11 Dec Leadership and Value Creation: Alan Mulally
Our title is but a thinly veiled allusion to the hero of the namesake novel [Герой нашего времени] by the illustrious Russian novelist and poet Mikhail Lermontov who, on the death of the legendary Alexander Pushkin, assumed the role of Russia’s leading poet.
The hero in question (Pechorin) is not the kind of heart-throbbing, virile, impeccable stud personified by a fictitious character, like James Bond. On the contrary, Pechorin is a deeply flawed, some would even say amoral, man. It may surprise you that the quintessential hero of 19th Century Russian literature is not someone we would want as Santa Claus. Yet when one looks beneath the surface, a stomach for moral ambiguity is precisely the hallmark of a true hero. Douglas MacArthur and George Patton, to name but two American heroes, were certainly not innocents. One day, we will all come to grips with the fact that perfection defines the manager but is wholly incompatible with the properties of a hero. As everyone knows, managers do things right, leaders do the right thing.
André Gide once said, “C’est avec les beaux sentiments qu’on fait de la mauvaise littérature[1]”, and so it is with leadership. The challenge of leadership, and therefore of “heroism,” does not lie in saying yes to everybody as a politician does to get elected and then managing everyone’s anger afterwards. The heroic in the hero is nothing, save having the courage and steadfastness to make the right choice and stick to it, however unpopular. Rather, it rests in the secure knowledge that certain painful, hence unpopular decisions are necessary to save the organism and avoid more pain down the road. Those who do their best and blow with the prevailing wind are losers, not winners. Ultimately, true leadership is tragic. The essence of tragedy does not consist in seeing someone die for his country, but rather that his death could easily have been avoided but for the failure of leadership.
Alan Mulally is a man who brought leadership to American industry at a time when it was sorely needed. The following is but a short tribute to the open corporation and one of its greatest assets.
The Event-Horizon
Thanks to a gracious and much appreciated invitation from Morgan Stanley’s Private Wealth Management group, Ann and I recently attended a classic New York-style event at the American Museum of Natural History, where the venue was inspiring, the hors d’oeuvres to die for and (last but not least) the dialogue stimulating. This November 29th soirée, fifth in Morgan Stanley’s series “CEO + CEO, Perspectives on Excellence” featured Mulally and James Gorman, his counterpart at Morgan Stanley.
The Streitgespräch between Gorman and Mulally covered a wide range of topics but centered on Mulally recounting with vividness and color how he was able to transform the culture of Ford from the staid, out-of-control, inefficient bureaucracy that even Bill Ford could scarcely manage into a new American success story–and Mulally himself into an icon of the automotive industry.
Today, perhaps via a strange twist of fate, the automotive industry can count among its leaders three of the most accomplished, savvy and battle-tested executives the world has ever seen: Alan Mulally (Ford), Carlos Ghosn (Renault-Nissan) and Rupert Stadler (Audi). And, although it was evident that Mr. Mulally is not as comfortable with public speaking as President Obama or even as the confident Mr. Gorman, his apparent discomfort served as a backlight to his legendary execution abilities.
If you are not familiar with his accomplishments, Mulally’s inaugural pas de deux was a flawlessly executed masterpiece of financial restructuring that transformed Ford’s pension liabilities from defined benefits to defined contributions. It became textbook finance as soon as it went down for demonstrating clearly the emerging possibility of a bold way forward, not only to the rest of the bloated US auto-industry but also to the American body politic.
Next, his ability to let managers admit, or shall we say confess for the first time their operational problems without fear of retribution was a key ingredient in Ford’s abrupt transformation from a CYA culture to a collaborative, functional organism able to adapt analytically to a rapidly changing field conjecture and perform consistently within the gauntlet of cut-throat competition characterizing the international automotive industry.
I do not need to point out that Mulally’s stellar performance, honed by innate ability and personal drive, is directly traceable to his training as an aerospace engineer!
To someone who–as he pointed out–was used to machines with four million parts, the auto industry with 10,000 parts in the average car, must have seemed at first below his pay grade. To be sure, he encountered different challenges at Ford. However, the potential for success is always related directly to the seriousness with which one carries out duty, no matter how menial that duty may appear at first blush.
Luckily, Mulally could not have been better trained to take over Ford than he had been at Boeing through a combination of uniqueness of method and performance under stress, for these are the elements that separate amateurs from professionals. When an airplane crashes, people always die, which is not normally the case when a car crashes.
Compare these outcomes to what happens when a structured deal crashes, a now unremarkable event during which no one has ever died. The point is this. The average intellectual ability that can be reasonably expected of senior executives in any industry is directly proportional to the severity of the empirical consequences of a crash in that industry. The aerospace industry is arguably the most demanding, sophisticated and rigorous of all simply because amateurishness cannot be tolerated there for the same reason it is so commonplace in finance.
A case in point is the fate and fiscal health of Ford itself. As a CEO, Mulally professes expertise only on the left side of Ford’s balance sheet. By contrast, most of us in attendance that evening claim expertise on the right side. Thanks to his relentless work, Ford’s asset side now seems to be in great shape, but what can be said of its liabilities? According to Wall Street, not much except the perennial and naïve buy recommendation. Much more could be done by research analysts to benefit Ford directly and significantly, at literally no expense to Ford or the investor public. Many of Ford’s corporate bonds only have a few months of remaining life. Consequently, these particular securities’ default probability is virtually zero. Therefore, their credit rating is AAA by definition. This is not true of longer-dated securities because, in spite of what credit rating agency analysts might say publicly, corporate credit ratings are based on cumulative default probabilities. If rating agencies were actually doing what they are well paid to do, i.e. their job, Ford’s corporate bonds would be upgraded on a timely basis to their actual credit quality as they get closer to maturity.
Regular upgrades should be conducted so that one of two things could then happen:
- the bonds could be resold in the secondary market at a premium to par (credit spread compression) or
- the bonds could be restructured on the spot, alleviating the firm’s interest rate burden
Where this new, dynamic equilibrium would wind up is anyone’s guess–most likely a AAA rating. By reducing in real time Ford’s interest rate burden, regular upgrades would further improve the company’s key accounting-ratios, leading to another round of upgrades, and so forth. In mathematical parlance, this can be expressed by saying that although the macro-canonical ensemble would remain unchanged, the micro-canonical ensemble would have been altered. Under this framework, either Ford’s investors in the secondary market or, even better, the company itself would experience a welcome cash boost, this as a result of having either borne or paid for credit risk. Should both parties opt to share the attendant economic benefits equally, everyone would end up better off at no cost as if by magic.
In the final analysis, the magic of properly executed structured finance is precisely that there is no magic. Ladies and gentlemen, unlike market risk, credit risk is not a zero-sum game. When a dilettantish rating agency analyst says these dynamics “do not matter” to the firm’s credit rating or that “we rate through the cycle,” he is assuming that the universe of Ford investors is static and unchanging. This assumption is patently false, not to mention crassly self-serving. On the one hand, it enables financial neophytes to sit on their proverbial behind while hard-working Americans at Ford and elsewhere struggle against the forces of nature, and without earning a single dime from their operational excellence or marketplace validation. On the other, Ford is still paying dearly, and indefinitely it seems, for its erstwhile marketplace failures. Clearly, such people have never heard of the ergodic hypothesis, but Mulally most certainly is comfortable working with it.
Ford Motor Credit is a benchmark player in automobile structured finance. Not only is cyclicality in credit space symptomatic of Ford’s balance sheet, but the vast majority of its ABS securities also experience dynamic, telescoping credit ratings. This is because the value of structured securities is dynamic by its very nature. Even if credit ratings fail to track these dynamics, the credit risk will change naturally with the passage of time, improving or deteriorating. Therefore, structured bonds must be re-analyzed each time a new servicer report is made available so their current credit quality can be reassessed. Doing less amounts to a betrayal of Ford workers.
At the very least, investment banks who really want to add value to their customers’ ABS offerings should be facilitating credit rating changes, routinely and pro bono. In point of fact, this would not be new. In the good ole’ days 15+ years ago, Ford was one of the few frequent ABS-issuers whose subordinated ABS were regularly upgraded. Nobody should be surprised to hear that neither Ford nor its investors called up to request a downgrade. In other words, what exactly investment bankers do with monitoring information remains at their sole discretion. We are not talking about a no-holds-barred, tell-all page-turner here, but only about actually doing what one claims to be doing in the first place.
Epilogue
At the end of the evening I approached Mulally, to tell him something he didn’t know. The Federal Reserve that we have come to know and love was an aerospace engineer! Needless to say, he was agreeably surprised to hear that. For my part, I was surprised he had not heard that the greatest single innovation in American finance was created by someone very much like himself, who knew there was a better way and had the courage, fortitude and determination to make it happen.
Looking at the Fed’s web site today one would think the Fed invented itself, since not a single reference to its creator can be found. Even the Fed’s Wikipedia entry blandly states that Paul Warburg was “an attendee of the meeting and long-time advocate of central banking in the US.” Is that so? All he did was to attend a meeting. I wonder why he was there at all since apparently he had nothing to do with this deal!
I suggested to Mulally to move to NYC pronto, to take over the helm of some malfunctioning, large commercial bank of which there are plenty. He told me that was not in the cards.
Ah well, nice try!