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Were consulting firms culpable for financial crisis?

24 May 2010  |  4535 views  |  1

Were consulting firms among those culpable for the financial crisis?

Back in 2002, Business Week (July 8th issue) raised the question in the midst of the Enron scandal where McKinsey was a major advisor  “What accountability does it [McKinsey]--or any consulting firm--have for the ideas and concepts it launches into a company?”   Eight years on, that question remains unanswered, yet still relevant. Now the question is what role did consultants have in the financial crisis.  Consultants are fortunate to be able to hide their involvement under the veneer of “client confidentiality” although Businessweek (April 10th http://www.businessweek.com/news/2010-04-07/citigroup-expanded-in-cdos-on-consultants-urging-maheras-says.html)  and Consultants News (May 10th issue) have reported that Citi was prompted by advice in 2005 from its strategy consultants, Oliver Wyman, to ramp up its business in collateralized debt obligations (CDOs) backed by high-risk or sub-prime mortgage loans.  This ultimately lead to a requirement for Citi to be bailed out by the federal government due to the implosion of the sub-prime market.  How many other financial institutions were encouraged to take greater risks based on the advice of consulting firms?  And during the crash how many of those same firms earned fees on advising on how to clean up the mess.

Consultants appear to have an immunity from the consequence for any advice they provide to their clients.  Should organizations expect that in return for the large fees that they pay to consultants, that the consultants be accountable (legally and/or financially) for the realization of the business and public policy objectives of the initiatives they participate in?

Consultants maintain that their fees are worth the value they create for their clients. But what happens when they destroy value?

Fortunately for them few companies track how much they spend on consultants and compare the actual outcome to what was expected in order to the calculate the value realised or lost from the use of consultants.

It is time for companies to start holding consultants to their promises to deliver value, and to hold them responsible if they do not. This requires more discipline and sophistication on the part of the client to extract this value.    

Comments: (2)

Chris Barry
Chris Barry - V2 Innovations - Raleigh | 24 May, 2010, 19:30

It is likely that the consulting firms provided substantial value based on the engagement. The engagement is where the request for solving a problem is fleshed out and in the case of the instruments of the crisis the engagement probably had something to do with new ways to increase revenue.

If this was the case, before the market tanked the financial institutions that implemented recommended strategies from the consulting firms likely made billions as indicated by the bubble prior to the crash. I will also wager that the consulting firms likely provided a risk profile along with the opportunity profile on final recommendation. It would be up to the financial institution to manage the risk against the returns if they implemented the consulting firms' advice. I assume that risk was set aside as a result of the massive amount of return being generated prior to the crash - pour the coals to it and engine be damned mentality.

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A Finextra member
A Finextra member | 25 May, 2010, 16:08

I have seen how some of these consulting firms operate. They usually tailor their advice to what they know it is that their client wants to hear. In the context of subprime, how do you think a consulting firm's advice to shun subprime MBS would have been received in 2005?

Consultants were there to advice and suggest. Its up to management to follow or pass. In this specific Citi case, profits were gained from subprime MBS in 2005 all the way to the following year. If Citi held on to these subprime MBS past 2006, then no one else is to blame than Citi.

Consultants know that their reputation is on the line. This in itself, is the normal penalty for giving bad advices.

I'm curious. Given the current conditions in the U.S., do you think its safe for banks to accumulate new MBS to their fixed-income portfolios?

 

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