The Firm: The Story of McKinsey and Its Secret Influence on American Business (37 page)

Clients liked McKinsey so much that the inexorable diaspora of McKinsey consultants into the CEO ranks of industry continued at full force. A
USA Today
article in 2008 concluded that the odds of a
McKinsey employee going on to run a $2 billion-plus company were the best of
any
company—besting perennial management breeding grounds General Electric and IBM.
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Despite the firm’s early success in Washington, McKinsey hightailed it out of town in the 1960s when margins came under pressure. The firm had largely steered clear of Beltway business for the next forty-plus years. That all changed in the new century, in two significant ways. First, the firm reestablished a public sector practice under the guidance of partner Nancy Killefer. Second, McKinsey infiltrated the Obama administration.

After working in the Clinton administration for three years as an assistant Treasury secretary between 1997 and 2000, Killefer had returned to the firm in 2000 and expressed a desire to continue working with the public sector, even if she was now on McKinsey’s side of the table.

Though he became a champion of the practice later on, Ian Davis wasn’t immediately supportive of Killefer’s desire to reestablish a U.S.-based public sector practice. “He told me he didn’t think it was such a great idea,” recalled Killefer, an honors graduate of Vassar College (economics) who has an MBA from MIT’s Sloan School of Management. “I had a bunch of consumer products clients, and he suggested that focusing on them would be the best use of my time. I said to him, ‘I don’t think you understand, Ian. I’m not asking for permission. I’m calling up to tell you what I’m going to do as a courtesy.’ ”

Not only did Davis think her abilities might be better used elsewhere, he also wondered whether McKinsey could serve governments
around the world in the same way it served corporate clients—that is, by advising on best practices. “Ian believed that all politics is local,” Killefer continued. “I argued that we could add value by connecting governments.” Killefer was right, and Davis came to embrace the public sector practice. By 2010 it was one of the fastest growing in the firm, with work spanning the United States, Europe, Asia, and Africa.

Killefer and her team helped the post-9/11 FBI build a domestic intelligence capability, including rethinking how the agency ran not just operations but recruiting. In China, McKinsey lowered its usual sky-high fees in order to get a foothold; but when it came to U.S. government work, the firm held the line. According to public disclosures made as a result of McKinsey’s government contracts, it cost taxpayers $164,165 a week for the services of one engagement manager and three associates.
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In typical McKinsey fashion, the firm argued that this was in the best interests of its government clients. “I didn’t want it to be anything less than what we give our private sector clients,” said Killefer. “I wanted the same commitment of the firm, the same caliber of people. I didn’t want us to become a stepchild of the firm.”
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Remarkably, skinflint governments around the world decided McKinsey was worth the price.

That was true at the municipal level as well. New York Mayor Bloomberg used McKinsey repeatedly. McKinsey sometimes worked for free (troubleshooting the police and fire departments’ responses to 9/11) and sometimes for pay (a report on how the city could stand its ground in high finance against London). The Department of Education has also used McKinsey consultants, and New York City’s PlaNYC—an ambitious and wide-ranging effort to address population concerns, aging infrastructure, climate change, and an evolving economy—was based on McKinsey data crunching.
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When Barack Obama was elected president in 2008, he tried to lure Killefer back into the fold by nominating her to be his “chief performance officer,” but she was ensnared in that classic Washington gotcha!—a failure to pay taxes on household help. In early 2009 she withdrew her nomination and decided to stay at McKinsey. But Killefer wasn’t the only McKinseyite on the president’s radar. Two members of his transition team were McKinsey alums—Michael Warren, cohead of the Treasury team; and Roger Ferguson, once a Federal Reserve governor, on his economics team. He named former McKinsey Global Institute chief Diana Farrell as deputy director of his National Economic Council, and McKinsey vet and venture capitalist Karen Mills became head of the Small Business Administration.

In noticing Obama’s predilection for hiring McKinsey types, the
Economist
pointed out how it signaled a distinct change from the Bush administration’s apparent love of former Goldman Sachs employees. “[The] national mood has changed,” said the magazine’s editors. “Under Mr. Bush, working for Goldman Sachs, the greatest of Wall Street’s then-great investment banks, seemed in itself to be a qualification for high office. This, after all, was an era where what counted was understanding the financial markets and globalization, and having great connections all over the world. . . . The new era may place a higher value on finding practical ways to improve the workings of vast bureaucracies.”
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For their part, the Clintons had been favorable to Rhodes scholars.

The magazine had a point. If the previous ten years had been about growth for growth’s sake, then the post-real-estate-bubble era was about how to fix everything that had been broken. Wall Street types are better suited for the cheerleading era. McKinsey people are fixers. Even presidential candidate Mitt Romney said, if elected, he’d consider bringing the firm in to “fix” the government.
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That said, the firm’s closeness with the Obama administration was
also another example of just how malleable McKinsey can be. The McKinsey Global Institute is a strong proponent of the idea of unfettered markets for both labor and capital. Barack Obama does not necessarily feel the same way—he not only supported the bailout of Wall Street but has supported the subsequent and extensive regulatory overhaul and has not let the national housing market find its natural bottom. It is, in some ways, intellectually disingenuous for McKinsey people to be so close with this president. But it’s not that surprising, as power and influence have always trumped ideas at the firm, no matter what it might argue. And Harvard eggheads tend to seek each other out anyway—Obama holds a law degree from the college. “Consultants are nothing if not ingenious in getting their feet on the fender,” the
Economist
later wrote. “The Obama administration [was] a perfect mark when it came to Washington . . . on a wave of hope and hype.”
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In July 2009, MGI issued a research report on just how much the federal government could save from productivity gains over the course of a decade. Anywhere from $45 billion to $134 billion, the consultants decided. “Don’t think about it as cost reduction, think about it as adding value. . . . It’s a lot of money to go after,” said Killefer at the time.
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McKinsey went after it with full force, and not just in the United States: Work that the firm has done for no less than six Western defense ministries has resulted in a cumulative economic impact to clients of more than $15 billion.
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If McKinsey has succeeded in getting lucrative government business around the world, the one place where it has truly infiltrated government is in London, where it has had pretty much uninterrupted access to 10 Downing Street for decades. The head of Britain’s Financial Services Authority since 2008 has been Lord Adair Turner, a McKinsey alum. Lord Blackwell ran Tony Blair’s Policy Unit in 1995, the closest any McKinsey alumnus had come to the true center of political
power before alum William Hague became British foreign secretary in 2010.

In early 2012 an expansive article in London’s
Daily Mail
laid bare the degree of McKinsey’s influence in the country’s National Health Service. Revelations included allegations of egregious conflicts of interest, such as advising the government to revamp the way it handled health service contracts in ways that would benefit McKinsey’s own corporate clients and then sharing those proposals with the private sector clients in advance.

The article also highlighted the means of achieving influence, including the consultants’ spending lavishly on an NHS regulator—including business class flights to New York, a five-star hotel stay, and a lavish banquet. The regulator? David Bennett, a former McKinsey consultant himself. Several consultants have passed through the revolving door between McKinsey and NHS, including Tom Kibasi, who left the firm to become a policy adviser to NHS before eventually returning; and David Cox, who left McKinsey to become strategy manager for London NHS.
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If McKinsey was caught unawares by the dot-com boom, it was no laggard when it came to the surge in financial services at the turn of the century. In 2002 the firm served 80 of the world’s top 120 financial services companies.
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McKinsey had long earned gargantuan profits from banks and bankers, be it from Merrill Lynch and Citigroup in New York, or its near monopoly on providing advice to the giant Swiss banks. Its alumni also populated the executive suites of nearly every financial company of importance.

McKinsey felt comfortable enough about its financial expertise to
engage in public displays of “big think”—a 1997 editorial in the
Wall Street Journal
by consultants Lenny Mendonca and Greg Wilson announced: “Financial Megaplayers’ Time Is Here.”

The McKinsey partners were precisely correct when they predicted that “five years from now the financial services industry will look nothing like it does today. . . . The financial services business will be . . . dominated by a handful of national and global giants that dwarf even the biggest players today.” There is no better example than JPMorgan Chase, the product of twenty-plus years of consolidation by Bank One, Chase Manhattan, Chemical Bank, First Chicago, JP Morgan, Manufacturers Hanover, and the National Bank of Detroit.

But they were precisely wrong when they concluded that, “as in other consolidating industries, these megaplayers will be tightly run, highly productive, highly innovative, highly skilled at mergers and acquisitions . . . Shareholders, customers and society at large will all be better off as a result.”
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With Jamie Dimon at the helm of JPMorgan Chase, that bank was both tightly run and skilled at mergers and acquisitions—witness the bank’s Hail Mary acquisitions of both Bear Stearns and Washington Mutual in 2008. But that was the exception. It was an exception in another way too—it was the only one of the large banks to make sparing use of McKinsey consultants. Nearly every other major financial institution—from Lehman Brothers to Merrill Lynch to Citigroup (all major users of McKinsey)—showed a distinct loss of both effective management and risk control at the peak of the boom. In the end, shareholders were not better off, nor were customers, nor was society at large.

The postmortem on the real estate bubble is pretty much in, and there’s blame enough to go around: from unscrupulous bankers to shady mortgage brokers, misguided policy makers, inept regulators and central bankers, and greedy homeowners. But while McKinsey
might advise the occasional mortgage broker and policy maker, its bread-and-butter customer is the bank. So what were its consultants telling clients at the time?

One thing they were endorsing was the notion of the “ability to influence [one’s] regulator”—an idea more aptly described as “regulatory capture.”
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McKinsey was certainly not on the “more” side of the oversight debate. This worked to the detriment of not only the industry but also society itself when it turned out that regulators had turned a blind eye to the excesses of their charges.

Another: The consultants were telling banks the very same thing they had celebrated at Enron, that moving assets off one’s balance sheet—by securitization or in some other manner—was the surest route to continued, unhampered growth. Much of this advice was based on historical analysis—the kind that showed that securitization was a wonderful thing—but it ultimately proved flawed in its backward-looking perspective when widespread bond failures resulted in the bottom falling out of the nation’s real estate market. This reliance on models came directly from the theory of the McKinsey/Harvard axis that the past was a reliable indication of the future.

“What you get from Harvard Business School is a wonderful network of people who were there with you and a set of tools that you can then bamboozle people with for the rest of your life,” Radio 4 business reporter Peter Day told London’s
Sunday Times
in 2009. “It is a habit of thought—conventional responses to conventional situations. Harvard teaches on a case-study basis, so it is always telling people how to respond to things that happened in the past. No wonder that when something like the credit crunch comes along, huge numbers of highly skilled people in compartmentalized worlds are unable to respond to it.”
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What’s more, McKinsey and others wholly endorsed bankers’ move farther out on the risk curve in search of higher returns. Specifically,
they were pushing the concept of risk-adjusted return on capital, or RAROC, as well as a notion called “shareholder value added,” or SVA. Both ideas were based on a simple premise. “In theory, if a bank took capital out of a business with low-risk adjusted returns and put it into a business with high-risk adjusted returns, its overall return on shareholder funds should be higher. So would its position in the banking food chain,” explained Kevin Mellyn in
Financial Market Meltdown
. “It seemed like a good idea at the time.”
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It wasn’t. McKinsey wasn’t alone in pushing RAROC, of course. Smaller, more focused financial services consultants were selling similar ideas. But McKinsey’s ability to take an idea and then “leverage” it up, using its brand and organizational effectiveness through an essentially industrial-style process made its consultants far and away the most effective disseminator of ideas via the consulting process.