Friday, December 05, 2008

What Linked the Parallel Declines of Citigroup and the Harvard University Endowment?

Increasing efforts to understand the global financial collapse, or whatever history will end up calling it, may shed light on what has gone wrong with health care, and, in today's example, the management of academic medicine.

The Collapse of Citigroup

The near-collapse and putative rescue of financial giant Citigroup have raised questions of the responsibilities of one of its most prominent leaders. Two weeks ago, a lengthy investigative report in the New York Times suggested some of the bad decision making and mismanagement that humbled once one of the largest financial corporations in the world. Emphasis on short-term profit trumped concerns about risk. In particular, the risk inherent in exotic derivative investment instruments like "collateralized debt obligations" (CDOs) was underestimated and misunderstood. This may have been enhanced by incentives to leaders based primarily on short term results; and the lax oversight of risk, perhaps due to close personal ties among risk managers and traders. Poor integration after hasty mergers lead to disorganization and miscommunication. But dominant was that, as one anonymous interviewee said, "senior managers got addicted to the revenues and arrogant about the risks they were running."

The Times article highlighted the role of Robert Rubin, former US Secretary of the Treasury.

The bank’s downfall was years in the making and involved many in its hierarchy, particularly Mr. Prince and Robert E. Rubin, an influential director and senior adviser.

Citigroup insiders and analysts say that Mr. Prince and Mr. Rubin played pivotal roles in the bank’s current woes, by drafting and blessing a strategy that involved taking greater trading risks to expand its business and reap higher profits. Mr. Prince and Mr. Rubin both declined to comment for this article.

When he was Treasury secretary during the Clinton administration, Mr. Rubin helped loosen Depression-era banking regulations that made the creation of Citigroup possible by allowing banks to expand far beyond their traditional role as lenders and permitting them to profit from a variety of financial activities. During the same period he helped beat back tighter oversight of exotic financial products, a development he had previously said he was helpless to prevent.

The Times article charged that Mr Rubin had a particular role in encouraging excess reliance on risky CDOs.

[Former Citigroup CEO Charles O] 'Chuck Prince going down to the corporate investment bank in late 2002 was the start of that process,' a former Citigroup executive said of the bank’s big C.D.O. push. 'Chuck was totally new to the job. He didn’t know a C.D.O. from a grocery list, so he looked for someone for advice and support. That person was Rubin. And Rubin had always been an advocate of being more aggressive in the capital markets arena. He would say, ‘You have to take more risk if you want to earn more.’ '

Later, in 2002,

Mr. Prince and his board of directors decided to push even more aggressively into trading and other business that would allow Citigroup to continue expanding the bank internally.

One person who helped push Citigroup along this new path was Mr. Rubin.

Robert Rubin has moved seamlessly between Wall Street and Washington. After making his millions as a trader and an executive at Goldman Sachs, he joined the Clinton administration.

Mr. Weill, as Citigroup’s chief, wooed Mr. Rubin to join the bank after Mr. Rubin left Washington. Mr. Weill had been involved in the financial services industry’s lobbying to persuade Washington to loosen its regulatory hold on Wall Street.

As chairman of Citigroup’s executive committee, Mr. Rubin was the bank’s resident sage, advising top executives and serving on the board while, he insisted repeatedly, steering clear of daily management issues.

But while Mr. Rubin certainly did not have direct responsibility for a Citigroup unit, he was an architect of the bank’s strategy.

Former colleagues said Mr. Rubin also encouraged Mr. Prince to broaden the bank’s appetite for risk, provided that it also upgraded oversight — though the Federal Reserve later would conclude that the bank’s oversight remained inadequate.

Once the strategy was outlined, Mr. Rubin helped Mr. Prince gain the board’s confidence that it would work.

After that, the bank moved even more aggressively into C.D.O.’s. It added to its trading operations and snagged crucial people from competitors. Bonuses doubled and tripled for C.D.O. traders.

But as the sub-prime mortgage crisis hit, the value of the CDOs plummeted, and it all fell apart.

Soon after the Times story came out, the criticisms of Mr Rubin began.

Steven Pearlstein wrote in the Washington Post,

What is indisputable is that all of the decisions that have led to Citi's recent troubles were taken while Rubin was chairman of the executive committee, and made by executives with whom he worked closely. He defended them repeatedly and unequivocally, and as a director, he approved compensation packages that rewarded them (and himself) handsomely for judgments that proved disastrous.

Thomas Friedman wrote in the NY Times,

[The NY Times report above] exposed — using Citigroup as Exhibit A — how some of our country’s best-paid bankers were overrated dopes who had no idea what they were selling, or greedy cynics who did know and turned a blind eye.


the bank’s executives, including, sad to see, the former Treasury Secretary Robert Rubin, were clueless about the reckless financial instruments they were creating, or were so ensnared by the cronyism between the bank’s risk managers and risk takers (and so bought off by their bonuses) that they had no interest in stopping it.

Mr Rubin tried to defend himself in an interview in the Wall Street Journal, but not very successfully

Robert Rubin said ... [Citigroup's] problems were due to the buckling financial system, not its own mistakes, and that his role was peripheral to the bank's main operations even though he was one of its highest-paid officials.

After disclaiming any responsibility for Citigroup's failures, Mr Rubin did not do a good job explaining why he should have been paid $115 million for his time at Citigroup, especially given that he said

From the time Mr. Rubin joined Citigroup in October 1999, shortly after leaving the Treasury, the former Goldman Sachs Group Inc. co-chairman said he didn't want to run any of Citigroup's businesses. At the time, he told colleagues he wanted more time for activities such as fly fishing. In the recent interview, he said his task was to meet with clients and have an advisory role as an 'experienced senior person who has no ax to grind.'

This, not unexpectedly, lead to more derision.

In the Working Life Blog, Jonathan Tasini entitled a post "Robert Rubin: Coward Or Liar - Or Both?" In the Market Movers Blog, Felix Salmon said no one could read the interview "and think of him as anything other than a pompous and out-of-touch plutocrat, puffed up with more self regard than common sense." Jessica Pressler, writing in the Daily Intel Blog for New York Magazine Blog, opined,

Like a cocky serial killer on Law & Order: Criminal Intent, his determination to prove he was smarter than his investigators outweighed his common sense, and the former Treasury secretary decided to give two interviews, to The Wall Street Journal and Newsweek, to set things right. Naturally, they only made him look even guiltier.

An editorial in the Providence Journal concluded,

What a con man.

A major theme on Health Care Renewal has been the bad leadership of health care organizations. We have described how health care policy "experts" urged breaking up of the supposed physicians' "guild," and giving control of health care to bureaucrats, managers and executives. Yet the transformation of health care from a calling to a business occurred during a time of declining business ethics. We have gone from the bubble to the collapses of Enron, Worldcomm, MCI, etc, to now the global financial meltdown. The leaders of finance were once considered "Masters of the Universe." It is likely that the business-people who now lead health care have done their best to emulate them. In doing so, they may have been emulating over-rated dopes, greedy cynics, and con men.

The Collapse of the Harvard Endowment

There is, however, a somewhat more direct link between the story of Mr Rubin's humbling and the woes of academic medicine. Bear with me for a bit.

At the same time that the fortunes of Citigroup were cratering, the financial fortunes of some of the largest and most elite US academic institutions were likewise tumbling. Particularly striking was the case of Harvard University's endowment (whose medical school and teaching hospitals have lately had their troubles, as noted in these posts here and here.)

This week, the Wall Street Journal reported,

Harvard University's endowment suffered investment losses of at least 22% in the first four months of the school's fiscal year, the latest evidence of the financial woes facing higher education.

The Harvard endowment, the biggest of any university, stood at $36.9 billion as of June 30, meaning the loss amounts to about $8 billion. That's more than the entire endowments of all but six colleges, according to the latest official tally.

Harvard said the actual loss could be even higher, once it factors in declines in hard-to-value assets such as real estate and private equity -- investments that have become increasingly popular among colleges. The university is planning for a 30% decline for the fiscal year ending in June 2009.

It turns out that Harvard University, like Citigroup, had become enamored of various exotic investments. A report in Bloomberg noted that the University is seeking to quickly sell investments in a variety of private-equity funds, and that the University currently has about $4.5 billion invested in "buyout funds." This seems to be one reason that the University president expected such a large loss. The prices of such illiquid investments are set infrequently. The new prices to be set soon are likely to be much lower than previous ones. A report in the Boston Globe suggested that Harvard had diversified its endowment funds, but mainly into some risky and exotic vehicles, including 22% in foreign stocks, 18% in hedge funds, 13% in private equity, and 26% in commodities, land, and real estate, but only 11% in domestic stocks.

Who Lead Both Citigroup and Harvard?

So who was responsible for the University's risky, and now, in retrospect, unlucky strategy? The ultimate responsibility for the university's leadership resides in the Harvard Corporation, known formally as the President and Fellows of Harvard College. Its six members, according to the Harvard web-site, are:
- James Rothenberg, President and Director, Capital Research and Management Co, (part of the Capital Group Companies, investment managers)
- James R Houghton, Chairman and CEO, (actually Chairman emeritus) Corning Inc
- Nanerl Overholser Keohane, past president of Duke University and Wellesley College
- Robert Reischauer, President, the Urban Institute
- Robert E Rubin, Chair of the Executive Committee, Citigroup
- Patricia A King, Carmack Waterhouse Professor of Law, Medicine, Ethics, and Public Policy, Georgetown Law Center (and member of the board of directors of Golden West Financial from 1994 to 2006, when it was acquired by Wachovia, which failed this year)

So half of the six person Corporation are current or former leaders of financial organizations. Furthermore, its members include none other than Robert Rubin, the previously acclaimed senior leader of Citigroup, now labelled as everything from clueless to a con man for his infatuation with reckless, opaque, and ultimately mainly worthless financial instruments. Maybe that has something to do with why a university endowment, which seemingly ought to be invested conservatively to benefit generations of students and academics, was given over to the tender mercies of hedge fund and private equity managers.

We previously posted on governance issues at Dartmouth, and how the self-appointed members of its board of trustees, the vast majority of whom were also leaders of finance, have increased their own power in the name of diversity (diversity among hedge fund, private equity, and bank executives?) Now we find that half of the Harvard Corporation are also leaders of finance, including one whose own company's decline seemingly has paralleled the decline of the university's endowment.

It seems that the former Masters of the Universe were not content with driving the global finance system into the ground. Their leadership may have also lead to financial crises for American universities. One wonders whether the examples set the presence of "overrated dopes" and "greedy cynics" on university boards of trustees encouraged some of the sorry misbehavior Health Care Renewal has documented at medical schools and academic medical centers?

It seems that we need to completely rethink how we lead academic medical institutions.

Hat tip to posts by Candace de Russy and by Fred Schwarz on the Phi Beta Cons blog.


Anonymous said...

With respect to Harvard's endowment, how do its losses compare with what they would have lost if they had simply invested in the S&P 500?

Anonymous said...

The Obama administration has an opportunity to bring together a new group of stakeholders to transform the medical community as we know it today. An indication of the growing realization that we are not being served by our current leadership is the Dec. 5th WSJ article by Alicia Mundy highlighting calls by Rep. Bart Stupak not to name Dr. Woodcock as interim or permanent FDA chief.

My reality is that as my wife and I travel to other countries we see medical care considered a social cost. Here in the US medicine is considered a money making opportunity and those involved, even large advocacy groups, try to feed at the public trough. The result has been massive waste, and institutionalized and regulated standards for medical care that are not supported by evidence based standards.

I have no desire to reinvent the wheel, but do feel there is a large group of academic and practicing physicians, along with policy wonks, willing and able to step forward to provide leadership without the social and financial baggage our current leadership posses. The revolving door of government has left us with a group of wealthy individuals who have lost touch with the realities of day to day working people and physicians.

We will not see the massive and dramatic changes necessary to begin to fix our medical system until those in positions of authority are free of conflicts. Breaking the strangle hold that some industries and institutions hold on medicine will take courage and the realization that these actions will result in no sweet industry deal after the fact.

Two hundred years ago government service was just that, service. You went, you served, you came home. Today it has become a stepping stone to a higher paying job in industry and thus the new master is the money that job offers. We need to break this cycle.

Steve Lucas

Roy M. Poses MD said...

To try to answer Marilyn Mann's question, according to the Boston Globe article, the 22% loss from July to October was just slightly less of a loss than that of the S+P 500 during that time.

However, as I noted above, the loss to Harvard's endowment was probably bigger, maybe much bigger, since the recent loss did not take into account decreases in value in private equity and some of the endowment's other investments in more exotic and less liquid investment species.

Furthermore, keep in mind that Harvard spends a lot of money on the active management of the endowment. These costs presumably are much higher than would have been incurred by simply investing in an S+P 500 index mutual fund. I don't think these management costs are figured into the loss.

Presumably, the steep prices Harvard pays for endowment management are supposed to produce better returns than simply putting all the money into some mutual funds. That expensive management did produce better returns for a while, until the bottom fell out.