Former Citigroup CEO Chuck Prince made what could be considered the most infamous statement of this credit crisis when he said:
"as long as the music is playing, you’ve got to get up and dance. We’re still dancing."
-Citi Chief on Buyouts: ‘We’re Still Dancing’, DealBook, July 2007
This statement was correctly interpreted as a defence of a reckless disregard for risk.
Most pundits at time considered it a simple "everybody’s doing it" kind of statement that you might expect from your unrepentant teenager when he is caught doing something he knows is wrong. But, in truth, what Prince was acknowledging is that risky behaviour wins when risk is rewarded.
If the Fed drops interest rates to extremely low levels and investment banks are leveraging up 30 to one and partying like it’s the the tech bubble days of 1999 again and there is zero regulatory oversight, it’s a green light to take risk.
When commenting on this in December, I said James Galbraith, author of The Predator State:
sees the latest episode of financial crisis as a Minsky moment predicated on ‘Ponzi’-style debt pyramiding that is the end game in the cycle of stability to instability as it was post-1929.
My view is that a lack of regulatory oversight allowed the system to veer away from macro-prudential finance. This is not a case of Madoff-style fraud with everyone in finance cooking up schemes to defraud homeowners. Yes, these cases of predatory lending existed. However, I see the systemic risk as more pertinent.
Systemically-speaking, the Ponzi phase is one of risky behaviour crowding out prudent behaviour in a world free of regulatory controls. If risky behaviour is temporarily rewarded with profit and this temporary period is long enough, then risky behaviour wins and drives out good behaviour.
Prince wasn’t saying "everybody’s doing it" at all. He was saying "you’ve created an environment that rewards risk in which I feel compelled to compete." He’s saying what I said in December about CEO motivations for lending to people at ridiculous multiples of income:
As prudence was thrown out, these constraints were relaxed. The Bradford and Bingleys of the world used lower interest rates to justify jacking these constraints up to 3.5 times or four times income. Eventually these constraints hit six times in the UK.
How do you compete against that as a bank? All of the business is going to Bradford and Bingley and you are getting stuffed. I guarantee you shareholders won’t like that. As an executive, you better find the holy grail of prudent but profitable lending or follow Bradford and Bingley on the road to easy money. Otherwise, you will be out of a job.
Eventually, even the prudent relax their standards too – that’s how risky behaviour drives out good when risk is rewarded.
So I wasn’t surprised to hear Chuck Prince saying exactly the same thing at the FCIC hearings in DC today. The Wall Street Journal reports:
Bill Thomas, a Republican former congressman from California who is vice chairman of the panel, which must produce a report on its findings by Dec. 15, compared the former CEO to "a lemming" because of his reluctance to rein in risk-taking as late as mid-2007.
The comment came after Mr. Prince tried to explain his infamous declaration in mid-2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing." Mr. Prince was referring to the dangers of leveraged lending for private-equity buyouts, but Mr. Thomas responded: "You weren’t going to be the lemming that stopped and said: ‘I don’t want to keep walking."’
Mr. Prince said Citigroup could have lost market share or key employees if it veered away from the sorts of bets that so many banks and securities firms were making at the time. "It would have been impossible," he said, "to say to bankers, we’re not going to participate … and expect to have any people left." Instead, Mr. Prince said he asked regulators to intervene to curb such risk taking industrywide.
Did Prince ask regulators to intervene and curb risk taking? I’d like to see the evidence of this. Irrespective, Chuck Prince has essentially confirmed that risky behaviour drives out prudent when risk is rewarded. Either
- The Fed has to take the punch bowl away and reduce the rewards for risk or;
- Congress has to pass laws breaking up risky institutions into less risky pieces and outlawing as much risky behaviour as possible (with regulators actually enforcing those laws) or;
- Regulators have to reach into financial institutions dictating what risks they can and cannot take.
I vote for number one first, number two second and number three never.