The former culture czar of Citigroup is sounding an alarm to reform the financial services industry, many of whose members consider it “a dangerous beast that must be contained or euthanized if we are to avoid repeated crises,” argues Christopher Varelas, now co-founder and managing partner of Riverwood Capital, in an interview with ThinkAdvisor.
Ironically, that fear stems largely from major changes in the industry over the last 30 years praised as wholly positive but that ultimately became “a manifestation of both good and bad forces, both beneficial and destructive,” Varelas contends.
In his candid book, “How Money Became Dangerous: The Inside Story of Our Turbulent Relationship With Modern Finance,” co-authored by Dan Stone (Ecco-HarperCollins — November 2019), Varelas, who held posts at Salomon Bros. and Bank of America before Citi, calls for changing the status quo from an obsessive focus on scale, scope and efficiency to “the human side.”
Speed and efficiency have replaced thoughtful analysis and decision-making, pressuring the industry to act quickly, he argues.
Varelas started out at Bank of America as a loan officer; later, The New York Times named him one of the 100 most important dealmakers.
His book explores long-term trends and developing bubbles, all of which material can likely help financial advisors make more informed decisions. On its pages also reside some juicy stories about famed Wall Street folks with whom he has crossed paths, including Sandy Weill (former Citi CEO), Michael Carr (now with Goldman Sachs) and David Wittig (formerly with Salomon and a convicted fraudster).
Varelas, 56, who in 2006 co-founded private equity firm Riverwood, investing in technology startups, spent two decades on Wall Street. He ran Salomon Bros./Citi’s global technology, media and telecom investment banking; was head of Citi’s National Investment Bank and held the job of culture czar (he explains that in the interview).
ThinkAdvisor recently spoke with Varelas, who was on the phone from his office in Menlo Park, California. He maintains that industry reforms must be made, such as firms’ instituting a products and services review process based on client suitability, along with the imperative to address ever-rising levels of debt, both consumer and government.
Here are highlights of our interview:
THINKADVISOR: You write that, because of changes to financial services over the last 30 years, “Many of us now feel the industry is pitted against us. We are wary, if not afraid, of the … system …” you write. Some feel the industry is “a dangerous beast that must be … euthanized if we are to avoid repeated crises.” Is that your thinking personally?
CHRISTOPHER VARELAS: I don’t feel it’s that extreme. But the industry is so focused on scale, scope and efficiency that it loses the human side. Since the financial crisis, we’ve been in such a defensive posture that the industry isn’t really thinking prospectively about the future. It’s much more about minimizing loss, blame and exposure than trying to figure out the best way forward.
“We will not survive the status quo. It’s imperative that we act,” you write. Please explain.
While complexity continues to increase, connectivity and accountability have decreased. We have a system that increasingly makes promises and commitments for the future without understanding how we’re going to [keep them]. We just keep adding to our debt burden, and debt levels keep going up. Pension obligations keep going up. Yet we aren’t addressing how we’re going to meet all those obligations.
“Speed, efficiency and precision have supplanted thoughtful, careful analysis in all areas of finance, including [those] best served by analytic reflection,” you say. How so?
Speed and efficiency are good, but they also pressure you to act more quickly. We used to say, “Here’s the challenge. What should we do? Should we invest in this company, or should we acquire it?” Now we just ask, “What’s my time horizon? When will my decision no longer be impactful to what it means to the stock price?”
You write that use of the computer spreadsheet has resulted in “the erosion of analytic integrity and loss of character” — that with this tool, came “a Pandora’s box of new challenges.” What’s an example?
Before the introduction of the computer spreadsheet, you had to know your borrower — your customer. But on a computer spreadsheet, there’s no column for character. I’m not arguing to go back to the time before the computer spreadsheet. However, [this tool] has led to secondary and tertiary effects that [are troubling].
In discussing financial and social bubbles, you write: “Ultimately, each bubble will burst with a tipping point impossible to predict.” … There’s “potential to push bubbles to a point where the center does not hold and the system breaks.” Will financial bubbles continue to form?
Yes. Right now, there’s a pension bubble, a student loan bubble, a federal deficit bubble, an entitlement bubble. As baby boomers continue to age, there’s going to be a retirement bubble. All these are interrelated and create follow-on challenges.
What are the implications?
In the next 10 to 30 years, we’re going to have to work our way through this demographic challenge. Perhaps that will take leverage; but we’re using up a lot of that capacity now, and it may not be there for us when we need it.
One of your suggestions for industry reform is to change the compensation structure for wealth managers and public fund managers to “align incentives with investment horizons.” Please elaborate.
It’s amazing to me that the industry [except for some firms] is still tied to the annual compensation cycle rather than being aligned with the long-term interest of all parties. With the annual compensation cycle, you want to make the most year after year. That detracts from the psychological enjoyment and benefit of work. We need to move more aggressively away from the tie to annual compensation [and evaluate people’s work over a longer period].
What are your thoughts about compensation transparency?
There’s an unhealthy focus on compensation as the priority determinant of one’s worth in society. There was a time when you didn’t know what other people made and what you made relative to others in your firm and the industry. But with increasing transparency, you know. So [one’s thinking is]: Where do I stack up relative to everyone else in my firm and in the industry? Over the last three decades, the focus has been not only on what you’re making but what you’re making relative to everyone else.
One of the other reforms you suggest is for each firm to have is an internal review process to assess the suitability of every product and service marketed to clients. This could have prevented the Wells Fargo scandal and the 1994 Orange County bankruptcy, you say. Please comment.
Some banks have that process, but it needs to be put in place more aggressively [at other firms]. There are risk committees: What’s the systemic risk, or what’s the financial risk of this product? But as to who does it serve in their best interest, that should be heavily scrutinized and prioritized.
You say that financial institutions can inspire employees’ “positive behaviors and discourage unsavory or harmful behaviors.” How?
It has to come from the leaders in the industry. They must say, “This is the behavior we want.” They have to model that behavior. They need to define the organization’s mission beyond just pure economic interest, scale, scope and efficiency.
At Citi, one of your official titles was culture czar. In that capacity, what were your responsibilities?
In addition to my job of running a big part of the investment banking operation, I was in charge of the commitment to improve the culture of the firm. We tied part of [employees’] compensation to their actual “culture score” — how they acted and how they worked with others. For instance, were they team-oriented? It was a big challenge, but I’d like to believe that we shifted the attitudes of employees and the firm in a positive direction.
After 20 years on Wall Street, why did you leave and co-found Riverwood Capital in California?
I thought it was time to try something new. Plus, it seemed the world [of technology] was migrating more aggressively away from Wall Street and toward Silicon Valley, where all the interesting activity was happening. Once the dot-com bubble burst, I saw a real opportunity to invest in the industry. It’s much easier to build a business during a downturn than during an upturn. So when all the U-Hauls were moving East, I moved West! I had been advising technology companies on their strategy, whereas now I’m investing directly in the companies and helping them scale their businesses.
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