Business/Finance

The Contrition of the Bankers – the Rules can't save you now

Iceberg Enterprise“Come before the American people and take that deep bow and say I’m sorry. And then either do one of two things, resign or go commit suicide,” said US congressman Chuck Grassley in an interview on radio station, WMT.

He was discussing AIG, and apologised later for the heat of his language. Many people probably feel that he was too polite.

It must be very cathartic to lay all of the blame for the financial crisis at the doors of bankers and investment brokers. No-one has yet asked how it is that a single industry has managed to attract nothing but liars, lunatics, imbeciles and pathological hucksters while the rest of the world is filled with wide-eyed softies who have been taken for a ride.

Point is that the banking community is still comprised of people not unlike any other part of society; in parts filled with kind souls, mournful mutterers, soccer-moms, hipster wannabes, waiting for retirement and whatever other social class you can lay your hands on.

The disaster in the banking sector is deeper than the vapid demonization of a few men, and contemplation of that disaster should give thoughtful people the tremors.

Banking is no less a complex industry than are hospitals, schools, factories, and farms. Where-ever large groups of people are managed in order to produce a product, or serve a customer, only a small number of people are at the coal-face.

Call it the Iceberg Enterprise. You only get to see a small amount of what is really going on.

In order to align all the people at various levels of the organisation with the bits that are visible, we use management theory. So we divide companies up into profit centres and set staff measurable targets, giving them incentives to hit those targets. Then people play by those rules.

From the original “scientific management” of Frederick Taylor, who divided up every part of work processes into tiny, repeatable steps, and measured them (back in the 1880s); through to Six Sigma and Total Quality Management today. Rules guide how people interact in complex business environments.

Setting the Rules

Let me give you a feel for how improbable the results of such rules can be. I studied a number of major European public hospitals for a research project. Each hospital is broken down into a number of cost and function centres. Each department has a budget, and input costs, but they don’t recover their costs directly. This is pretty-much how many companies are structured.

So, the pathology lab has a budget and must minimise their input costs on specimen test kits and pathology devices; each of trauma, out-patient care and the various departments making up elective care have their own budgets; and a trust manages the accounts.

My study was to calculate what causes patient waiting lists to rise. There are many causes, but I’ll give you one. The path lab did their job of saving costs by reducing the cost of a ubiquitous set of blood collection devices. They saved 20% of the unit cost, which equalled significantly less than 1% of their overall costs. The new devices met all the relevant CE-mark certification requirements, but the company that supplied them didn’t offer any training or support as part of the process. Specimen rejections went up, but the devices were so cheap, no-one minded.

However, a rejection isn’t just a new plastic container. It is a whole new test. It is a patient who spends an extra few hours in the hospital, taking up space and time that other patients could have used.

You only need a few extra rejections and waiting times become extremely large.

But everyone is obeying the rules. Costs were saved in one department, earning the purchasing officer his bonus, and costs went up everywhere else.

There have been other rule-based horror-stories: of the policeman who arrested a 10-year-old boy for spraying a friend with a water pistol (because he needed to hit an arrest target); of traffic police blanketing car-parks with fines (to hit their targets); of surgeons refusing to perform risky surgery (lest they endanger their survival target rates).

On a recent project, we were told that a new technology wouldn’t be allowed in a German hospital because the efficiency gains were not permissible by law.

All these rules seem sensible at the time they are written, but the net impact are small inefficiencies that degrade the whole.

Sharpening the Iceberg

One of the most frenetic target-setting parts of any large business is in sales. Reps are given specific targets which they must reach or risk getting fired without pay. Since most of their pay is commission-based anyway, they’re already focused on selling, no matter what.

Every quarter the targets are re-appraised and you can bet they don’t go down.

This is how banking got itself into trouble; massive targets for deal-closure. Staff hit them, at the price of making credit easier and easier to get.

So we demonise bankers.

But most businesses and organisations are structured this way. Charities have professional fundraisers who collect cash in a similar way; no-one ever asks if the charity concerned can actually absorb the cash so-raised. Many cannot, and rot soon follows.

The US health service is one of the most expensive and inefficient in the world. Medicaid is all but bankrupt, and will be finished off once the baby-boomers retire. France pays the highest agricultural subsidies in the world based on income from the EU, paid by Germany.

Everyone is hitting their targets.

Banking just happened to fail first. Unsurprising, really, since banking is at the cutting edge of all these bright new management ideas.

However, in singling out bankers, in treating the problem as if it is only to do with capital and finance, the underlying problem is being ignored.

The fundamental way in which complex organisations are organised and the way in which goals are set needs to be reviewed.

Otherwise, in a few years, maybe we’ll be witch-hunting some other unfortunate industry who today are considered “Masters of the Universe”.

4 replies »

  1. Great article.
    One should study the business models and methods of such companies like Cargill, McDonalds, and Wal-mart to see how Total Quality Management should work. Especially Cargill, who has elevated it to another level.

    Jeff

  2. Be it right or wrong to single out AIG – they are in the cross hairs now. My overwhelming sense is that people are frustrated by the confusing nature of this whole process – but they clearly understand one thing. They don’t get bonuses for screwing up.

    I’m waiting to hear the voices that speak to the underlying reform of fundamentals. So far it’s just an angry shouting match.

    Thoughtful article, thanks.

  3. “Come before the American people and take that deep bow and say I’m sorry.”

    This is clearly indicative of a culture of lawlessness. Yet, it isn’t recognized as such. This idiot congressman is inviting the crooks to voluntarily do something.

    They should be in chains, an entire lock down on the massive fraud and companies which engaged in it.

    The congress works for Wall Street, and so Wall Street has no fear of the Congress, except that maybe they won’t be able to rape our descendants for enough trillions to satisfy their immediate greed.

    It’s truly through the looking glass, a kleptocracy in free fall, and yet they refuse to stop the fraud. The popular “president” cheers on the plunder, but frowns when some of the dirty money is accounted for in news headlines.

    Folks, three quarters of the top of the federal government should be in handcuffs, with previous administrations already in cells. That’s if America had the balls to actually care about the rule of law, freedom, democracy, all those hollow buzzwords they can’t get enough of.

    War criminals and scam artists, this is what the super empire is really all about. That and deceiving their ignorant masses in order to continue the rape and pillage.

    This is about an unaccountable protection racket, where laws don’t apply to the masters. Changing this should be job one, including a call for impeachment once the love affair with Obama is over, and his numerous betrayals have a chance to sink in.

    Steal a slice of pizza in California, and it could put you in jail for life. Steal billions, when you’re highly connected to the powers that be… no biggie. But you really should come and apologize, you big baddie.

  4. Good article. You should also write about the whole principal-agent problem in the finance sector – google it, along with “trader’s option”, “yield hogging” etc. Most people in investment banks and finance are engaged in strategies that make money 99% of the time, paying large bonuses on their 5-20% of profits, but inevitably blow up spectacularly once every 5 to 10 years. Yet that means you have an 80-90% chance of getting at least one huge bonus for doing something that loses money on average and requires no talent whatsoever.

    The main problem is the difficulty of observing the true quality of decisions. Naturally we focus mostly on performance, but in certain fields, performance in the long-run is not the same as short-run performance – and in fact in some cases, such as finance, they can often be *the exact opposite*. The best strategy from 2005-2009 was to totally withdraw from real estate and the credit markets. Yet anyone who did that in 2005, 2006, 2007 would have been fired. Meanwhile those who pursued the worst strategies, that bankrupted their firms and impoverished themselves (Dick Fuld, Jimmy Coyne etc lost 90%+ of their life savings in 1 year on this), were given huge bonuses.

    Ultimately you cannot remove the human factor from the equations. Us humans are dumb as rocks, and this time is no different.

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