`Out of Control' CEOs Spurned Davos Warnings on Risk

Posted by archive 
By A. Craig Copetas
October 24, 2008 (Update1)

Oct. 24 (Bloomberg) -- Once upon a time, the World Economic Forum was the ultimate Wall Street jamboree.

Now, in the riptide of the worst financial crisis since the Great Depression, WEF officials and delegates say many of the chief executive officers who gathered in Davos, Switzerland, over the last five years didn't listen to warnings from their peers. Davos organizers also say they failed to play tough with the financial-industry bosses, opting to accept their funding and let them turn Davos into a rave-up for Wall Street excesses.

``The partying crept in,'' says Klaus Schwab, the 70-year- old WEF founder and executive chairman. ``We let it get out of control, and attention was taken away from the speed and complexity of how the world's challenges built up.''

The fallout has left the WEF riddled in buyer's remorse, with officials throughout the organization asking what they have wrought and, like Wall Street, whether they offered too much of a good thing.

Schwab says the delegates treated him like ``Cassandra'' whenever he questioned the logic of their wisdom on asset-price bubbles in housing, stocks and other financial instruments.

WEF Chief Operating Officer Kevin Steinberg says the vast sums of money that rolled in from Wall Street celebrities for marquee billing in Davos contributed to complacency among forum organizers and often obliged them to publicly massage the viewpoints, wishes and status of their superstar guests.

``We catered to what the financial leaders wanted: solo speaking slots, luxury hotels and VIP treatment we wouldn't afford anyone else,'' Steinberg, 38, says. ``We gave them a soapbox. It was all political. We try to minimize the politics, but can't.''

`Psychological Denial'

In his office outside Geneva, about a three-hour drive from Davos and overlooking the French Alps, Schwab says the WEF began issuing warnings in 2003 to investment banks, insurance companies and hedge funds about the systemic risk gnawing at the foundation of the global economy.

``But the financial community didn't listen,'' Schwab says. ``They were told that any serious look at the economic fundamentals showed that we were in an unstable situation. It was denial, total psychological denial.''

For next year, Schwab says his goal is to transform Davos into the ``Bretton Woods of the new millennium,'' a meeting targeted at establishing a fresh set of global rules for commercial and financial relations, much as the original Bretton Woods conference in New Hampshire did in the summer of 1944.

Ending the Merrymaking

As for the merrymaking, Schwab vows ``it won't happen again.'' Unlike Bretton Woods, companies will still pay as much as $750,000 each in annual fees to send executives to Davos.

William Browder, founder of Hermitage Capital Management Ltd. in London and an eight-year WEF veteran, isn't so sure Schwab can pull it off.

``An exercise in moderation is something the private sector doesn't do very well,'' Browder says.

Each January, global financial titans and their entourages gathered in the Alpine hamlet. A band of fluegelhorns wandered in hotel lobbies, heralding the arrival of delegates such as Lehman Brothers Holdings Inc. CEO Richard Fuld Jr., Freddie Mac CEO Richard Syron and U.S. Treasury Secretary Henry Paulson, along with actresses such as Angelina Jolie and Sharon Stone.

Bundled in cashmere coats and goose-down parkas, the WEF's 2,500 ``global leaders'' set off to attend a medley of 500 public and private sessions designed to isolate economic problems, clarify disturbing market trends and forge innovative solutions.

The Stunts

In the days leading up to the conference, volunteers in lederhosen draped the village with hundreds of white and blue banners that declared the 38-year-old conclave's purpose: ``Committed to Improving the State of the World.''

WEF organizers often pulled stunts to hoodwink delegates who preferred partying and meeting privately with clients over attending forum sessions.

In the ``Why Do Brains Sleep?'' meeting in 2007, a cadre of eminent psychologists and psychiatrists explored whether financial leaders got enough rest and ``what that tells us about the quality of their decision-making.''

To spur delegates into addressing financial-market alienation, a session in 2004 was held to discuss whether extraterrestrials had taken control of Wall Street: ``Have Extraterrestrials Made Contact With Government Leaders?''

The ruse didn't work.

Steinberg recalls the attitude among some of the delegates at Davos from 2003 through last January.

Didn't Listen

``It was clear irresponsibility on their part and it's more damning than anyone can imagine,'' says Steinberg, who has been with the WEF for more than a decade. The former McKinsey & Co. management consultant supervises the forum's finance-industry delegates.

``By 2003, the over-leveraging of the system was a serious topic of conversation, but the some 60 of WEF's corporate members from the financial world never had an understanding of how big a problem it was,'' Steinberg adds. ``We had assembled the world's greatest economic experts to confer with them, and the financial community was not aware of that expertise.''

In 2005, Schwab says WEF's delegates from Wall Street were eyebrow-deep in booming markets, easy money and intense pressure to take greater risks, borrow more and seek higher returns.

One of WEF's sessions that year was ``Spotting the Next Bubble Before It Bursts.'' Goldman Sachs Group Inc. CEO Lloyd Blankfein ran the meeting with Syron, then CEO of Freddie Mac, the now-discredited U.S. government-sponsored mortgage buyer and reseller that along with Fannie Mae in September required a $200 billion U.S. government bailout.

Spotting Bubbles

The Blankfein-Syron mission: ``Spotting where and when the next bubbles are likely to occur and how we can get better at spotting and resisting bubbles,'' according to the program.

Yet Wall Street ignored the solutions offered at the meeting, says WEF Senior Director W. Lee Howell, 44, whose office created the session.

``I often wonder how many members were actually listening to what was being said,'' Howell says. ``I know the American financial community didn't show up in Davos to listen.''

Another ``bubble'' session the following January looked at real estate and was led by Stephen Roach, then Morgan Stanley's chief economist, who now is chairman of Morgan Stanley Asia Ltd.

``A sharp decline in housing prices could have a tremendous impact on the global economy; in the U.S. alone, 40 percent of new jobs since 2001 have been related to the housing sector. With low interest rates and excess liquidity, other bubbles may follow,'' the program read.

Divide, Conquer

Steinberg says the most-discussed housing issue among some delegates centered on Davos's Belvedere Hotel, where corporate chieftains and their deputies were ``more interested in entering into bidding wars to secure the biggest party room than they were in attending sessions held there.''

As Steinberg tells it, Wall Street arrived in Davos with a ``divide-and-conquer strategy'' that focused on using WEF to woo new clients and ``launch sales campaigns'' instead of ``collectively taking action to mitigate the evident systemic risk.''

The five-day annual forum, which also attracts scholars and scientists, has always been eclectic. Racing Audis on the ice of a nearby lake and attending snow-polo matches in St. Moritz have been popular diversions. The dress code was casual, and the garb of Wall Street, Schwab says, was perhaps unsuited to the cold and candid camaraderie of Davos. ``There is a certain discomfort with snow,'' Schwab says.

Storm Flags

Steinberg says there were scores of ``intelligent people'' raising storm flags in Davos for the last five years.

In 2007, former U.S. Treasury Secretary Lawrence Summers warned of complacency. He returned to the village in 2008 to say ``a cascading loss of confidence'' threatened to paralyze the global economy, comparing the market mood with the economic sentiment that prevailed just before World War I.

Guidance was offered by monetary-policy makers such as European Central Bank President Jean-Claude Trichet and Bundesbank President Axel Weber as well as economic wise men, including Yale University Professor Robert Shiller, U.S. Congressman Barney Frank and World Bank Director of Governance and Anti-Corruption Daniel Kaufmann. Such advice was swatted away by American confidence salesmen such as Michael Klein, co- president of Citigroup Inc.'s investment-banking unit, and David Rubenstein, managing director at the Carlyle Group buyout firm.

``I warned them all about global risk and the abusive nature of their actions, but they had no incentive to change,'' says Kaufmann, recalling his seven years as a global leader at Davos. ``And why should they have listened to us? I see it with my 10- year-old daughter, who scolds me because I don't put the garbage in the correct bin. Let's not delude ourselves. It's impossible to teach old dogs and investment bankers new tricks unless you change the incentive structure.''

The `Animals'

``It was all laid out in Davos,'' says WEF delegate Daniel Loeb, 46, owner of Third Point LLC, a New York-based hedge fund. ``The investment bankers got so caught up in competing with each other that they used the place to schmooze, instead of actually learning about what was going on in the world.''

Howell describes the Davos attendees in zoological terms:

``The investment banks, private-equity funds, hedge funds and insurance companies were the animals Davos was most fascinated with. But they were exotic animals that people who ran these businesses never took the time to grasp what the world at large thought they knew.''

To contact the reporter on this story: A. Craig Copetas in Paris at ccopetas@bloomberg.net.
Last Updated: October 24, 2008 15:45 EDT