Short-Term Shareholder Thinking Ruins Banks, Krawcheck Says

Sallie Krawcheck's had some time to think over what's wrong with the banking industry in the year since Bank of America fired her.

Yes, bankers are overpaid. Yes, they're greedy. But setting those flaws aside, myopic shareholder capitalism is failing, inadequate diversity is causing C-suite groupthink, and regulators are unwisely "attacking complexity with complexity," she said on Monday at a Harvard Business School talk in New York.

The longtime Citigroup exec and former Bank of America Merrill Lynch investment management chief made her remarks in the context of "sustainable capitalism," tossing in some details of her experience as a banker along the way.

"After B of A chucked me to the sidewalk, for the first 24 hours, I drank a lot. Like, alone," she declared to audience laughter. "The next 24 hours I sent emails to all of the board members, asking them how I could have done better."

Krawcheck has plenty of ideas for how the industry could improve. At the heart of industry mistakes is the unrealistic assumption that globe-spanning banks should be able to routinely produce returns that outstrip GDP growth. That's led shareholders, boards, and executives to spend the overwhelming majority of their time on trying to fix "underperforming" business lines, rather than questioning operations that appear unreasonably lucrative.

"Board members need to spend more time on businesses that perform well," she said, arguing that in the majority of cases sustained outperformance was a sign of excess risk-taking or something else amiss.

"If you have low barriers to entry, your returns should revert to the mean," she said, adding that few elements of banking are not readily replicable.

Shareholders have encouraged shortsighted behavior with unrealistic expectations, she said, citing former Morgan Stanley executive Phil Purcell, whose conservative approach got him ousted in favor of John Mack in 2005.

"He had exactly the right strategy going into the crisis, but was drummed out by shareholders before the results showed," she said.

Dividend policy also reflects shareholder capitalism run amok, she argued.

"Dividends should not be set dollar amounts, they should be a percentage of income," she said. "It would have made a huge difference if they'd stopped paying them going into the downturn."

As in previous talks, Krawcheck declared that financial products have become far too complex. The industry is responsible for this, she said, because opacity allows for higher than reasonable margins.

"Complexity was thrown up as a barrier to entry," she said. "If you can put together a product so complicated that the guys at Goldman can't understand it, you can make money for a period of time."

Though critics of complexity often point to financial engineering in the securities business as their main complaint, "the consumer business is complex, too," Krawcheck said.

Regulators have failed to stop the industry's march toward incoherency, she said. Instead of propounding collections of highly detailed rules, she said, regulators needed to stop the "arms race" toward increasing complexity. "Less detail, big sticks," she recommended.

She also questioned some executives' insistence that higher capital requirements would mean lower returns over the course of a full business cycle. "Are we sure about that?" she said, noting the cost of debt financing.

Krawcheck does not expect additional major financial reform absent another financial crisis, however.

Watching industry giants like Sandy Weill and Phil Purcell debate whether to reinstitute Glass-Steagall is "like watching an alumni basketball game. It's very entertaining, very competitive, and the score doesn't matter at all."

Krawcheck made an impassioned argument for diversity in the upper levels of banks, arguing that the institutions themselves would benefit. While the topic often makes bankers defensive, she said, a solid body of research demonstrates that diverse teams tend to outperform ones which are more competent on paper.

Unfortunately, the industry's gone backward on diversity, she said.

"We went into the downturn with white, male, middle-aged management teams, and we've come out with whiter, maler, middle-aged-er management teams. We've doubled down on that."

Asked why she believes banks have halted their progress in this area, she argued that it comes down to comfort.

"When we get into a position of stress, we want to be with people we really know, people who can finish our sentences," she said, noting that diverse teams tend to debate more. "When I'm under stress, I don't think, 'gee, diversity is great.'"

Despite her belief in bringing in those with different perspectives, Krawcheck said she hasn't been a fan of formal "mentoring" programs for women.

"I found them very awkward," she said. Much better was for young women executives to simply develop a good relationship with their bosses and receive regular feedback.