On April 28, 2004, the Securities and Exchange Commission, in a barely-noticed, though momentous decision, decided to modify the net capital rule, which capped the amount of debt a securities firm could take on against its assets. The rule change allowed firms such as Bear Stearns, for example, to borrow up to $33 for every one dollar of assets. The previous acceptable ratio for Bear Stearns and the other big investment banks was $10 of debt for every one dollar of assets. At the same time, the SEC made another momentous change. Instead of monitoring the riskiness of investments such as collaterized debt obligations itself, as it was supposed to do, the SEC inexplicably decided to rely on computer models designed by the banks to monitor the risk. Finally, by changing the net capital rule, the SEC gave itself the right to oversee the banks’ mortgage-related securities, a right it did not have previously. But as The New York Times reported, “The supervisory program was a low priority.”

While the decline of General Motors and the capitulation of Bear Stearns and Lehman Brothers may appear to be unrelated, there can be no doubt that there was at least one common cause. By repeatedly rejecting Congress’s calls for stricter fuel standards, by continuing to believe that car buyers’ infatuation with the Hummer and SUVs would never end, by refusing to listen to the “car guys,” the engineers who wanted to design smaller, more fuel efficient cars, and by refusing to believe that they were part of the problem, the auto executives were easily authoring their firms’ decline. Any moral capital they had left was lost when, testifying before Congress, they refused to accept that the failure of their very own strategies – not the global financial meltdown – had caused them to come begging for a bailout. Small wonder that long-time auto industry analyst Maryann Keller has suggested that, “…no CEO, chairman or senior executive have access to reporters. They cannot help their cause, whether it’s selling cars or winning sympathy for the bailout.”

The pleas for sympathy – and disingenuous disavowals of culpability – uttered by Citigroup’s Vikram Pandit, Lehman Brothers’ Richard Fuld and Bear Stearns’ James Cayne not only destroyed their credibility. Failure to accept responsibility for engineering the downfall of their firms laid bare the very fact that they and bad management practices brought their firms down. In a perverse interpretation of the phrase made famous by Bill Clinton in the 1992 election campaign, the Wall Street captains’ seemed to be saying, “Aw, c’mon. It’s not us. It’s the economy, stupid.” But, to paraphrase Joe Louis’s characterization of challenger Billy Conn, “They can run, but they can’t hide.” Make no mistake about it: Bad management, like greed, is always conspicuous. Even a colossus like a Merril Lynch cannot survive with bad management.

For sure, bad management – manifested by faulty risk assessment models and inadequate management oversight, the latter exemplified by lackadaisical, irresponsible risk managers who failed to question the risk assumptions behind collaterized debt obligations, and the “too big/good to fail” gene implanted in the organizational DNA – caused the meltdown. And for sure, feckless and even reckless regulatory agencies – not inadequate or insufficient regulation – caused the meltdown. (See the SEC’s loosening of capital requirements described above. As well, the Federal Reserve had the authority to regulate the sale of mortgage loans, but for whatever reason, it decided not to do so). And while no party can be excused for bad management or ineffective regulation, the fact remains that both practices were enabled and even sustained by a party that was even more ineffective – the board of directors.

The apparent absence of management oversight or extensive questioning of business strategy – whether by directors at General Motors or Citigroup – calls to mind the very apt title of a report on corporate governance published by the Toronto Stock Exchange in 1994 – “Where Were the Directors?” The fact is that no director or board of any of the corporations that either failed or have asked to be bailed out appears to have raised a dissenting voice or cast a negative vote, at least in the media accounts published so far. One could say that directors were inaudible, but in fact they most likely did not speak up. One could also say that they were invisible; though they were probably “present” they were, in all likelihood, not really “there,” fulfilling their fiduciary responsibility. Otherwise, how could have men and women, most of them chosen for their expertise and accomplishments, have approved risk evaluations that were based on faulty or incomplete models? How could they have bought in to the questionable strategy sold to them by overly enthusiastic CEOs? How could they not have seen that credit default swaps, exempted from regulation by Congress in 2000, might cause a certain kind of mass destruction? How is it that even a single director, at least as far as we know, did not try to deflate the certitude and hubris exhibited by the likes of Rick Wagoner and the senior managers who developed their companies’ respective strategies?

Minutes of board meetings are not published, but it is not much of a stretch to assume that most of the boards in question accepted the strategies and business cases presented to them with unanimity, and without any serious probing of the reasoning underlying those presentations. Given the gravity of GM’s and Chrysler’s situation, and the paint-with-one-brush cause of the fall of Wall Street’s giants – reckless behaviour – it is easy to see a similar, unfortunate pattern of non-involvement, or at least any evidence of rigorous questioning, in the behaviour of the many boards in question.

The fact that all directors on a particular board lean a certain way has been discussed before in numerous articles and books on corporate governance. When directors’ desire to conform is greater than their urge to dissent, or at least to criticize openly, the result is groupthink. In his book, Behavioral Corporate Finance, Professor Hersh Shefrin writes that, “A group exhibits groupthink when the drive for achieving group consensus overrides the realistic appraisal of alternative courses of action.” According to Professor Shefrin, some of the conditions that are especially conducive to the emergence of groupthink include group dynamics that feature amiability and esprit de corps; the presence of a powerful, opinionated leader, which strongly influences group members’ desire for social conformity, and the absence of an explicit decision-making process. (Please see Professor Shefrin’s article, Ending the Management Illusion, elsewhere in this issue).

There can be little doubt that the behaviour of boards of directors was a major cause of the meltdown. Perhaps it is the absence of a polarizing figure, a Ken Lay or a Conrad Black, but the possibility that poor corporate governance practices may have been a cause – perhaps even the cause – of the meltdown has hardly been raised. Nor have questions been raised about the degree to which information asymmetry may have caused certain directors to be unaware of certain risks. Public inquiries will be held and questions will be asked. While CEOs will have to answer questions, one would hope that certain board chairmen will also be asked to appear, and if nothing else, to answer this one compelling question, “Where were the directors?”