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Citigroup CEO Pandit, Columbia Business Prof Analyze Root Causes of the Crisis

  • The Find: What's to blame for the financial meltdown? Imbalances, says one expert. Flawed metrics, says another.
  • The Source: A lengthy interview with Citigroup CEO Vikram Pandit and a blog post from Partha Mohanram, Associate Professor of Business at Columbia Business School.
The Takeaway: There's been no shortage of speculation on who or what is responsible for the financial crisis currently engulfing much of the world (BNET has gotten into the act here, here and here). Two experts are offering their choice for a primary culprit.

Citigroup's Pandit points the finger at four imbalances that, in a hellish perfect storm, are all undergoing a simultaneous correction:

  1. A housing imbalance: "There's just too much housing compared to the demand, and it's not clear exactly when and how the housing market [will be] cleared, where the prices stop."
  2. A consumption/saving imbalance: "Everybody thought they were saving because their housing prices were going up. Well, they no longer are. And the U.S. consumer has to start saving at some point."
  3. Leverage: "When you look at the financial system around the world, [it became] overloaded over a period of time. They have to figure out how to de-lever themselves."
  4. Global growth: "There's a lot of growth elsewhere in the world and the world is trying to figure out how to grow without causing inflation."
Where did these imbalances come from? Pandit tells a long and compelling story that begins with an insatiable appetite for yield post-9/11, passes through some shoddy risk management, gets concentrated in a small number of financial institutions and ends with us embroiled in the current mess. If you're interested, it's well worth the time to read it in full.

Columbia Business School's Mohanram, however, is focusing his ire on shoddy metrics and those gullible enough to fall for them. His ruling: "We're in this situation because we've focused almost exclusively on the income statement and ignored the balance sheet.... Almost no one looks at profitability -- we focus on raw profits instead, to our detriment." Who is this "we"? Monhanram spreads the blame around:

Who's "we"? It's the manager chasing growth in sales and earnings, without worrying about the resources used to obtain the growth. It's the financial analyst who incessantly focuses on Earnings Per Share (EPS) targets without any concern for whether the targets were met by organic growth or by value-diminishing acquisitions. It's the investment banker who spends most of his attention on whether a transaction is going to be "accretive" or "dilutive" to EPS, not on whether the transaction is going to improve asset productivity. It's the business media, which focus on these flawed metrics and increase the pressure on managers to meet rising earnings expectations, even at the cost of declining profitability. It's investors who focus all their attention on whether the firms meet analysts' estimates, harshly penalizing firms that miss by a few cents. It's the board of directors who compensate managers based on earnings targets instead of profitability targets. It's the regulators who have permitted firms to park many of their toxic assets off the balance sheet. And it's all of us in business academia for not properly explaining to our students that profit growth and profitability growth are not the same; in fact they are often opposites.

This post first appeared on BNET1.

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