set to be decided in the future, the only fair answer to that question is that no one really knows yet.
Up next: a few things we do know about Obama’s health care reform.

Creating a Culture of Integrity in the Corporate World

2010-05-14T11:44:00.000-07:00

Only a few of us will ever lead a big company or wield considerable influence over corporate decision making. But we don’t have to wait for others to promote a culture of integrity, we can do it ourselves, now!
Here are five ideas:

1. Do the right thing in a situation where there’s a temptation not to.
My husband told me a story from his law firm days. Working with a team of lawyers to close a deal, he was in a conference room as they phoned around to all the parties involved. When the call had ended with the opposing counsel it became obvious that the other side hadn’t hung up and my husband’s team could hear their private discussion. The senior partner in the room moved swiftly to hang up the line saying “They’re not aware we can hear them. We shouldn’t be listening.”
Nothing speaks louder than being a model of personal integrity and people remember you for it.

2. Show people you trust them
Give people extra responsibilities or information they might not have as a way to build a relationship of trust. Remember the words of Henry Stimson, the American secretary of war during WWII, “The only way to make a man trustworthy is to trust him.”

3. Tackle problems as soon as they arise.
Remember the old adage “There’s never been a problem that can’t be fixed; unless it remains hidden.” If you can’t fix the problem yourself get help from others.

4. Admit mistakes
No one likes to admit mistakes but grimly hanging on and denying the mistake is not a good look either. Neither is finding clever ways to weasel out of it. Face up to what you did wrong and work swiftly to correct it.

5. Point out what’s working well
Make sure you look for what others in the firm are doing well. Discuss it, learn from it and replicate it.

Tapping into the Power of Social Contagion

2010-05-13T08:16:00.000-07:00

Friends from Australia who recently moved to New York City were horrified when their name appeared on a list of donors to the private school their son attended. While it can be daunting to those unaccustomed to the practice, the main purpose of publicly acknowledging donors is to encourage others to give. Charities have found that if they publish the identity of donors, it encourages others to donate, either to be associated with those already on the list or as a way to fit in.

There are times though when we see other people breaking the rules and it makes it a lot easier for us to do the same. Think of driving. When everyone else on the freeway is travelling above the speed limit, chances are we will too. Why? No one really believes in the speed limit. That is, we don’t really accept the speed limit as the law. Plus we don’t often get caught and when we do it’s not that big of a deal.

So how do we encourage the contagion of good behavior?
These three ideas, used together, are a good place to start:
1. Allow behavior to be open and visible
2. Establish well understood norms
3. Insist on accountability

Coming up next:
You really can create a culture of integrity in your own corner of the corporate world. Here’s how.

Integrity is Contagious

2010-05-11T11:04:00.000-07:00

Here’s an interesting experiment. David Rea, a social scientist in Wellington, New Zealand recently conducted a test on his students. He presented 28 university students with five ethical dilemmas. The students were split into two groups, given a questionnaire about the dilemmas and asked how they would respond in each case. The questionnaires were identical except that each group received different information about how others had responded to the same dilemma. For example one dilemma about paying taxes was presented to the first group Rea called the ‘ethical group environment’ as:

A very small number of tertiary students use accounting firms to file their tax returns. They do this to access a soon to be closed legal loophole that gives them a refund of $1000 on their student fees. Would you pay $40 to an accounting firm to access this refund?

While the ‘unethical group environment’ was presented with the following:

Almost all tertiary students use accounting firms to file their tax returns. They do this to access a soon to be closed legal loophole that gives them a refund of $1000 on their student fees. Would you pay $40 to an accounting firm to access this refund?

The results were significant. Individuals in the ‘ethical group environment’ acted ethically on average 58 per cent of the time while those in the ‘unethical group environment’ acted ethically only 38 per cent of the time.

Rea’s experiment is important because it provides valuable insight into our own behavior. Human beings have a deep need to fit in. When we see others doing the right thing we tend to follow. But the reverse is also true. If we see others cheating, it tends to encourage us to do the same. Rea’s work also builds on experiments by other social scientists. In one previous experiment, social scientists found that people were less likely to litter if they saw other people throwing garbage in the trash can.

Can you think of an instance when seeing other people’s behavior has affected your own? I’ve noticed it when I leave the grocery store, usually with a cart full of groceries, my children on the verge of a tantrum, and in the middle of a sudden downpour. After I load up the car, I look around and notice where other carts have been left. If I see carts strewn around in parking spaces, higgledy piggeldy, I find it much harder to force myself to trudge over to where you’re supposed to return your cart. But if I see carts neatly stacked at the entrance to the grocery store, I make the effort.

Knowing that people’s actions can be influenced by other people’s behavior is an empowering realization. Importantly, it means that we can create corporate and economic cultures where integrity is internalized and becomes the norm. (Yes even in finance!) Not by adopting onerous and restrictive rules though, but by taping into human nature and fostering self reinforcing integrity systems. It’s an exciting possibility at our fingertips! Stay tuned to find out more.

Does Goldman Sachs offer its customers a satisfaction guarantee?

2010-05-07T11:24:00.000-07:00

Think about that for a moment. When a business offers a satisfaction guarantee it communicates trust and a bond of trust with customers is extremely valuable. Not only does a guarantee show a business trusts its own products and services but it also trusts customers to treat its products and services fairly. It’s a critical question every business needs to ask. “Can I offer a satisfaction guarantee?” If not, a firm needs to think long and hard about why it’s ok for customers not to be satisfied with what they’re getting. Whatever the costs of a satisfaction guarantee, the benefits are large. For one thing, it’s an incredibly useful way for companies to get feedback from customers about how products and services can be improved. In the investment business, guarantees are certainly not the norm. But moving toward some form of satisfaction guarantee could be a big step banks take in rebuilding trust.

Is Goldman Sachs the next Toyota?

2010-04-29T08:17:00.000-07:00

The lawsuit filed by the SEC against Goldman is in the same category as Toyota’s unintended acceleration problem. Both are about tainted products and whether the firms dealt honestly with their customers. And it could be just as devastating to Goldman’s business as it was to Toyota’s. At stake is the bank’s most valuable economic asset—its integrity.

Conventionally, we think of integrity as an ‘eat your spinach’ topic: a personal issue, entirely up to individuals. But integrity is widely misunderstood. Integrity isn’t personal, it’s collective. It’s the underpinnings for all our commercial transactions. Integrity is a shared asset that brings financial and economic rewards. To understand why, you need to see integrity as a relationship of trust. To actually practice integrity there has to be someone on the other side of the transaction. On one side of the transaction is the firm operating with integrity (or trustworthiness) on the other side is a customer who buys into that integrity (who trusts). Once you have a relationship of integrity and trust you have an asset that produces economic value. Integrity isn’t something nice to have it’s something a firm has to have in order to sell its product and create wealth.

Goldman has built up enormous integrity over decades. It’s the gold standard for the financial industry. Whether or not the firm broke the law though, the lawsuit raises doubts about whether the bank deals honestly with its clients and whether clients should continue to trust Goldman. It also raises big issues about how it operates with trading and investment banking under one roof. It’s critical how Goldman handles this integrity crisis. First, Goldman has to move quickly to explain the extent of the problem in a convincing way. Second, it has to provide a solution that builds trust with its customers. So far, Goldman has told its customers they should have known better. That is, Goldman has effectively blamed its own customers. If Goldman is as smart as everyone says, they will learn from Toyota’s initial mistakes and turn this lawsuit into an opportunity to build greater integrity that may underpin its prosperity for years to come.

The Biggest Blunder on Financial Reform

2010-04-16T05:05:00.000-07:00

Thank heavens President Obama is taking on financial regulation as his next priority. It’s our biggest economic policy issue by a long shot. The trouble is the pitch is all wrong and that’s why it’s shaping up to be a tougher fight than it should have been.

The White House wants to make sure that we “never again” have to bail out our big banks. But arguments in favor of safety work best during times of fear. More than a year has passed since the worst of the crisis, and during that time the fear has abated, at least on Wall Street.

For many ordinary people, financial reform still seems like a no brainer but not to bankers. To understand why you have to enter the mind of a Wall Street banker. Here’s what he’s thinking: “I (or my company) took a lot of risks. We effectively went bust. But the government got so scared that it bailed me out and all but a tiny minority of my colleagues. Most of us got to keep our money and our jobs too. And then the government showered us with limitless free money that we are using to make money hand over fist. Why, exactly, should I worry about another crisis? Things look ok to me. In fact, I strongly prefer keeping things just the way they are!”

There was a time not so long ago when bankers were scared themselves. Terrified in fact. The story goes that Hank Paulson (formerly Goldman’s chief) actually got down on his knees—his knees!—to beg Nancy Pelosi to pass the TARP bill. If some of our officials, like Geithner, Summers, Bernanke or President Obama had taken that opportunity to make the bailout conditional on smart reforms, there would have been nary a whimper. But alas the chance was missed, and with the passage of each day the strength and resistance of the bankers increases.

So what should the pitch be? Instead of appeals based on altruism or increased “safety” the focus should be on self interest. Putting people in jail or outlawing practices that are easily evaded won’t accomplish much. We have a unique opportunity to build a better, more valuable financial system. If the US seizes the opportunity and offers real leadership to improve the global system, Wall Street will benefit by continuing to be the global center of capitalism for years to come. That’s what a financial system less prone to cheating can do. It’s a message we can all get behind: politicians, the public and Wall Street. And it means bankers themselves can use their creative brain trust to help make the financial system better and stronger without waiting for Washington. (see Top 5 Ways for Wall Street to regain Trust)

There may not be a second chance.

The Shoe is on the other Foot

2010-03-09T08:03:00.000-08:00

After 20 years as a journalist I’m getting a taste of what it’s like to be on the other side of the media. Two days after my book “The Economics of Integrity” was published the Wall Street Journal mentioned it in its “Heard on the Street” column. Which is fine with me, except that the reporter involved admitted to me he didn’t actually read it before he set out to make a jibe at it. The Journal wouldn’t agree to a retraction, but they did print my letter. I’m not all that upset about the incident. On the whole I probably shouldn’t complain too much about people discussing my book, even in ways I don’t approve. But it will give me a little perspective as I write, not always flatteringly, about the people, firms and institutions affecting our economy.

Digging into another myth about health care

2010-01-25T12:59:00.000-08:00

Trying to distract myself during a medical appointment this morning, I asked my doctor what she thought of the health care reform proposals before the House and Senate. In a resigned tone, she flatly stated that the proposals did little for doctors or patients and mostly benefited insurance companies. I agreed with her and we commiserated together that little would probably end up being done to fundamentally reform health care. Then I asked what she thought about a government funded health care system. She was favorable to it and had familiarity with the British system but wondered how such an overhaul could be carried out in the United States. I was encouraged that she didn’t run a mile from the suggestion. So often we are told that our doctors would stop being doctors under a government funded national health care plan. In fact, my doctor seemed to indicate just the opposite. She told me stories of her doctor friends who are struggling just to stay in business under the current system. When I got home I checked the number of doctors per patients in major industrialized countries to see if there was any truth to this argument. According to the OECD, Australia, France, Germany, and the UK, all nations with so called ‘socialized medicine’ have more doctors per patients than the US. Only Canada and New Zealand have fewer doctors per person than the US. The claim that there would be a doctor shortage under “socialized medicine” turns out to be just another myth.

Practicing physicians, Density per 1 000 population (head counts)
(Source: OECD 2006 data)
Australia 2.81 Canada 2.15 France 3.37 Germany 3.5 Netherlands 3.82 NZ 2.28 UK 2.44 US 2.42

A Darker Side to Claim's of Women's Earnings Progress

2010-01-19T11:25:00.000-08:00

This morning I listened to NPR and was interested in the latest findings about the economics of marriage. New research by the Pew Research Center has found more men are marrying women with higher incomes than anytime in the past. Both the radio and newspapers portrayed this in a positive way for women—that women are becoming more educated than men and in fact are making gains in the workforce. I wish that were the entire story. Unfortunately there is a disturbing and darker side to this. Is it really women making gains in wages or could it also be that high paying jobs, traditionally held by men, are disappearing? Haven’t we all heard that during this recession most jobs being lost are by men? According to the US department of labor, women’s median wages were still 79.9% of men’s in 2008. While women’s wages have been increasing as a percent of men’s over the past few decades those gains are masked by what is happening to average male earnings. They have been stagnating at best. According to the National Association of Colleges and Employers, real starting pay for men with bachelor’s degrees fell 3.2 percent between 2000 to 2007 and 1.7 percent among women during that time. This isn’t only about gender it’s about what’s happening to the middle class. And it’s not a pretty picture.

Who Benefits from Complexity?

2010-01-15T06:41:00.000-08:00

This week Jonathan Gruber, an MIT health economist who provided the key analysis which supported the Obama Administration’s health care reform plans, was being criticized for not disclosing a lucrative government contract. What’s fascinating about this incident is what it reveals about public policy. (See my HuffPo post for more) There’s only one expert in the entire nation who has the know how to quickly estimate the effect of health care reform in various scenarios. And none of us have a clue so we have to take his word for it. Isn’t that a little crazy? What’s the value of having such complicated legislation so that only one person in the entire nation actually takes the time to dig through it?

Why we shouldn't give up on the public option

2010-01-08T10:58:00.000-08:00

At first when I thought about health care reform I thought of universal health care as a moral issue. But when I took the time to look behind the rhetoric and dig into the numbers I discovered that universal health care, or more explicitly government funded universal health care, is really an economic obligation. When you compare the US to other industrialized nations on the basis of costs, health outcomes, quality and satisfaction there’s only one conclusion you can reach—it’s foolish and wasteful not to move to a government funded health care system. I just wrote a Huff Po post looking at one of the more startling facts about cost. There are lots of angles to look at, and they all seem to point in the same direction. If the current health care legislation does pass, it absolutely can’t be the last word. Without a common sense system similar to other developed countries, the US will be competing with a serious economic handicap.

What do financial reform and health care reform have in common?

2009-12-28T14:56:00.000-08:00

Consider both the financial reform and health reform proposals on the table. Both contain many changes and every detail has been hotly debated. But these changes tend to be on the margin and may or may not produce positive effects. At this point in fact they look to have little impact because the fundamental institutions that need reform are not just preserved but further entrenched.

The health care reform maintains the principal features of our existing insurance system and pulls in additional payers to spread the cost. That works out well for insurance companies who get more premiums but what about the public? It’s not cynical, nor is it without precedent, to predict that changes at the margins won’t significantly alter a bloated, broken system. The problem in health care is not only that millions of Americans don’t have health insurance. It’s that the current system of health insurance doesn’t work very well at all. Think of enormous premiums, low coverage and poor quality of services. Surely more of the same is not the answer. And in the case of financial reform, the proposals on the table also boil down to more of the same. Financial institutions will remain quite free to take excessive risks with other people’s money and the public will remain obligated to pick up the pieces.

Let’s stop pretending that these so-called reform acts represent important changes in the public interest and acknowledge what’s really going on; continuing protection of corporate interests disguised as reform. In essence both sets of policies look like they will end up feeding our flawed institutions while the public hopes for scraps.

Pigs at the Trough

2009-12-20T08:28:00.000-08:00

Some thoughts about executive pay; and in particular about banker pay. Landon Thomas had a nicely written piece in yesterday's NYT wherein he related a telling response from Robert Diamond, Barclays’ head, as to why he was paid so much ($22 million in 2008!). Three reasons: first, I’m senior; second, I did deals that “transformed” the bank; and third, I am entitled to benefit together with everyone else from the financial system.

Which leads me to the following thought experiment. Why is it, exactly, that bankers can be worth so much? They don’t invent the wheel, after all; they lend money or, perhaps more typically in the world of high finance, they promise to pay over money under certain conditions which may or may not occur. So why are the individuals so valuable? Well, it could be that they have secret knowledge of proprietary “products” or methods or inside information that the rest of the market doesn’t have and that customers are paying enormously for. But does that seem very likely?

Isn’t the real reason they get paid because of their “relationships”? But think about that for just a second. What is a relationship, after all? Isn’t it an arrangement of mutual benefit? So if a CEO wants to deal with a banker (or institution), and we all know he has practically equivalent choices at many banks, what is the mutual benefit? Perhaps we should be looking for the quid pro quo that is virtually certainly there. Remember that CEO’s don’t cut the mustard unless they are “trusted” by Wall Street. And how, exactly do they earn that trust? Not by sticking their finger in the eye of bankers, that’s for sure. Doesn’t it look a bit like a mutual payola deal, where overpaid bankers assure the hiring of overpaid executives, and vice versa. Could that be what they really mean when they champion the so called free market?

I have no problem with executives getting paid very well for creating long term value. But anybody who does a deal and then claims a bonus is just a glorified pirate, as it will be years and years before the true success or failure of any deal becomes apparent, and as those in the business can tell you it requires the efforts of many people over many years to achieve that success.

First Post!

2009-12-16T07:18:00.000-08:00

I’ll kick off this blog by telling you what to expect. I took the plunge last week with my first blog post on the Huffington Post. I love to produce analysis and think pieces on the economy and my formal work will be found on the Huffington Post and in other publications. My blog will be more informal. I’d like to include interesting facts and ideas about the economy and policy as well as input from economists, academics and policymakers who are wrestling with important issues. With a little luck some of what you read here will inspire you, or provoke your own thinking.

The Economics of Integrity

2009-09-26T08:47:00.000-07:00

Through her colorful—and often surprising—stories (examples range from pouring milk on your corn flakes to international gold trading) the acclaimed journalist takes us on a journey that reveals the deep layers of trust involved in even the simplest of transactions and how our stock in integrity is our most valuable economic asset.

A big idea book with the entertainment value of Predictably Irrational, it also sheds light on our current economic crisis and the inner workings of global financial markets.

Beginning with things we take for granted in our daily lives—milk, money, and markets—this book shows how much we depend on and benefit from integrity.

Through the eyes of Toyota, the number one carmaker in the world, we learn how integrity is an investment with a financial payoff and through the experience of successful start ups like eBay and Amazon we can understand how integrity is built up over time.

Not only does this book reveal how integrity is an important source of our prosperity, but it also lays out a system for how to generate more integrity and more wealth. Bernasek explains the DNA of integrity and reveals the key building blocks of disclosure, norms, and accountability. This book isn’t just an interesting read about the way global markets really work.

It also delivers clear and practical steps to building a stronger economy based upon trust that will benefit everyone. The Economics of Integrity offers a bold new way to look at our economy; this is a book for our times.