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Chicken Biscuits & Credit Default Swaps


I’ve never eaten at a Chik-fil-A although I have been told the food is good. Nearly everything I know about the company concerns its distinct corporate culture, which Forbes compared to a “cult.”

This culture goes beyond not being open on Sundays: Many franchises host Bible studies; and the chain was criticized for its links to “anti-gay” groups like Focus on the Family.

The critics, who have nicknamed the chain “Jesus Chicken,” have had zero impact on sales, which were an estimated $3.5 billion last year, up from $2.3 billion only four years earlier. On the contrary, the fact that many of the most vociferous critics live in places where you can’t eat at Chik-fil-A may have helped sales in a kind of “we’ll show those coastal elitists” way.

If you ask Chik-fil-A fans, many of whom are evangelical Christians, to explain the chain’s distinctive culture, virtually all of them will point to the personal faith of the chain’s founder, S. Truett Cathy and his family, who regard the company as a kind of sacred trust whose purpose is to “glorify God by being a faithful steward of all that is entrusted to us.”

While the family deserves the credit it receives for the distinctive corporate culture, there’s another, equally necessary, factor that likely won’t be mentioned: Chik-fil-A’s corporate status. The company is privately held: You can’t buy Chik-fil-A stock. While this limits the company’s ability to raise capital, it leaves the Cathy family free to run the company as they see fit. They can sacrifice earnings in pursuit of Christian principles, such as keeping the Sabbath and making sure employees spend time with their families.

If Chik-fil-A was publicly traded or sold to a company that was, the Sunday closings would probably end in the amount of time it took to draft the press release. Shareholders wouldn’t go along with sacrificing one-seventh or more of potential sales. The rest of the company’s Christian ethos, starting with its mission statement, would follow, since maximizing shareholder value, not glorifying God, would be the primary mission.

I thought about Chik-fil-A after watching the HBO film Too Big to Fail and reading the book by Andrew Ross Sorkin on which it was based. What struck me was that much of the behavior that caused the financial crisis, at least among investment bankers, was not only legal but almost mandatory.

Even Sorkin’s harshest critics, such as Matt Taibbi at Rolling Stone, acknowledge that Goldman Sachs’s dumping “a huge lot of deadly mortgages on its clients, [lying] about where that crap came from and [claiming that] it believes in the product even as it’s betting $2 billion against it” may not constitute criminal fraud.[i] (Instead, he urges that Goldman be prosecuted for lying to Congress about it.)

An obvious retort would be that just because an action is legal, or least not criminal, that doesn’t make it right. Having read thousands of pages about the financial sector and its, for a lack of a better expression, moral ecology, I’m not sure if this applies to Wall Street.

I’m not being cynical: I’m looking at the institutions and incentives and drawing a reasonable conclusion. Take the aforementioned “dumping of deadly mortgages” by Goldman Sachs: it paid a record $550 million fine for its actions, which when subtracted from its $2 billion position, still left it $1.45 billion ahead. This no doubt made its shareholders and senior management happy.

Sure, investors are angry but most concerns about the bank’s future profitability have less to do with its moral reputation than with concerns that it can’t maintain its place in the investment bank pecking order.[ii]

I’m not defending Goldman Sachs and other financial giants -- I’m simply pointing out that all of the institutional and personal incentives point towards getting as close to the line between what is legal and what isn’t as you can. And if you occasionally cross it, just make sure the offense is a civil, not criminal, one. A character in David Lender’s novel Bull Street compares it to aggressive slalom skiing: What matters isn’t missing gates but whether someone sees you miss the gate.

Even that line may be a bit conservative: In his New Yorker article about the Raj Rajaratnam insider trading case, George Packer refers to a poll of 2500 “Wall Street professionals.” They were asked “if they would use inside information to make ten million dollars if the chances of getting caught were fifty per cent. Seven per cent said yes. But, if there was zero chance of getting caught, fifty-eight per cent said that they would break the law.”

All of this makes us wish that these banks were a lot more like Chik-fil-A. Actually, they used to be in one important respect: They weren’t publicly traded. Until 1970, the New York Stock Exchange prohibited investment banks from being publicly traded. They all operated as partnerships and their capital was limited to that provided by the partners themselves.

After the NYSE changed its rules, investment banks started going public. (Goldman was the last holdout: It didn’t go public until 1999.) As James Surowiecki pointed out in the New Yorker, going public had a dramatic impact on the bottom line: “Between 1995, [Lehman Brothers’] first full year as a public company, and 2007, its revenues more than sextupled, while its profits grew more than seventeen times.”

Of course, Lehman ceased to exist in 2008, and therein lies the tale: Going public changed the behavior of these banks in not-so-subtle ways that destroyed at least two of them, nearly killed the rest, and stuck all of us with a $700 billion tab and a financial mess that may take a decade to unwind.

According to Surowiecki (and everyone else who understands the subject), “Going public allowed companies to raise huge amounts of capital, which, in turn, increased the amount of money they could borrow to leverage their bets.” Stated differently, the banks were now playing with someone else’s money instead of their own, which made them less risk-averse.

It was this access to other people’s money that enabled what Treasury Secretary Henry Paulson would call Wall Street’s “gambling problem.” They never would have taken the risks they did if it were the partners’ money that was at stake.

The other change in behavior resulting from going public was the impact of what Surowiecki calls “minute-by-minute referendum, in the form of the stock price, on the health of their operations.” While he’s specifically referring to the way the market turned on Lehman Brothers and then on the other investment banks, the impact of this “referendum” predated 2008.

Citigroup CEO Chuck Prince famously told the Financial Times in 2007 that “when the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Prince’s statement is regarded as an encapsulation of the irresponsibility, shortsightedness, and group-think that got us into this mess. True enough. But why did he feel that he had to keep “dancing?” The first part of his statement clearly indicates that he knew things might end badly.[iii]

Part of the reason was that investors would likely have punished banks that declined to dance. In a market where most investors were caught up in the speculative frenzy, being cautious was akin to being a preacher at a keg party. Surowiecki’s “referendum” would have a been a vote of “no confidence” in management. So, they danced.

Once again, I’m not justifying the actions of those who contributed to the financial crisis -- as Spock told the residents of Stratos in “The Cloud Minders,” understanding something is not the same as approving of it.

And I’m not saying that all “Wall Street Professionals” are amoral cretins driven by greed; after all, as many as 42 percent of them would forego committing a felony even if there was no chance of their being caught.

What I am saying is that to change people’s behavior for the better, you have to understand what caused it in the first place, and you can’t understand that without taking into account the context, what I call the “moral ecology.”

Of course, proper moral instruction is vital, but it’s not enough. Institutions and incentives help to define what we can reasonably expect from people. Christians know this: They aren’t content to simply teach their kids about right and wrong regarding, say, sex. They are also concerned about what an acquaintance dubbed the “pornoculture”: the Internet, what’s on television, etc. These concerns sometimes manifest themselves as efforts to transform the institutions they (rightly) see as working at cross purposes to their own desires for their kids.

Efforts at transformation aren’t limited to persuasion -- they can take the form of legislation and regulation. If you’re afraid your kids are growing up in a sewer, you want the sewer cleaned up, voluntarily if you can, coercively if you must.

What’s true of sex is just as true when it comes to money: Institutions and the incentives they create matter. As Preet Bharara, the U.S. Attorney who prosecuted Rajaratnam, told Packer, “There are often two categories of reasons to do the right thing.” There’s a sense of right and wrong -- what deters the 42 percent.

When that isn’t enough, and as Bharara noted, it often isn’t -- especially when you take into account the huge sums of money involved -- there’s the threat of prison. This is what keeps the 58 percent in line.

This isn’t an admission of failure. It’s an acknowledgment that human behavior is situated: It takes place in a particular context. While the rightness or wrongness of an act isn’t a function of this context, the likelihood of people consistently doing the right (or wrong) things is.

That’s why it’s vital to understand the role of institutions and the incentives they create. Getting them right can take us a long way towards creating that elusive creature we call the “good society.” Ignore them and no amount of instruction or exhortation will overcome their influence.

It’s as true of credit default swaps as it is of crispy chicken biscuits.



[i] As of this writing the Manhattan District Attorney’s office has subpoenaed Goldman’s records as part of a possible fraud investigation. Stay tuned.

[ii]Goldman undertook an eight-month review of its business practices in 2010 whose results were summarized by one wag as “you shall not screw your client.” We’ll see.

[iii] It ended badly for Prince. Sort of. A few months after he made this statement he was out as CEO at Citigroup. But he got a $38 million as a consolation prize.


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