Thursday, November 10, 2011

The Cost of Poor Governance

The world is mostly run by organizations. Some are large. Many are small. But almost everything of consequence is done by organizations. How well an organization functions is crucial to its success. Today offers vivid examples of why an organization's governance processes matter.

The European Union. The first and best example is the structurally flawed EU. Its charter calls for a constrained and disciplined central bank, mandated to prevent price inflation. The 17 EU members that adopt the Euro are required to control their fiscal expenditures and hold deficits to 3% of GDP or less. But there are no effective controls over fiscal spending. Thus, when Greece, Ireland, Portugal, Italy and just about all other 17 members violated the deficit limits, the EU had no effective way to police their conduct. These tight monetary controls and basically non-existent political controls combined to produce a toxic excess of debt that can't be addressed in time-honored fashion by depreciating the Euro. And the EU's clumsy governance process, which generally requires unanimity of its members, prevents a swift response to a rapidly deteriorating crisis.

The EU's governance flaws have already proven costly. The EU has already committed hundreds of billions of Euros to a bailout fund. Then, there are the losses that creditors have taken or will take in the Greece bailout. In addition, we have the expense of the Benelux bailout/nationalization of Dexia, SA, and the failure of MF Global. Ongoing market consternation over Greece's and Italy's failed governments is imposing more costs as stocks gyrate. And then there are the future costs, which are now inevitable even if we don't yet know what they are.

The EU is a political entity without effective political governance. That's a formula for disaster, and the disaster is upon us. The European Union remains a wealthy part of the world, and has the economic resources to solve its problems. But it doesn't have the governance process to determine the baseline question: how among creditors, debtors, insurers and taxpayers will the cost of the sovereign debt crisis be allocated? So the EU--and the rest of the world--may suffer severe consequences.

Pennsylvania State University. The Penn State child abuse scandal has blown up the pristine reputation of a storied football program and ended the career of the greatest college football coach of all time. This, because people holding crucial positions in the university's internal governance process allegedly couldn't figure out that the welfare of minor children is more important than the reputation of their football program. This isn't altogether surprising. The day-to-day pressures on employees of maintaining and enhancing organizational performance can exaggerate their perception of the importance of the organization's priorities, and diminish their perception of external considerations. Personnel may forget that the organization exists within a larger community, and ultimately is subordinate to that community. This is true of universities, and also of major Wall Street banks. Failure to maintain perspective and humility can be very costly, both to the organization and those that are victimized.

The United States of America. There's a lesson for America from the two preceding examples. But we see little sign that the processes of the federal government have improved since the debt ceiling debacle a few months ago. The budget deficit supercommittee is wallowing in dysfunction. The President hasn't exactly been front and center to provide leadership. One gets the sneaking suspicion that all elected officials in Washington are laying the groundwork to play the blame game in next year's election, rather than trying to actually do something. But fingerpointing falls into the category of poor governance. Unless America figures out some way to make things work, we can look forward to sharing the fate of the EU and the Nittany Lions.

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