POLITICS APRIL 1, 2009
Back in October, not long after Lehman Brothers collapsed and triggered a meltdown on Wall Street, one of the hottest e-mail forwards making the rounds among finance types was a letter by Andrew Lahde, a hedge-fund manager who had posted eye-popping 866 percent returns in 2008 by betting on increases in U.S. subprime mortgage defaults. Lahde was getting out on top, and his "So long, suckers!" missive made headlines--partly for his broadsides against predatory lenders, partly for his earnest digression in support of hemp products, and partly for his boasts about getting rich at the expense of Wall Street's "low hanging fruit, i.e., idiots whose parents paid for prep school, Yale, and then the Harvard MBA." These MBA grads, Lahde sneered, "who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government."
And, with that, Lahde had kicked off a new round of scapegoating: What had they been teaching our nation's best and brightest in these MBA programs, anyway? A few days later, the usually prim Financial Times mocked the champagne-swigging alumni at Harvard Business School's 100-year anniversary gala as they quietly squirmed over their responsibility for the mess. ("We will leave the talk of fixing the blame to others," Harvard's dean assured the gathering.) BusinessWeek piled on, hosting an online debate: "Business schools are largely responsible for the U.S. financial crisis. Pro or con?"
Nowadays, it's getting harder to find a business school professor who isn't agonizing over what Wall Street-bound students might have taken away from their classes. "In a way, finance professors caused this problem--I'm not bragging about this," says Charles Trzcinka, who chairs the finance department at Indiana University-Bloomington's Kelley School of Business. He points out that many of the financial tools that played a starring role in the current crisis, from the countless ways to divvy up and sell mortgage-backed securities to the explosion of credit default swaps, were taught and developed in business schools without, often, a full appreciation for how they could go sour--if, say, housing prices cratered or large counterparties went bust.
Business schools aren't, of course, primarily responsible for the implosion of global finance: On the list of culprits, they rank well below the bursting real-estate bubble, skyrocketing bank leverage, and the decline of regulatory oversight. Plus, it's not as if everyone on Wall Street has an MBA--though the list of failed bank CEOs educated at top-tier b-schools, from Lehman's Dick Fuld to Merrill Lynch's John Thain, is suspiciously long. But, across the country, business-school faculties are grappling with the possibility that they've been instilling generations of students with a naive faith in free markets, teaching them to focus solely on short-term profits, and justifying some of the more outrageous executive-compensation schemes that have become Exhibit A in the case against corporate America. Many of those notions are tumbling quickly. But what comes after the fall?
Business schools weren't always so closely identified with unchecked capitalism. When the first management schools opened in the United States--Wharton in 1881, Harvard Business School in 1908--their wealthy founders were worried to a large degree about social legitimacy. Big corporations were only just arriving on the scene, and the public was still wary of these new behemoths, especially in the wake of countless bloody labor disputes. Partly as a defensive measure, business schools tried to show that companies could be managed in the public interest. During the 1930s, Harvard faculty taught courses emphasizing the legitimate role of regulation and researched issues like the psychological strain facing workers in the Depression. This impulse carried into the postwar period--business elites were trained to act as elder statesmen who would, at least in theory, work in partnership with civil society groups, labor, and government. "It was fueled by patriotic fervor. ... The view was that, if you wanted to avoid radicalism in America, you needed well-trained, enlightened managers who didn't wield their authority arbitrarily, but used it constructively," explains Rakesh Khurana, a professor at Harvard Business School and author of From Higher Aims to Hired Hands, a history of business schools.
This whole mindset started to wobble during the economic malaise of the '70s. Disgruntled investors blamed unfocused executives for mismanaging their empires at the expense of shareholders. A younger generation of academics started arguing for hostile takeovers and deregulation to make companies leaner and, well, meaner--and they endorsed Milton Friedman's idea that managers should focus solely on stock prices. After all, according to the efficient-market hypothesis, short-term share prices were the best marker of a company's health. What's more, managers, who were untrustworthy by nature, required proper incentives, such as stock options, to ensure their interests were properly aligned. (As corporate raider T. Boone Pickens complained in 1985, too many managers "don't relate to the shareholders' interests because they aren't substantial shareholders themselves.")
Business schools didn't just reflect these new trends--they helped amplify them. Modern MBA classes may focus on dry technical skills--from negotiation strategies to, say, learning four different ways to calculate the Weighted Average Cost of Capital--but a distinct sensibility still manages to seep through. One survey by the Aspen Institute in 2001 tracked a generation of MBAs over two years and found a "shift in priorities": Students started downplaying their responsibilities to employees or the community or even customers; the shareholder became king. "It's easy to caricature all those automotive execs now flying to D.C. in private jets [to ask for bailout money]," Khurana told me. "But look at the model they were operating in. They've never had to think about things like social legitimacy--what did that have to do with maximizing shareholder value?"
In recent decades, the swelling of the U.S. financial sector has meant boom times for b-schools. The parade of corporate scandals in 2002 barely blunted the momentum--many deans blamed the Enrons of the world on a few rotten apples and simply mandated new ethics classes like Harvard's "Leadership and Corporate Accountability," where students could read about the rise and fall of Ken Lay and discuss Martin Luther King's "Letter from Birmingham Jail." (Less explored was the possibility that a single-minded focus on short-term stock gains might have helped lead to all those misstated earnings and back-dated stock options.) By 2007, some elite business schools were shipping out roughly 40 percent of their graduates to large investment banks, hedge funds, and private equity firms, while students were elbowing their way into electives like "Corporate Financial Engineering."
Trouble was, many students weren't exactly taking Ph.D. courses. "There were so many people who just wanted to learn enough to get a job in this field," says Trzcinka. "This market was full of people who were really just salesmen. You'd get them in class and ask them questions [about the latest financial innovations], and, for the first ten minutes, they sound sophisticated. Then you probe a little deeper, and, for the next ten, they're an idiot." Out in the corporate world, many managers failed to grasp the subtleties and limitations of the boggling mathematical models that were helping them earn outsized returns. "Look at Lehman Brothers in 2005--if you were one of the chief risk officers, what could you have done to convince senior management that you were heading for disaster?" asks Andrew Lo, who teaches financial engineering at MIT. "I'd argue virtually nothing. Unless senior management understood these models to the extent that [their quantitative analysts] did, there's no way you could convince them to pull back--business was too profitable."
Nor were faculty members sounding as many warnings about Wall Street as they could have. "Our tendency was just to get excited by the novelty--and by our belief that markets could do no wrong," says Jay Lorsch, a professor of human relations at Harvard Business School. Lorsch points out that most MBA programs have to maintain friendly ties with the corporate world--professors often consult on the side and work closely with companies to develop case studies, while business schools depend on big firms to send students to their executive programs. "This all created a tendency to go along with the business community, to not be too critical."
Naturally, there are also less-forgiving takes. Henry Mintzberg, a professor of management studies at McGill University and a longtime critic of business schools, insists that the whole MBA model is fatally flawed--management isn't something you can teach in a classroom, and the idea that you can has bred a dangerous sort of arrogance. "Look at the case-study method they teach at Harvard," he says. "You read [about] companies you know nothing about, and you come in to class and are forced to pronounce on what those companies should do. You've got no in-depth knowledge at all--you're just shooting your mouth off!" Mintzberg didn't seem shocked that many MBAs brought this swagger to Wall Street. "My recommendation? Close them all down, period."
Not everyone's ready to fall on their swords just yet, but, these days, the deep recession and bleak job market, coupled with mass outrage over multimillion-dollar executive pay packages, have led to a genuine sense that something's gone badly awry. At Wharton this spring, a new class on the financial crisis filled its 300 spots in less than 48 hours. And it's not just that professors are putting more emphasis on smarter risk-management and asset bubbles. Economic theories that would have been heretical 20 years ago--the idea, say, that people and markets don't always behave rationally--are being greeted with fresh interest. At Harvard, informal debates are said to be breaking out in faculty lounges about whether professors should focus more on teaching students how to run businesses that are sustainable in the long-term, rather than just pawning off the latest hedging techniques.
Still, the changes amount to something less than an outright revolution. When I asked current MBA students what sorts of things they weren't hearing discussed in class, the list of still-too-delicate topics included: whether executive pay schemes might have led people to take excessive risks; whether investment banks are really "value creating"; and, of course, what role MBAs might have played in the current crisis. Khurana told me that business schools still need to have a perhaps-uncomfortable discussion about their broader purpose in the world--a question that involves pondering "the fundamental relationship between the economy and society." Not the sort of thing, alas, that's easy to stick in a textbook.
Bradford Plumer is an assistant editor at The New Republic.