A New York Magazine story by Andrew Rice, The McKinsey Way to Save an Island, pulls back the curtain on the consulting firm’s $3.3 million a month assignment for the five member oversight board that is effectively running Puerto Rico in its bankruptcy. What it reveals isn’t pretty. It shows the firm to be greedy and out of touch, confirming the picture presented by a recent alum in a Current Affairs piece, Capital’s Willing Executioners.1 And that’s not just my opinion. I sent the piece to several ex-McKinsey colleagues. All were appalled. As one put it, “I am so glad I left there before things turned so clueless and ugly.”
McKinsey is acting like a private-sector IMF, squeezing the government’s budget hard so that more payments can be made to the holders of $74 billion in Puerto Rico’s bonds. To add insult to injury, McKinsey has no meaningful experience in government restructuring yet is being paid mind-bogglingly high fees. And it’s not as if these bond investors didn’t know they were buying paper that had a high risk of default. Many were issued for the purpose of servicing outstanding debt, a red flag. Puerto Rico had also been a marketing target for interest rate swaps (the sort that burdened Jefferson County and many municipal transit authorities) and a Lehman Brothers innovation: the securitization of sales taxes…which Lehman persuaded the struggling colony to impose.
Because Puerto Rico was barred from going to bankruptcy court via Congress in 1984, when its finances became utterly unworkable, the Obama Administration sponsored the Puerto Rico Oversight Management and Economic Stability Act, which was passed by Congress in 2016. The board, widely called la junta in Puerto Rico, supercedes the elected government. It’s not only in charge of the budget but also of the negotiations with bondholders. And while it’s beyond the scope of the New York Magazine article, other coverage, particularly by Juan Gonzalez (co-host of Democracy Now! who has written extensively about Puerto Rico) and Naomi Klein, contend that PROMESA is favoring the bondholders and squeezing Puerto Rico’s citizens, who were struggling even before Hurricane Maria.
Budget-cutting to try to pay creditors is a failed strategy. If McKinsey had the expertise consistent with its fees, it should know better. The IMF’s chief economist, Olivier Blanchard, admitted in 2013 that blood-letting in weak economies was counterproductive. In econospeak, “fiscal multipliers are greater than one” which means a $1 cut in spending leads to a greater than $1 fall in GDP. That means the debt burden relative to the size of the economy rises making repayment even more difficult.
So why is McKinsey siding with creditors and bleeding Puerto Rico white? And make no mistake that that’s what’s happening. Consider this section of the New York Magazine piece:
Soon after he started the job, [gubernatorial appointee attorney Christian] Sobrino said, he met with U.S. State official Natalie] Jaresko and, via speakerphone, McKinsey consultants. They presented him with a report, “The Path Forward”; on the first page, beneath the heading “The New Normal,” were three questions:
• What are you not going to do?
• What are you going to do differently?
• How does that decision lead to savings?
The patronizing tone, Sobrino said, was typical of McKinsey, as was what followed: charts projecting an imminent budget shortfall and outlining a “right-sizing initiative.” He expressed withering scorn for the “McKinsey-bots,” his name for what he described as a constantly changing cadre of hotshots who fly into Puerto Rico for short stints and treat local officials with condescension. “I think the first phrase I heard from a McKinsey-bot was, ‘We are going to corporatize the Puerto Rican government,’ ” Sobrino said….
The critics of the oversight board — or la junta de control, as it is called by people in Puerto Rico who say its powers far exceed oversight — decry both the impact of the cuts and the fact that much of the resulting savings would go to repay creditors, including the hedge funds, many of which bought bonds at a deep discount after Puerto Rico defaulted on its debts….
Complaints about the fiscal plan fall into several broad — and sometimes conflicting — categories. Critics such as Sobrino concede that some cuts were necessary but object to their being imposed clumsily by unelected outsiders. Others think the plan is not transformative enough. Dentist Rafael Torregrosa lobbied in vain to persuade McKinsey to consider health options that were less reliant on private insurers. “We’re paying good money to them as consultants of la junta to push only one model,” he said, “which happens to be the worst model in health care.”
The overwhelming sentiment, though, is sheer exhaustion with austerity. After Hurricane Maria, there was an expectation that the debt would be quickly resolved, with bondholders accepting a giant reduction in what they are owed — a “haircut,” in bankruptcy terminology. Hopes for debt forgiveness were bolstered by bankruptcy expert Donald Trump. “We’re going to have to wipe that out,” the president told Fox News two weeks after the hurricane. “You can say good-bye to that.” But administration officials quickly walked back his statement, and creditors are still fighting to be paid.
“We’re just being squeezed, squeezed, squeezed,” said Luis Carlos Robles, who works for a nonprofit that serves an impoverished San Juan neighborhood. His community of 26,000 people surrounding the Caño Martín Peña — a polluted, debris-choked waterway — had absorbed a double blow. Maria left around a thousand people there homeless, while the budget cuts led to the closure of four of its eight schools and the possible cancellation of a planned government dredging-and-redevelopment program. Crime is “exploding,” Robles said, with gangs committing murders in broad daylight and victims sometimes left lying in the street for hours.
The description of the condescending meeting sounds accurate because I’ve heard complaints of McKiney’s arrogance for over two decades from search and other professionals who deal at the C-suite level. Among McKinsey’s bad habits are presumptuous sales pitches. One pattern is McKinsey consultants would meet with prospect and tell them they thought the potential client has a problem that McKinsey can solve. When the client says no (“We’ve thought about that and we don’t think it’s that big a deal because Y” or “We’re already working on it”), the consultants would get aggressive and effectively tell the client it was wrong, they really did need McKinsey.
The article includes a lot more description of the human costs of the deep budget cuts. And it mentions, early on, one reason that McKinsey might be so friendly to the vultures that are putting the screws on Puerto Rico: McKinsey, through its in-house investment arm, holds at least $20 million of Puerto Rico’s bonds. Even worse, McKinsey failed to disclose that conflict of interest at the time it pitched for the Puerto Rico assignment. Senator Elizabeth Warren and Representative Nydia M. Velázquez criticized McKinsey’s conduct and asked for more information.
The article misses that McKinsey almost certainly has an even greater commercial conflict of interest. Bankruptcy specialists work for creditors or debtors, not both. Creditors are more attractive customers because they are regularly involved in bankruptcy restructurings. McKinsey has a business incentive to favor the creditors because that’s its customer target.
McKinsey partner Bertil Chappuis, a Puerto Rican who is a technology specialist, not a government or cost-cutting expert, spoke at length to New York Magazine’s Rice. Chappuis has so little perspective on what he is saying that toads regularly hop out of his mouth. He uses the worst sort of corporate babel-speak, a predictable tell of charlatanism, of the virtues of “right sizing” and running government like a corporation.
Chappius repeatedly attributes Puerto Rico’s woes to its government, implying that having it wear McKinsey’s hair shirt would solve its economic woes. That’s misleading. Puerto Rico, as a de facto colony of the US, is even less in charge of its destiny than a US state. The article mentions in passing that Puerto Rico has to foot more of its Medicare payments than even the poorest US state because it has no Congresscritters lobbying for it. The island has also been victimized by the Jones Act, which requires that only US-flagged ships can visit its port, which results in high shipping costs, making it hard for the island to be competitive. Puerto Rico’s debt load started rising sharply when the US started phasing out tax breaks the Puerto Rico government had been able to offer with IRS approval to attract manufacturers (which due to how US pharmaceutical companies gamed the rules, meant it wasn’t a big job generator, but it wasn’t nuthin’ and provided a meaningful boost to the economy), which ended in 2006. The island took a further hit in the crisis, leading to even higher levels of borrowing.
I strongly urge you to read the entire well-researched article in full. This part gives a taste of McKinsey’s preening self-regard:
“People don’t come to work at McKinsey for the money,” Chappuis insisted, echoing a sentiment I often heard from the firm’s employees. Its entry-level salaries are generous, and its senior partners make millions, but that compensation pales in comparison to what Chappuis said he could make in, say, private equity or investment banking. “I have a team of people who are — I know the word passionate is used a lot — but we have people who are deeply, deeply committed to the work.”
I challenge McKinsey to identify a single graduating MBA who got an offer from an established private equity firm and turned it down to join the firm. Maybe McKinsey can sell that bunk to journalists who won’t challenge the idea because it’s secondary to their story line, but anyone in finance knows it’s hogwash.
Starting from when I was at the firm in the 1980s, McKinsey started losing out to Wall Street on a regularl basis and had to considerably loosen its hiring standards, going from making offers only to the top 10% of the graduating class to over time, the top 30%. Similarly, McKinsey regularly loses partners to private equity firms. It’s inconceivable that someone who was senior enough to participate in a private equity carry pool would leave that to join McKinsey.
But the more obviously bizarre part of the argument is that the public is supposed to believe that McKinsey professionals, because they claim to have left money on the table with their career choices when partners make millions are year, are somehow inherently virtuous because of that. This is awfully reminiscent of a famed Winston Churchill riposte:
Churchill: “Madam, would you sleep with me for five million pounds?”
Socialite: “My goodness, Mr. Churchill… Well, I suppose… we would have to discuss more, of course… ”
Churchill: “Would you sleep with me for five pounds?”
Socialite: “Mr. Churchill, what kind of woman do you think I am?!”
Churchill: “Madam, we’ve already established that. Now we are haggling about the price”
To belabor the obvious, McKinsey isn’t a charity, and it should be judged by its actions, not bizarre claims about its piety.
And for the praise of passion? Jihadists and other religious fundamentalists are also passionate. That doesn’t mean what they do is virtuous, merely that they have blind conviction.
1 I’m overdue for a post on McKinsey’s growing list of ethical lapses. I also have to differ with some of claims made in the Current Affairs piece. The author considerably exaggerates McKinsey’s historical clout; it’s almost as if, as a jilted lover, duped about McKinsey’s recruitment pitch about its special goodness, he now needs to see them as especially bad. And I don’t find it hard to believe that the firm often is pretty bad now. But even if McKinsey had been inclined to be many years ago, Corporate America wasn’t as rapacious as it is now, which served as a constraint on behavior, and McKinsey wasn’t as powerful or influential as the Current Affairs author suggests; it looks as if he needs to detox from this part of the firm’s Kool Aid.