Spend Matters welcomes another guest post from Santosh Nair of GEP.
On Sep 15. 2008, Lehman Brothers filed for the largest bankruptcy in US history. The 160-year-old firm had over 25,000 employees and $600 billion in assets. A few hours later, Bank of America swept up Merrill Lynch in a fire sale. Over the next several days, there was a domino effect around the world. Credit markets seized up, money stopped flowing through the veins of the global financial system, stock markets crashed, and many large companies saw imminent insolvency. Five years later, there is insight to be gained by reflecting on the causes of the crisis, the diagnosis, and the efficacy of the solutions pursued by different entities. Here are three observations and lessons from the crisis:
Incentives matter everywhere.
In the years leading up to the crisis, several banks were reporting record profits by repackaging sub-prime (below stellar credit) mortgages into CDOs and trading actively. Loans were being issued with zero due diligence and everyone bet that housing prices would continue to rise for the near future. Homeowners traded up to bigger houses, hoping to become rich soon. Rating agencies stamped toxic mortgages as AAA. Everyone was incentivized to participate in the bubble and had no reason to stop.
We see this on a daily basis in the procurement world as well. Suppliers are incentivized to offer the lowest price in an RFP process without completely considering service expectations; buyers are incentivized to meet savings targets; and business unit stakeholders are incentivized to minimize operational risk. A holistic view of the risks and rewards in the system converted into appropriate incentives for all parties involved would avoid the building up of a bubble erupting in a major crisis.
Strategy is not enough, bold execution is critical.
As we stood at the edge of a financial catastrophe, there was a mad scramble by central banks to pull the system back from the brink. The US Federal Reserve was quick to respond and immediately bought a majority equity stake in AIG. Later in the week, the Troubled Asset Relief Program was approved and $700 billion was used to prop up the financial system. The Fed continued its efforts through the QE program, and while debates continue on its scale, one has to appreciate the single-minded focus of the Fed in executing the strategy. Contrast this with the European Central Bank, which had more complex issues and stakeholders to deal with and failed to act swiftly and boldly. Not surprisingly, the US is slowly returning to its GDP growth potential while Europe continues to struggle with its economic performance.
As a third-party service provider, I’m frequently struck by the wide gap between the grand strategies designed by some company leaders and the reality of executing them. The winning formula entails complete clarity on the strategic vision, commitment to executing it, empowering leaders, and incentivizing them to meet the objectives. The Fed Chairman and Treasury Secretary have such institutional capability; the European Union unfortunately has many more limitations.
Leadership (or lack thereof) impacts organizations profoundly.
The financial crisis exposed the leadership strengths and gaps of several key individuals around the world. Corporate titans, political leaders, central bankers, and policy makers were suddenly tested on their readiness for primetime. Some were; others sadly were not. And the decisions made by these individuals over the course of the tense days and weeks have impacted the lives of millions of individuals. America lost 5.4 million jobs from Sept. 2008 to April 2009. The pace of recovery is slow, and it is unlikely that we will return to full employment soon. This is a stark reminder to institutional leaders that our actions have much broader impact – well beyond the narrow definitions of our roles.
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