the Urge to Cheat

A news story this week out of Los Angeles reports that federal investigators applied for search warrants to follow up on suspicions of illicit activity at four museums.

It was alleged in affidavits related to the search warrants that staff at two museums looked at artifacts in the possession of a smuggler and meet with the sellers of stolen goods, knowing that the objects headed their museums might be tainted.

In an odd twist of fate, one collection of materials acquired by the Pacific Asia Museum came from Ban Chiang in Thailand, a bronze age site that I discovered in 1966.

Patty Gerstenblith, a law professor, commented that “by not thinking about what they buy, they are putting money into an international network of smugglers, looters, thieves and destroyers. As educational institutions, museums have a responsibility to look beyond that particular object that they may be acquiring.”

In short, overlooking all the circumstances, not taking long-term factors into account, is unethical for museums and their staff as well.

It seems that the urge to cheat, to profit selfishly at the expense of others, is not limited to participants in business and market transactions.

Another corporate scandal – this time its worse!

On January 17^th, Merrill Lynch announced its largest loss ever – US$9.8 billion dollars for the 4^th quarter of 2007. This came as a result of a write down of the value of certain assets held by the company – US$16.7 billion loss in book value. The assets had been purchased as part of the subprime mortgage bonanza of a few years ago.

The subprime “bonanza” first turned into a “mess” then to a “crisis” and now has pushed the entire US economy to the tipping point of “recession”.

Wall Street stock prices are down – the necessary consequence of any major market miscalculation by business. President Bush is suddenly talking of a huge financial stimulus package from the federal government budget into the pockets of American consumers. When Republicans talk about dumping billions of federal dollars into consumer hands, you know they are worried about prospects for economic well-being.

These results should come as no surprise. We are living through yet another cycle of irresponsible corporate decision-making. Bad ethics – selfish exploitation of immediate advantage in disregard of long-term consequences – has once again led to bad economics.

The mismanagement of subprime lending has all the hallmarks of a classic business scandal. Truth about risk was not made transparent; too much capital was invested seeking easy returns causing an excess of activity which, self-evidently could not be sustained; and wheeler-dealers seeing fees drove the process.

On the other hand, this business scandal does not have the features of intentional fraud in manipulation of earnings reports that marked the Enron/WorldCom era. Nevertheless, it has resulted from the same character flaws in decision-making as the previous episode of financial malfeasance.

Products were prepared to be sold in our financial markets to meet investor appetite.

Then it was stock in supposedly high-growth companies. Now it was supposedly low risk, higher return mortgage products.

The dysfunction in both scandals was intentionally separating those who carried the risk from those who stood to profit, a violation of fundamental equitable principles of capitalism. In capitalism, those who hope to get the lion’s share of returns should shoulder the lion’s share of risk.

In Enron/WorldCom, risk was put on purchasers of stock and returns were earned by insiders. In the subprime mess, risk was put on low-income, poor credit rated mortgage borrowers and on the purchasers of interests in derivatives collateralized by such subprime mortgages. Fees were earned by originators of the mortgages and sellers of the derivatives who assumed no long term risk of loss.

This pushing off of risk to those who either could not bear it or who did not know about it was socially irresponsible corporate behavior.

In both the subprime mess and in Enron/WorldCom, the perpetrators of the scandals were the best and the brightest minds in our financial markets.

It is only just that now some investment chickens have come home to roost with Bear Sterns, Citibank and Merrill Lynch. But at a serious cost to the rest of us who are entirely innocent and don’t deserve to live in stressful economic conditions not of our own making.

The Enron/WorldCom cycle of scandal did not pose as much of a threat to average Americans as this malfeasance in the use of capital has. Housing prices are down; the equity wealth of most Americans is therefore down; consumer spending is down with impact on production and employment; the economic is facing a general recession.

2007 - a year of transition

What strikes me in looking back on 2007 are the fundamental geo-political trends that emerged more clearly in view. These forces are to me natural; they embody potentials and demands deep within natural and human reality; they are to be ignored at our peril for they will not go away.

Some are new and some are re-emerging, shaking off past constraints and containments.

We saw an acceleration of the break-up of the 19^th century international order of nation states.

The European Union is becoming a new force in history, larger and more powerful than any previous integration of European peoples under the Romans, Charlemagne, Napoleon or Hitler. The effective presence of the EU is embodied in its single currency the Euro, which by the end of the year was worth more than the US dollar.

Tribalism returned in Kosovo, Iraq with rival Sunni, Shi’a and Kurdish zones of control, the fragmentation of Somalia, regionalism in Georgia, the division of the Palestinians into two rival zones of control, breakdown in Lebanon, presidential rivalries in Kenya, the success of Scottish nationalists – even perhaps the political division of the United States into Red and Blue states, mimicking the old division between Union and Confederacy during the Civil War. Thinking in terms of tribal rivalries provides a compelling explanation of the unremitting tension between Israel and the Palestinians allied with Hezbollah.

Religious fundamentalism within Islam is also a kind of tribalism where loyalty is to the brotherhood, the band, the sect and not to wider, more inclusive, pluralistic communities.

Convergence around cultures, ethnic identities, religions rather than citizenship in 19^th century states and empires is the predominant driver of politics.

In its own way, economic globalization and the continual expansion of a single, integrated financial system is taking power away from political elites administering national state structures. The world’s financial centers are nodes in one network, doing business 24 hours a day.

To make the point, Islamic banking, once seen as sectarian and inappropriate for the rational pursuit of profit, is being absorbed into the world’s financial system.

The decline of the dollar is another marker of a changing global order. The United States spends too much on the wrong things, adding to its indebtedness; it is losing ground relative to other fecund centers of economic wealth and growth.

This past year saw the end of the Bush/Blair/Howard imperial attempt to impose a political order in Iraq. Blair left office, Howard was rejected by Australian voters, and Bush is sliding to the end of his term as president without the trappings of accomplishment as a world leader. The Iraqis are making their own destiny through ethnic and sectarian cleansing and the end game as they want it looks like some form of partition – an arrangement that perhaps should have been made right after World War I in the breakup of the Ottoman Empire at the hands of the British and the French.

Oddly, last year saw the definitive rise of Russia and China as great national power, very much in the 19^th century pattern of hegemonic advance. Russia under Putin is orderly and growing in economic power after its long experiment with Communist internationalism.

Similarly, China has recovered from 150 years of weakness under the Manchu’s and war lord leaders and from its experiment with Mao’s form of Communism. It is once again a great regional power militarily and a rising world power intellectually and economically.

The parallel rise of Russia and China has an inevitable feel about it.

In Latin America, 2007 did not bring to the fore any significant trend, only further oscillation between conservative and populist (colonialist and nativist) approaches to political and social justice. Populism advanced under Chavez of Venezuela with his oil money, Morales in Bolivia, and Lopez-Obrador in Mexico. But the tide of populism hit a beach wall of opposition. Lopez-Obrador narrowly lost the presidential election; Chavez lost a referendum designed to make him a Napoleonic caudillo for life and Morales’s effort to revise Bolivia’s constitution was stalled.

Latin America still needs to find a balance way towards growth and middle-class social sensibility.

Overriding all the ups and downs of elite politics was global warming. Great natural forces heating up the climate. Under the specter of climate change, worries about political order and who’s on first base seem trivial.

Cheating in American Baseball

A report was just issued stating that many renown players working for professional baseball teams in America have used steroids and other muscle-building drugs to enhance their natural ability and win out over other players.

Here is an instance of moral grand corruption.

The ethic of sport - going back to Greek Olympics - was supposed to be in the character of the athlete - in his or her mental effort, self-discipline, skill and courage. Winning was only icing on the cake.

Now winning seems to be all and at any price. A winning record leads to more money, lots more money, in the business of professional sports.

Just like winning in the stock market - to get the most out of it for ourselves, why not take a few performance enhancing drugs? In the world of finance, such drugs are misleading information about a company's prospects. See Enron, WorldCom, et. al.

Misleading information gives a company unfair advantages in the competition for investor interest.

Professional sports in the United States provide moral and ethical standards for a large number of Americans. The behavior - noble or vile - of sports celebrities triggers imitation among the young and, thus, has a public good quality about it. The behavior of such role-models cannot be overlooked by society.

What surprises me is the lack of programs in business ethics for professional sports companies and their employees.

Like Death and Taxes - there are consequences

Advocates of cash flow as the “summum bonum” of capitalism often take the position, as they must, that there are no negative consequences attendant upon such a course of business enterprise worthy of note.

The assumption they make is that the enterprise is autonomous, separated from society by various walls such that the only costs of material concern are those that show up on the income statement.

Thus, the “costs” of enterprise born by stakeholders – the environment, civil society, customers, employees, investors, creditors – do not count. They can be ignored.

This point of view is very short-sighted and so wrong as several developments here in the United States make very clear.

First, in the sub-prime mortgage mess; The consequences of rising foreclosures on home mortgages were set by entrepreneurs who extended mortgages to borrowers who were very much at risk of non-payment when conditions changes. By pushing off risks on borrowers with marginally secure abilities to pay, the originators of the sub-prime lending set off a sequence of developments that carried within its economic logic high risks of social dislocation.

With homes in foreclosure, with the prices of homes dropping for America’s great middle class, with the banking system under great stress, the government could not leave the market alone. Anxieties were too high and the demand for protection from market forces too intense.

So, President Bush felt compelled (it’s presidential election season as well and his party is not doing well in the polls) to step in. He imposed an emergency freeze on the raising of the interest rates on certain mortgages. The freeze will last for five years.

Nothing could be more alien to his principles of free market autonomy, where private actions without government regulation bring about optimal outcomes for society.

The moral lesson from the sub-prime adventures is: as you sow, so shall you reap. There are consequences for business that don’t always show up on the quarterly income statement.

Second, there are recent developments with UnitedHealth Group. This company in Minnesota underwrote for premiums the health care costs of millions of Americans. It paid its CEO William McGuire hundreds of millions of dollars and gave him stock options as well. The company’s stock rose in the market.

But it then turned out that many of his stock options had been rigged – backdated – to give him even more financial advantage.

When the back-dating was discovered, the Securities and Exchange Commission began an investigation and investors brought litigation. On December 6, 2007, McGuire decided to settle the claims against him. He agreed to give back to the company some $420 to $460 million in stock options and pay and to pay a $7 million fine.

He is still left with over $500 million in stock options so he will be able to live for the rest of his life as a gentleman should.

But there were consequences that followed upon his taking short-term financial advantage of the company.

Now, one way in which McGuire’s leadership of UnitedHealth Group had led to substantial profits was to squeeze its customers – the insured and doctor’s to be paid for their services. As a result of these business practices, the company in recent years lost 315,000 customers this year and angered doctors.

So, as a consequence, it is changing its practices. It will now show doctors and patients on the day of a doctor’s visit how a claim will be paid; it will pay doctors more quickly; UnitedHealth employees will be given incentives to put quality and patient advocacy first and productivity (i.e. cash profit) second.

Like death and taxes, consequences cannot be avoided. There is no free lunch in capitalism. Ethics is material to the bottom line.

In China it's culture, not ethics or CSR

A conference this past week in Beijing was most informative on several levels. The topic was to discuss in a Chinese context business values and corporate culture. The audience was engaged – very engaged; more engaged than audiences in most of the conferences I have attended where the topic is business ethics or corporate social responsibility.

The substance of our discussions in Beijing was essentially the same concerns as inform discussions of business ethics or corporate social responsibility. But the conceptual framework, the lens, brought to bear on the subject matter was unique. The starting point was “culture”, not ethics, not the business case for taking stakeholder concerns into account when running a for-profit enterprise.

In prior workshops on business ethics in China my observation was the absence of concern for the topic on the part of Chinese business owners and managers. This recent discussion, however, was very different. It struck me as being very authentically Chinese while the previous meeting seems now in retrospect to have been the extension of a foreign framework into an unresponsive Chinese intellectual and emotional milieu.

Something like the assertion of exterritorial legal jurisdiction in China by the western powers during the glory years of Western colonial dominance. For example, Western powers had their own tribunal in Shanghai to resolve matters according to French, British, or other European legal norms and practices.

In startling contrast, in this past week’s conference and panel discussions, the Chinese asserted conceptual ownership of the subject and fully engaged their minds as well as their emotions.

It appears that, for them, the discussion of “culture” is not a trivial matter.

Which fact, I suppose, should not have come as a surprise to me. After all, Chairman Mao’s great effort to shape China in his image was undertaken as a “cultural” revolution.

In ways that were quite exciting and revealing, speakers and commentators asked basic questions as a starting point on the way to defining appropriate levels of business conduct.

They asked what is human nature? Are people basically sinful and greedy? Do people have a capacity for moral behavior? Can they acknowledge the claims of society on their freedom and autonomy? Don’t we have to choose between “profit” on one side and ethical conduct on the other as Mencius argued so many years ago?

I felt as I listened that the objective of the conversation was to find a formula for “market freedoms with Chinese characteristics.”

The need to find such a formula is palpable as the Chinese Communist Party is moving more and more beyond Deng Xiao Ping’s formula of “Socialism with Chinese Characteristics” that justified the program of reform and opening up that began some 30 years ago.

The unstated question in everyone’s mind in the conference seemed to be “what kind of company behaviors will maximize market efficiencies and so create wealth but at the same time not be destructive of social harmony and non-financial values?

“Corporate culture” seemed to be assumed to be the meeting point of profit and social responsibility. One participant described the role of culture in a market setting as the brakes to off set too much pressure on the gas pedal. Excessive acceleration – a metaphor for excessive individualism or self-seeking – is tempered by putting on the brakes and keeping the car under the speed limit or safely hugging the road as it twists and turns.

This assumption is not a bad one in my opinion. Culture is a restraint on individualism. Culture is the action of the moral sense within us; culture arises within communities and sustains communities with commonalities of values, behaviors, practices, understandings.

Our discussions in Beijing had the following logic: with the right culture in place, companies will be ethical and socially responsible.

But the approach to implementation starts with culture – the psychology of the human, the needs and motivations of people - not with debates over moral theory or a list of stakeholder interests.

At the same time, a discussion of “culture” provided a way to reclaim China’s moral heritage. We spoke of Confucianism, of Taoism, even Buddhism, as rich sources of cultural “brakes” for companies in today’s China.

I very pleasantly felt that the Caux Round Table had a constructive role to play in this conversation as we have in a number of cultures been successful in mapping global standards of ethics and corporate social responsibility to core values within national settings. I was very pleased that our colleagues Dr. Roger Conant, Hiroshi Ishida, Andy Whitford from Westpac Bank, and Brinton Scott from the Fredrickson & Byron law firm office in Shanghai could make notable and constructive contributions to the discussions.

It’s the same all over

I arrived in Beijing on Sunday night the 2^nd of December for a conference discussing CSR and the cultural imperatives of Chinese companies.

This morning in the paper were two front page stories that caught my attention.

One was about the sentencing to 16 years in prison of a Shanghai “tycoon” for abusive “brute” capitalist behavior. He had embezzled money, forged tax receipts, defrauded investors in the stock market, among other criminal acts carried out through the means of business enterprise.

This story put to me once again the role of character in free markets: cheating is everywhere; laws alone don’t stop it; free markets can clear it out only after the truth comes to light.

There would thus seem to be a constant, universal need to focus on ethics, character, personal goals and integrity as a third counter-weight to the human tendency to abuse power in private hands.

The second story was the report of a Chinese government agency that the average temperature in China so far during 2007 was at the highest level since 1951. This marks the 11^th year in a row of higher average temperatures than in previous periods.

Systemic temperature rise is prima facia evidence of global warming. It does not provide evidence of the cause or causes of the trend, but does leave us with the fact of a change in our environment.

And, to me, if we don’t like the implications of the trend, regardless of its causes, we should be taking steps to moderate the rise in global temperatures.