Napoleon Bonaparte once said, “In war, morale is to all other factors as three is to one.”
He meant that the mental attitude and confidence of soldiers are of greater importance than the number of troops or guns. He proved this adage by repeatedly defeating armies with superior numbers at battles such as Marengo and Austerity.
Despite long assuming that human decisions are rational, economists now recognize that in economics, as well as in war, intangible factors such as confidence play key roles.
Nowhere is that more true than in capital markets, where maintaining investor trust in the safety and soundness of banks and investment firms is crucial. That’s why William Webster needs to jump or be pushed now from his post as the head of the new accounting standards oversight board.
Let’s start with a historical precedent. A wave of bank failures shattered public confidence in the banking system from 1929 into 1933. As people grew more and more fearful of putting money in banks, available credit for businesses and households shrank. Economic contraction became a vicious circle.
The new Roosevelt administration immediately faced a new wave of bank failures. Officials declared a “bank holiday” and sent flying squads of bank examiners around to check on banks and indicate which were sound.
In reality, the inspectors did not have time to really check that much; the whole effort was aimed at restoring public confidence rather than auditing banks. But it worked. The panic stopped and that gave time to enact the Federal Deposit Insurance Act, which addressed the problem on a more permanent basis.
It’s no secret the primary purpose of deposit insurance is not to compensate depositors in case a bank fails. Rather, it is to maintain public confidence in the banking system so banks will not fail. It can accomplish this purpose even if no bank closes its doors. President Franklin Delano Roosevelt’s implementation of the “bank holiday” and FDIC restored public trust at a crucial time.
WHAT ABOUT NOW?
How does that relate to Webster? He was a federal judge when former President Jimmy Carter appointed him to run the FBI in 1978. In 1987, Ronald Reagan moved him to head the CIA, which he did into 1991. He earned a reputation as a competent administrator. But he had virtually no exposure to securities markets or law or to questions of accounting and corporate governance.
In the late 1990s, after leaving the CIA, he joined the board of a firm called U.S. Technologies. On that board, he became head of the audit committee.
Remember that the boards of directors exist to represent the interests of shareholders and board audit committees exist to ensure that the accounts and reports prepared by the firm are accurate.
While Webster chaired such a committee for U.S. Technologies, the firm’s external auditors, BDO Seidman, advised that they had found serious deficiencies in the company’s accounting practices that misrepresented its true financial position.
Now it should seem obvious that boards of directors, audit committees and external audits exist precisely to guard against such an occurrence. One might think Webster and other board members would have thanked BDO Seidman for the tip-off.
Instead, they fired the auditors. Regardless of any further details that may come out in pending litigation, the firing should make it obvious to anyone that William Webster was not a good choice to head a new governmental body created to restore public confidence in corporate governance and reporting.
One does not need a degree in law, ethics or accounting for this to be obvious. I asked my econ students if someone in such a position would be a good choice, and these 19- and 20-year-olds all laughed and said, “No!”
The fact that Webster did not immediately tell Securities and Exchange Commission chairman Harvey Pitt that he was an inappropriate candidate is prima facie evidence he is unqualified for the job.
The fact that he did raise the issue with Pitt, but was reassured that “it should not be a problem,” is clear evidence that Webster and Pitt have spent way too much time in Washington and are part of the problem rather than part of the solution.
President George W. Bush has spent too much time pussyfooting around on this issue. If Webster is too dense or jaded to step down himself, Bush needs to ask him to do so and to publicly announce his request. The desire not to embarrass an old soldier is understandable, but restoring confidence in U.S. financial institutions is far more important.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.