The Value(s) of Wall Street

On January 22, 2008, the day when the Federal Reserve began to lower interest rates to address a looming economic downturn, the New York Times ran a Tiffany & Co. ad on page three. The ad featured a lovely pair of diamond teardrop earrings for $230,000.

For most Americans, $230,000 is a lot of money. To put that figure in perspective: in 2007, the median American house price was $218,900, and the estimated average income for a family of four in 2008 was $65,900. An average American shopping for real value can have those earrings -- or a house -- by sending every cent earned for the next six years (after taxes) to Tiffany rather than feed and clothe the family.

On Wall Street, however, at least until recently, $230,000 was not even chump change: it represented but a small fraction of the base pay and bonuses of the people who created the Great Recession.

Many observers would have you think that the resulting liquidity crunch was the direct result of the economic illiterates who made the unwise decision to take out subprime mortgages on homes they could not afford. In reality, today's problems are the result of decisions made by economic sophisticates who pushed these loans and dumped them in secondary markets where they were repackaged in mortgage-backed securities and other esoteric, synthetic instruments. Michael Lewis writes of a Mexican strawberry picker in California making $14,000 a year who qualified for a $720,000 home with not a penny down. Where, then, does the blame really lie? Not with the strawberry picker.

The initial collateralization was helpful (as is the case with most normally functioning secondary markets which provide liquidity), but further spreading the risk through opaque financial instruments served only to fragment, and further obscure, the value and the risk of what was being sold. Wall Street's reigning philosophy at the time, according to one former hedge fund trader, was "pump and dump": pump out as much paper as quickly as possible, collect the origination fees, and then dump it at a discount somewhere else.

The fundamental problem now facing our economy is not the value of the initial subprime mortgages (after all, those mortgages are still backed by tangible, real property) but rather the value of some of the financial paper that was ultimately spawned by the mortgage practices: the collateralized debt obligations, structured investment vehicles, and derivatives. Although our financial system is mending, this paper still has uncertain (but certainly low) value, and it inhibits a return to normalcy. Many holders fear that if they sell now, the value of the paper would still be so low that they would face undercapitalization coupled with an immediate requirement to obtain more funds from a still risk-averse system to avoid bankruptcy. It may take years to unravel these complex relationships and bring some value out of transactions which, from the outset, offered very little, if any, real value creation.

How did this happen to our economy?

Part of the answer has to do with Wall Street's -- and the country's, for that matter -- fixation on short-term values. Long-term value creation was replaced by an obsession with quarterly earnings and, ultimately, the short-term speculative frenzy that marks the end of a bubble. Our capital markets began to operate as casinos rather than as vehicles for providing capital that invested in America's future. CEOs and others who bought into all of this were lavishly compensated by their boards, based on short-term indicators such as quarterly earnings. Most CEOs now stay in their jobs for far less time than they did 20 years ago. Among some, there's a sense of "get in, get mine, and get out."

We've all seen the comparative figures: 30 years ago, average CEO pay was approximately 40 times the average worker's compensation. In 2009, the CEOs of America's 500 largest companies earned an average of $9.25 million apiece, roughly 319 times the average earnings of the American worker (and 140 times the earnings of that family of four).

Ten years ago I had lunch in New York with a CEO who is now a principal at a prominent private-equity firm. We discussed CEO compensation, and he was worried then -- long before the problems of Enron and Worldcom appeared -- that if CEOs didn't manage to police themselves, the federal government would step in and do it for them. When he proposed to some of his fellow CEOs that they meet to discuss possible voluntary action they might take, no one could find the time, a few doubted whether their views would matter, and one said, in essence, "you got yours; when I get mine, let's talk."

Economists know that a price -- whether for a currency, a stock, a commodity, or CEO talent -- signals a measure of value, and that value ultimately rests on a level of confidence. The deleveraging in our financial markets signals, among other things, a loss of confidence in the underlying value of the paper generated by America's housing market bubble. Value scales are being upended dramatically, and it is important that corporate leaders understand that "deleveraging" must, and will, apply to them too.

The compact that existed 30 years ago between employers and employees no longer exists. Back then, the gap between the highest and lowest paid was much narrower, health care benefits were available through the workplace, and retirement security through defined benefit pension plans was far more commonplace. America's business leaders need to drop their short-term fixation on immediate profits and, instead, focus on their companies' long-term performance, recognizing that doing so also includes the long-term well-being of their employees and the communities in which those employees live. Their ability to do so will send an important signal about the value of long-term thinking, planning, and investing. This signal can, in turn, help move the entire country away from short-term behavior towards making the necessary investments in education, our physical infrastructure, our health care system, energy independence, and information technology.

Dark as the headlines have been, there exists a silver lining. For much of the last decade, American business has been playing a defensive game and has earned increasingly lower approval ratings. Such negative views of business are bad for the country, for our economy, and for the entire business community. Smart CEOs and their boards will recognize an enormous opportunity to correct this problem immediately by demonstrating sincere concern for another kind of value: the important public policy issues now facing the country that will also impact long-term corporate profits.

Forward-thinking CEOs like General Electric's Jeff Immelt (taking GE "green" through "Ecomagination"), former Wal-Mart CEO Lee Scott (reorienting the company internally and externally on health insurance and prescription drugs), Safeway's Steve Burd (championing a healthy workforce), PepsiCo's Indra Nooyi ("Performance with Purpose"), and PNC Bank's Jim Rohr (devoting $100 million of company money to its early education "Grow Up Great" initiative) understand the importance of repositioning business away from short-term thinking to a longer-term investment approach that benefits shareholders, employees, communities, and the country.

We need more CEOs and boards to follow their examples. Only when that happens can we be certain that the values that have led to short-term economic bubbles have really changed for the better.