September 14, 2011 · 0 Comments
Source: Naked Capitalism
By Yves Smith:
It might behoove a publication that styles itself as the newspaper of record to do some basic fact checking rather than take dictation from parties with an obvious axe to grind and publish it as news.
I’m going to give the disgraceful New York Times story, “Outsiders’ Ideas Help Bank of America Cut Jobs and Costs” a long form treatment, not only because it may help readers recognize PR masquerading as news, but also because the bits of this story that the Times didn’t bother to probe help illuminate how the retail banking industry became predatory and how some of the mechanisms to transfer wealth to people at the very top are well hidden from the great unwashed public. Thus, this post is a companion piece to our piece today on the rise in poverty and continuing destruction of the middle class in the US.
The New York Times piece is hagiography about the cost cutting process at Bank of America, in which the Charlotte bank will shed 30,000 jobs, more than 10% of its workforce. It starts with the misrepresentation of calling the belt-tightening a “turnaround plan.” That implies that the business of the bank is in trouble and the headcount reduction measures can save the day.
This is utter bunk. Bank of America was already a very cost and efficiency driven bank, to a fault. It botched its acquisition of the private bank US Trust by imposing its stingy ways on customers who had every reason to demand a bit of cosseting. It went so far as to impose ATM fees on a customer base that typically held 6 to 7 figure balances in checking accounts.
Banking expert Chris Whalen has called the cost cutting effort “criminal”. He points out the obvious: there is nothing wrong with the bank’s operating businesses. The threat to BofA’s survival comes from litigation on its mortgage backed securities business, and the bank would do better to preserve the fundamental value of its business by declaring bankruptcy.
While I encourage you to listen to this entire segment, take particular note of Whalen’s comment at 2:25: “They’re trying to throw things out of the balloon, if you use the metaphor, to save their own careers, Brian Moynihan and the people Ken Lewis put in place.”
So what is this New York Times story about? It’s to legitimate a unnecessary cost cutting process. And the ugly part, which the article perversely tries to present as a plus, is the role played by the consultants. In a remarkable display of a lack of basic fact gathering, the Times never mentions that they get a piece of the action. Indeed, not only does the Times fail to mention their pay arrangements, it compound the error by emphasizing an ungalmorous meeting, which creates the impression that their pay demands might be modest too (pizza, after all, is a staple of college kids and programmers):
As Bank of America executives prepared last week to announce the first phase of their turnaround plan, a group of consultants hurried to complete their recommendations for the overhaul, called Project New BAC.
The 44 senior bank managers and roughly two dozen consultants assigned to the initiative worked through lunch, barely pausing to enjoy the pepperoni, sausage and vegetarian pies that had been ordered from a pizzeria….
The consulting firms enlisted to help with Project New BAC — EHS Partners and the Promontory Financial Group — are what are known in the industry as bank doctors. Financial firms often turn to these specialists in periods of crisis, seeking out their recommendations on deep and wide-ranging cuts to bolster revenue and eliminate unnecessary expenses.
The idea is that outsiders can find thousands of small savings and inefficient processes that insiders may miss.
Promontory and EHS both have long ties to Bank of America, and to each other.
Eric Holder, who is leading EHS’s work on Project New BAC, and Neil Smith, Promontory’s head consultant on the project, were both members of a team from Tandon Capital Associates that helped the Fleet Financial Group with a similar effort in 1994.
On that project, called Fleet Focus ’94, Mr. Holder and Mr. Smith worked with a team of 50 internal managers known inside the bank as the “Nifty 50.” One of those 50 managers was a budding young lawyer named Brian T. Moynihan.
The ordering pizza in is a nice “gee we are all ordinary, roll up our sleeves” types, but don’t be fooled. The people at that table are raking in very big bucks for getting people fired.
Tandon Capital Associates is named for Chandrika Tandon, who was a partner at McKinsey. Neil Smith and Eric Holder also worked for McKinsey (I know Chardrika and Neil; Eric joined after I left the firm).
McKinsey has long done cost cutting work, and at least when I was there, in the mid-1980s,the firm was plenty ambivalent about it. In downturns, clients were most interested in that sort of project, and they were not difficult, anyone in the firm could do them (they were considered “process” studies: you followed a playbook). And in service firms like bank, all meaningful costs relate to headcount, so these studies were all about firing people. A lot of consultants, including partners, didn’t like firing people. In addition, there were mercenary reasons not to like firing people. Some of them would be senior, and would find new jobs. Anyone who had been given the heave-ho as a result of a McKinsey project would be certain to oppose the use of McKinsey at their new employer.
In the 1980s, some members of the financial institutions group focused more on pricing and cost related work. “Pricing” was often what Elizabeth Warren now calls “tricks and traps”, it’s the reason a standard credit card grew from one page as of 1980 to a full 30 pages (when all the relevant sections are included) in language Alan Greenspan has said he can’t parse.
The working oar on the first pricing study, for checking account products at Citibank, was a former econometrician, Zosai Mucha. It made the bank $30 million, an enormous amount of money in those days. A consultant named Paul Allen took that sort of work further and eventually left McKinsey to start his own firm (Chandrika, who brought the cost cutting expertise, and Paul Allen originally were partners; they later split up)
As CEO pay became more stock price related and top executives started to care more about meeting earnings expectations than growing businesses the old fashioned way, cost cutting was a much easier and faster way to boost bottom lines than developing new products. That provided the impetus for Tandon Capital and other headcount cutting specialists, such as Mitchell Madison, another group of ex-MckKinsey types that focused on saving costs in the purchasing area (this was a particularly shrewd focus; purchased goods and services account for 20% to 35% of most big firms’ total spending. You cut costs not by firing people at your client, but by squeezing vendors).
It is important to understand the business model of these firms. The predecessors of EHS and Promontory, meaning Tandon and Paul Allen’s firm (and to a lesser degree Mitchell Madison, since firms like EHS and Promontory also now look to reduce costs of major contracts), used pre-set pricing formulas in which they got a high percentage of the amount saved as their fee. Central to the approach of both firms was to have the whole project accounted as a restructuring, with their compensation buried in the total.
To give an sense of how large the fees might run, Chandrika’s firm had landed an assignment with the old Chase in the mid-late 1990s. The project was canceled as a result of a merger, but the contract was still valid and they payout was on the order of $100 million (my understanding is this was a breakup fee). Similarly, a guesstimate by an informed source is that the fees on a medium-large project, say $400 million in savings, would be 5% or $20 million. Fees presumably scale down as deal sizes increase, so the $5 billion BofA assignment would presumably be set at a lower percentage. By contrast, the going rate for bona fide restructuring specialists like Houlihan Lokey or Gordian Group (remember these deals are accounted for as restructurings) are in the 0.75% to 1.5% range.
The major consulting firms, such as McKinsey, Bain, and BCG, also do this sort of assignment for normal consulting fee, which results in a much lower price tag. So why do these specialists get hired? The boutiques did, and probably still, take a much more active, hands on approach than is typical for most consultants. Paul Allen once approached me about working on one if his project, and he and his entire team would move to the client’s head office for the duration of the project, which could run from five months to as long as a year. They would act as part of the senior management team which would give them board and senior
executive visibility that traditional management consultants would almost never have. This would likely produce a higher level of execution of the proposals made.
But the downside is creating client dependence. I joked that the goal at McKinsey was to invade at the fingertip and go for the brain, and these focused firms have done a much better job at it. One former Mitchell Madison partner has an ongoing relationship with one major financial services firm that spans 20 years, back to his days at McKinsey. That’s longer than the life expectancy of most marriages.
Now let’s see how this is dressed up by the Times. It starts with a sanitized account of the history, discussing the deal that put Tandon Capital on the map, for Fleet Financial:
At Fleet, the consultants recommended cutting Styrofoam coffee cups that cost the company $48,000 a year. Name-brand toner for Fleet’s laser printers was replaced with a generic toner to save $200,000 a year.
In all, Fleet cut annual costs by $300 million and laid off 3,000 workers. The changes helped Fleet’s bottom line and set the stage for an eventual takeover.
This is straight dictation. The Times gives two examples that total less than 0.1% of the total. There is no amount of painless styrofoam cup level ideas that will get you to $300 million in savings. In the case of the Fleet study, the team recommended (and got paid on) cuts that were too deep; the bank had to reverse some of them due to adverse side effects.
Moreover, it is unlikely that these ideas came from the consultants, as the article headline suggests. A standard practice in this type of work is for client teams to identify and rank savings ideas (this then begs the question of why you need consultants, ex to provide impetus and de politicize the firiings; I lived through Sumitomo Bank’s regular kaizen, and it pushed very aggressively for staff to come up with cost saving ideas. I’d defy any bank to run leaner than Sumitomo did; it went so far as to take five months to reimburse employee travel expenses!). And this is confirmed by the story in the case of the current Bank of America project:
Bank of America declined to comment on the two firms, and a spokesman said many of the changes made in Project New BAC had come from bank employees rather than from outside consultants…. In phase one, roughly 150,000 ideas were submitted by Bank of America employees, and the best were presented to Mr. Moynihan and his management team.
So given the failure to probe how this normally hidden business works, does the article do any actual investigation? All I could detect was on gossip. Holder and Smith, along with Jeremy Eden, had founded EHS Partners, but Smith and Holder had not gotten on and Smith had split to form the team at Promontory Capital (which is headed by former Covington & Burling partner and OCC chairman Gene Ludwig). So the one bit of sleuthing the Times does is on whether a pair that separated on bad terms is getting on in this big stakes project. Needless to say, they didn’t get much of an answer.
The Times completely misses any one of a number of possible real stories here: to what extent are these studies really successes (Fleet, after all, was eventually acquired)? Are the rich fees warranted? Given the Whalen argument, that Bank of America’s operating units are healthy and the cost cuts are all to delay the day of reckoning for Moynihan’s and the C level executives, aren’t these consultants enablers of and participants in looting (using gimmicks to report exaggerated profits and suck out more than is warranted in pay until the enterprise goes bankrupt)?
Ultimately, the Times missed the opportunity to look at cost reduction, which is really firing people, as one of the mechanisms for transferring income and wealth from ordinary people to the top 1%. But the Grey Lady is only occasionally willing to shoot at fellow members of the elite, so predictably, it gave the Charlotte bank and its hired guns a free pass.