A Too-Narrow Lens

Zach Carter hits on something interesting about shareholder democracy in The Nation this week (disclosure-longer-than-this-post: I wrote a piece for that magazine; Victor Navasky, CJR’s chairman, is its publisher emeritus; and The Nation Institute partly underwrote a story for us. Phew. Good thing this post doesn’t involve Goldman Sachs. And yes, we also read The Weekly Standard )

Where was I? Oh, right, shareholders.

It says in the headline that:

Shareholders Alone Can’t Correct ‘Too Big to Fail’

…and the story goes onto assert that they, alone, won’t be able to constrain bloated executive pay packages or incentives that reward short-term risk taking.

As Carter points out, there is obvious appeal in the idea of applying shareholder democracy to restrain bad practices, starting with the fact that the government’s record at this vital task isn’t all that impressive. Why not give market participants a crack at it?

We’ve just watched several regulators, from the SEC to the Office of Thrift Suspension to the Federal Reserve, fall down on the job—maybe shareholders who want to see a good return on their investment will exercise more prudence. For many companies, especially at small- and midsize banks, a stronger set of shareholder rights really will help curb corporate abuses. The savings and loan crisis was largely a story of small-bank executives looting their own companies at shareholder expense. The SEC has been far too complicit in allowing management teams to stack the deck against shareholders for far too long, steadily transferring power from those who own companies to those who run them—and blessing whatever lobbying interests the managers might find attractive in the process. In 2007 the SEC issued a rule that made it almost impossible for shareholders to challenge corporate directors in elections, allowing management teams to seal themselves off from shareholder criticism. This past May the SEC proposed amending the rule to allow shareholders to directly nominate directors, but this has not yet been enacted. Congress really does need to restore a set of meaningful shareholder rights.

Shareholder democracy is one of those apple pie issues. Not many people are against it. Gretchen Morgenson is a big believer in it, and advocates for it in her columns regularly. This New Yorker profile (subscription) of governance guru Nell Minow puts a lot of stock in the idea as way to solve what it calls “The Pay Problem.”

Carter, though, argues that investor interests can be at odds with the public’s.

But at major US banks, the public good and the interests of shareholders are in a fundamental state of conflict. “Too big to fail” financial behemoths have been the source of all the recent bonus outrages; and at “too big” firms, shareholders actually want their executives to be rewarded for taking on excessive risk. It’s the smart bet. If the risk pays off, the bank’s stock price soars. If the risk backfires, the government will spare shareholders from losses. You can’t solve a problem by punting the issue to the very parties who benefit from the imbalance.

Well, I’m not sure I go along with all of this. Investors making this bet would have been big losers in the case of Bear, Lehman, AIG, Fannie Mae, and Freddie Mac, to name five very big firms. An uncertain guarantee isn’t much of a guarantee.

But the larger point—of conflicting investor and public interests—strikes me as important for journalism because business-news organizations typically cast themselves, correctly, as defenders of investors against managerial manipulations. This is a good thing. Indeed, you could argue that this is what business journalism does best. Pick your own favorites; mine would include work like this excellent Wall Street Journal story from 2008 exposing Lehman managers’ fibs about the bank’s financial condition before the fall; hard-hitting probes into dubious small-company stocks, like this one by Bill Alpert of Barron’s, or come to think of it, almost anything by Fortune’s Carol Loomis, including this 2005 classic on Hewlett-Packard.

But increasingly, I fear, business journalism believes its mission stops with serving investors, as Damian Tambini of the London School of Economics found in this study of the business press last year, and may sometimes even conflate investor interest with the public’s.

There are limits to the investor-oriented approach to journalism. Carter argues that investors have been fobbing off risk on the public for years.

It may be hard to believe, but investors have been making this bet for decades. Throughout much of the 1980s the Federal Reserve and other bank regulators bailed out all eight of the nation’s largest money-center banks—banks like JPMorgan, Bank of America and Citibank—after all of them got in over their heads making unaffordable loans to developing nations. In the ’80s regulators used accounting tricks and funneled taxpayer money through the International Monetary Fund to save the banks, rather than going to Congress for a direct bailout, but the effect was the same, and investors know it. A year after the Great Crash of ‘08, investors also recognize that the “too big to fail” problem has actually gotten bigger, after emergency mergers designed to stave off collapse turned already giant institutions into great banking beasts.

Actually, I think it’s quite a bit simpler than that.

It’s important to remember the degree to which many of the firms that today are the worst basket cases were for many years earnings machines. Take Citigroup. Its earnings power was staggering. During the five years between 2002 to 2006, its annual net income was $15.3 billion, $17.9 billion, $17 billion, $24.6 billion, and $21.5 billion, respectively. Those are huge numbers, for any industry, by any standard. For a while it was in Exxon-Mobil territory (before the oil company’s earnings just hit the stratosphere; its net was $11.4 billion, $21.5 billion, $25.3 billion, $36.1 billion, $39.5 billion, during the same years).

Here’s a chart, courtesy of Bloomberg, of Citi net income from 1995 to 2006.

That’s impressive, until you think about it.

As we know from “Banking on Misery: Citigroup, Wall Street, and the Fleecing of the South,” the Polk-award-winning story by Mike Hudson from the summer of 2003, the period in question was one in which Citi engaged in its worst behavior toward borrowers, including documented, mass-scale predatory lending, and along the way piled up incredible risks that would cost taxpayers $50 billion in TARP money and put them at risk for another $301 billion in guarantees.

Point here is that Citi did very well by its shareholders over the short, medium, and it could even be argued, looking at the chart, over the long term.

It’s true that in the even longer run, yes, shareholders could and did pay, and so, would, on some level, have an incentive to step in and police managerial missteps and misdeeds.

But many profits were reaped, stock gains booked, and risks piled up in the interim. It’s doubtful shareholders would have wanted to rein in management even if they could have. For investors, Citi was working.

This is simply to argue for a business journalism that looks beyond the investor perspective. It is not a surprise to me that the alternative media, the muckrakers, actually had an advantage in the runup to the crisis, as Alyssa Katz, wrote here in September.

First and foremost, we looked for the real-world impacts of business practices. Financial journalists tend to focus on the internal benefits (to investors and bankers) of economic activity, without accounting for external social costs. We indies [independent journalists] saw benefits and costs as inextricably linked.

The muckrakers didn’t know of looming dangers to the global financial system (although this 2002 Nation story by Bobbi Murray certainly does put its finger on it); they just knew that what they were seeing was wrong. For journalists, that should be enough. As it happened, the effects of abusive lending was amplified via secruritization and its derivatives, so everyone paid, including buy-and-hold shareholders.

So, the broad view was the right view, even for shareholders in this case. But the broad view is always smarter. I’ve written that the business press, with rare exceptions, sees insurance profits over the moon and assumes that that’s a good thing. And it is, unless you’re a policyholder.

So a lesson of the meltdown for the business press: the investor’s perspective is valuable, but narrow. Pull the camera back.

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Dean Starkman Dean Starkman runs The Audit, CJR's business section, and is the author of The Watchdog That Didn't Bark: The Financial Crisis and the Disappearance of Investigative Journalism (Columbia University Press, January 2014). Follow Dean on Twitter: @deanstarkman.