The current collapse of asset values that started with sub-prime mortgages in the United States and flowed to global credit markets through the intermediation of CDOs and Credit Default Swaps is but another example of “irrational exuberance” at work in financial markets.
Allen Greenspan, former Chairman of the US Federal Reserve System, coined the cautionary term “irrational exuberance” to describe the asset bubble in dot-com and telecom equity stocks in the late 1990’s. That bubble burst when the accounting fraud scandals at Enron and WorldCom exposed many company values as illusory.
“Irrational Exuberance” takes over markets when prudent judgment and sound valuation methodologies lose traction in the minds of investors. Speculation, grounded on expectations of every rising equity values, drives out sound thinking and ushers into financial markets mere enthusiasm for self-advancement.
Certain styles of decision-making tend to favor the rise of “irrational exuberance” over more responsible approaches to valuation.
The Ethical Leadership Profile, developed for the Caux Round Table by Michael Labrosse and his associates, indicates that there are for most people, in general, four distinct decision-making modes of thought.
First is the Inquiring frame of mind. This approach to decision-making emphasizes analysis of data, conceptualization to see the “Big Picture” and future trends, to find meaning in facts by giving them weight and by putting them into patterns and categories. Here we find much of Barack Obama’s approach to decisions.
Second, and opposite to the approach taken by Inquirers, are the Pragmatists. These people look to experiences of practical success as the guide to their choices and recommendations. They are focused on immediate results within the context that is given them by society’s institutions. At their best, they have a dedication to craft and substance in what they do or produce. They tend to ask how can we complete the task and less why should we be doing this? The “why” question is of more interest to Inquirers than to Pragmatists. George W. Bush and his father, George H.W. Bush, both lean heavily towards pragmatism in their decision-making. George H. W. Bush became known for his cautionary mantra: “Wouldn’t be prudent.”
Third, on a different dimension than the continuum linking Inquirers and Pragmatists are the Unifiers. Their preferred approach to decisions is to find what is best for the organization to which they belong and for them as a loyal member of that structured community. They place priority on resolving issues of hierarchy and fairness within the organization; they place loyalty to their group over concern for outsiders; they stand up for their peers and reward loyalty with loyalty. They may often defer to the organizations rules and regulations and thus appear bureaucratic and happily bound up in red tape. Hillary Clinton with her passion for control and her distance from outsiders seems to have much of the Unifier orientation in her personal approach to the use of power.
Fourth, and opposite to Unifiers are the Entrepreneurs. They plan their moves with most concern for their own recognition and advancement. Their loyalty to the group responds to the group’s interest and ability to advance their careers and ambitions. Entrepreneurs are responsive to others, creative, intense and industrious. They are always drumming up some kind of profitable business for themselves. John McCain with his penchant for quick and decisive action would seem to embrace much of the entrepreneurial spirit in his approach to decisions.
But people are rarely active only at one of the paradigmatic poles; more frequently, they combine something from the Inquirer/Pragmatist axis and something from the Unifier/Entrepreneur axis. So, we might consider Bill Clinton as an eEtrepreneurial Inquirer – a man focused on his own opportunities but with strong intellectual gifts. Barack Obama would be an Inquiring Unifier, bringing conceptual clarity to the tasks and challenges of the organization and looking at the whole of the group and not just partisan sub-cultures. George W. Bush with his war in Iraq would be comfortable mixing pragmatic action with entrepreneurial risk.
Of these four dispositions, being an Entrepreneur is most conducive to promoting “irrational exuberance”, especially when compensation structures are commission or fee based so that deals done translate directly into personal reward and advancement. Entrepreneurs are less likely than Inquirers to consider the long term consequences for others of what they are doing. Entrepreneurs have a propensity to see the world in terms of sales; if you can sell it, do so and let the buyer beware of the consequences. You will move on to the next deal.
Nor are Entrepreneurs that considerate of the risks to their organization. They think of themselves not their organization as the vehicle of opportunity and success.
But when Entrepreneurs and Unifiers are mutually engaged in the same business, it can be a very risky combination. If the Entrepreneurs are “bringing home the bacon” for the organization, the Unifiers will stand by them, reward them, and not question the effect of their activities on those outside the organization.
In the case of Enron, both Jeffery Skilling and Andy Fastow were of the Entrepreneurial frame of mind. As long as they produced ever growing revenues for the Company, Ken Lay, the Enron Board, Arthur Anderson partners working in effect for Enron, and others loyal to the company had no complaints and rewarded them with high compensation and discretionary power. The conflict of interest rule was waived for Fastow so that he could be even more entrepreneurial for both himself and Enron.
In the companies that promoted the sub-prime mortgage bubble, the CDOs that derived from those mortgages, and the credit default swaps that were to give added security to those CDOs, Entrepreneurs and Unifiers came together with toxic consequences. Their business marriage of convenience led to a massive over-leveraging and resulting asset bubbles in housing and derivative CDOs.
Entrepreneurial mind sets kept up the deal flow for both sub-prime mortgages on more and more risky terms and CDOs which were sold in ever increasing amounts. Compensation for placement of mortgages and issuance of CDOs was fee based, an incentive system perfectly fitted to drawing out Entrepreneurial thinking and behaving in financial services.
As the asset bubble was growing and fees were being earned, Unifiers like the senior managements and boards of Merrill Lynch, Bear Sterns, Lehman Brothers, JP Morgan Chase, Citibank, AIG, etc., were loath to reign in their productive agents. Concern for the benefits to the organization trumped more strategic thinking about if and when the bubble should ever burst and prices would fall.
Largely left out of the decision-making dynamic that gave us the current economic crisis were the Inquirers and the Pragmatists. Inquirers were valued only to the extent that they could rationalize and justify with complex calculations and algorithms the deals that were being promoted by the Entrepreneurs. Pragmatists were thrown into the task of churning out more and more of the deals that could earn fees. Their reservations about the quality of what they were doing were mostly ignored.
Had the governance of these financial institutions been more evenly divided among Inquirers, Unifiers, Pragmatists, and Entrepreneurs, outcomes might well have been different.
More strategic thinking from Inquirers about long-term trends and consequences might have undercut the rush to “irrational exuberance”. More focus by Pragmatists on producing quality products that were reliable and durable would have slowed the deal flow and dampened down the accumulation of debt and the scope of the bubble in asset prices.
The possible learning from this reflection on the four decision-making tendencies highlighted by the Ethical Leadership Profile is that application of the Profile and seeking a proper balance of decision-making styles might have minimized the onset of this global crisis.
Tuesday, November 18, 2008
Thursday, October 9, 2008
Global Prosperity at Risk The Current Crisis and the Responsible Way Forward
Imprudent decisions on the part of US and European investment banks, banks, mortgage brokers, insurance companies, and consumers - all seeking profitable advantage - have brought the global financial network that sustains global capitalism to crisis.
Great American financial houses – even Lehman Brothers that survived the Great Depression of the 1930s - are no more; banks in America and Europe have been propped up by governments; and massive amounts of liquidity have been injected into the financial system by the US Federal Reserve System and other central banks.
This is not business as usual. Trillions of dollars in private wealth has been destroyed in a matter of weeks, some of it never to be regained. And governments have been forced to step in to protect the economically vulnerable where markets have failed.
Yet, ironically, inadequate regulation and government policies also contributed in various ways to risks being negligently addressed by financial markets, thereby paving the way for the current crisis.
Beyond dealing with the immediate crisis, the critical task will be to address the underlying causes through reforms to restore trust and confidence in financial markets. Functioning and sound financial institutions, despite their current failure to meet their fundamental responsibilities, remains of first importance for supporting a successful free market economy. Credit is now scarce and capitalism cannot properly function without it.
The triggers to this crisis were centered on a lack of: prudence in the extension of credit; rigor in valuations; and of transparency in management. This was compounded by the mispricing of risk via the bundling and sale of debt through collaterised debt securities and via complex derivative based credit default swaps. These failures reflected profound shortcomings in private sector governance both as prescribed and as applied. In short, risk was not appropriately managed; it was not even properly understood both by those creating it and by those bound to mitigate it.
Driving this lack of prudent management was a dysfunctional and shortsighted system of incentives and personal remuneration.
Compensation of senior executives, traders and fund managers was built on greed and self interest and was decoupled from long-term wealth creation. Compensation based on fees earned and other incentive-based benchmarks blinded otherwise intelligent managers to the long-term dire consequences of their decisions. Rewards rose with excessive risk taking and was provided in ways that has largely shielded senior corporate officers and fund managers from liability for their decisions.
As a result, the best interests of customers, owners, employees and communities have been systematically overlooked. Decision-makers, driven by short-term interests, paid too little to no attention to managing risk accumulation.
Short-term speculation dominated, with part of the market enriching itself by betting on and contributing to the destruction of wealth via short-selling. Not only did the regulators fail to halt the growth in systemic risk, some of the contributing market activity and behavior was allowed to remain unregulated.
This global financial crisis has further exacerbated the very low levels of trust which the global community places in business. The fact that the profits were in effect privatized to those who created the crisis through excessive rewards, and the losses are now being socialized to taxpayers has further outraged the community. Though justly perhaps, the shareholders of the ‘failed’ financial institutions responsible for the crisis have lost most of their ownership wealth.
This is not the first time that market capitalism has so failed. Less than a decade ago, global markets lived through the bust of the dot-com and telecom bubble in equities and the accounting scandals of Enron and World-Com. Before that, world financial markets were upset by currency collapses in Thailand, Malaysia, Indonesia and Russia. And before that, the United States lived through the savings and loan/junk bond bubble and bust.
More fundamentally, the current crisis represents the latest, albeit the most severe, fallout from the systemic erosion within the corporate world of the importance of ethics and responsibility in business decision-making. Ideological commitments to laissez-faire free market fundamentalism, social darwinism philosophies, and shareholder primacy at the expense of other stakeholders, have divorced business leadership from standards of good faith, wise stewardship and care for the public interest.
As a result, capitalism’s immune system of market discipline fails every so often and the cancer of “irrational exuberance”, greed and narrow self interest metastasizes. The object of reform, obviously, should be either to eliminate this deep cancer within capitalism once and for all or to boost society’s market immune system of accurate pricing, risk management and valuation transparency in order to keep the cancer in long-term remission.
At the core of all these market shortcomings were the boards of directors of the corporations involved. They were not sufficiently encased in an environment of accountability and transparency and ultimate accountability. The market failure, therefore, was ultimately a failure of governance.
With respect to the current crisis in financial markets, there are no clear remedies on the table. Business leaders are largely silent; academics have little to say beyond the immediate; and politicians, regulators and central banks are putting out fires. No one is focused on designing a sustainable future that removes once and for all the underlying problem.
Interestingly, the recent movement promoting corporate social responsibility via CSR standards, monitoring, reporting and ratings, has not proved adequate in preventing these failures of capitalism. It is now apparent that much of the CSR movement remains on the fringes and too removed from core of business risk management and strategy. Compounding the problem, business education has been lacking with a general absence of teachings in responsible and ethical business practices.
Uniquely, the Caux Round Table (CRT) Principles for Business provide strategic ethical guidance which, had it been followed, would have kept those institutions that have triggered the crisis more faithful to their obligations of stewardship, good governance and stakeholder risk management. The CRT Principles go to the heart of constructive and ethical behaviors that enhance risk assessment and stakeholder management, boosting bottom-line valuations of business success and sustaining responsible long-term wealth creation for society.
The way forward to free markets that are consistently reliable in their capacity for robust wealth creation is through the imposition of higher standards of good governance and transparency. Lack of good governance and transparency, again and again, leads market capitalism down wrong roads. Such opacity and lack of accountability has long been a fundamental flaw in institutions of private enterprise.
The following remedial steps to take responsible capitalism from the fringes of the business model and firmly entrench it in the heart of corporate strategy deserve priority attention:
• First, the principle of “enlightened shareholder value” should be codified in company law via non-prescriptive minimum standards for responsible decision-making and good governance. (The UK Companies Act 2006 provides an example of such legislation.)
o Directors should be required to document and defend their stewardship over company affairs via specific disclosure of:
the principle risks and uncertainties likely to affect the future development, performance and position of the company’s business; and
material risks and impacts relating to environmental matters, employees, customers, suppliers and social and community issues.
• Second, members of corporate boards should be trained corporate governance including Board oversight of the full spectrum of financial, social and business risks.
o Business is not without consequence for society and should, therefore, be attentive to the demands for responsible execution of its private office of trust and profit.
o The CRT risk assessment process of Arcturus provides an example of what can be required of companies in regard to stakeholder, social and environmental risks.
• Third, corporate boards should establish a dedicated sub-committee responsible for strategic risk consideration across the full range of stakeholder, responsibility and sustainability issues.
o The environmental, social and governance risk assessment processes and outcomes, should be subject to third party assurance.
o Boards should make annual disclosures of the material financial, environmental, social and governance risks assessment in easily understood prose that is meaningful to stakeholders.
• Fourth, executive compensation must be reformed to ensure incentives are aligned to the achievement of long-term wealth creation and reward prudent risk management rather than excessive risk taking.
• Fifth, equity and capital market regulation and taxation should be reformed to incentivize sustainable value creation and to penalize / ban market manipulation, short-selling and other value destruction.
• Sixth, derivative markets need to be regulated, including the introduction of a fully regulated exchange for credit derivatives.
• Seventh, opportunities for companies and individuals to illegally hide income by utilizing tax havens and secrecy jurisdictions should be eliminated.
These reforms will not only address the causes of the current crisis, they will have a salutary effect on a broader and longer basis. Such reforms to eliminate the underlying, systemic flaws in the system should have as an objective promotion of global social responsibility on the part of all companies.
End
Great American financial houses – even Lehman Brothers that survived the Great Depression of the 1930s - are no more; banks in America and Europe have been propped up by governments; and massive amounts of liquidity have been injected into the financial system by the US Federal Reserve System and other central banks.
This is not business as usual. Trillions of dollars in private wealth has been destroyed in a matter of weeks, some of it never to be regained. And governments have been forced to step in to protect the economically vulnerable where markets have failed.
Yet, ironically, inadequate regulation and government policies also contributed in various ways to risks being negligently addressed by financial markets, thereby paving the way for the current crisis.
Beyond dealing with the immediate crisis, the critical task will be to address the underlying causes through reforms to restore trust and confidence in financial markets. Functioning and sound financial institutions, despite their current failure to meet their fundamental responsibilities, remains of first importance for supporting a successful free market economy. Credit is now scarce and capitalism cannot properly function without it.
The triggers to this crisis were centered on a lack of: prudence in the extension of credit; rigor in valuations; and of transparency in management. This was compounded by the mispricing of risk via the bundling and sale of debt through collaterised debt securities and via complex derivative based credit default swaps. These failures reflected profound shortcomings in private sector governance both as prescribed and as applied. In short, risk was not appropriately managed; it was not even properly understood both by those creating it and by those bound to mitigate it.
Driving this lack of prudent management was a dysfunctional and shortsighted system of incentives and personal remuneration.
Compensation of senior executives, traders and fund managers was built on greed and self interest and was decoupled from long-term wealth creation. Compensation based on fees earned and other incentive-based benchmarks blinded otherwise intelligent managers to the long-term dire consequences of their decisions. Rewards rose with excessive risk taking and was provided in ways that has largely shielded senior corporate officers and fund managers from liability for their decisions.
As a result, the best interests of customers, owners, employees and communities have been systematically overlooked. Decision-makers, driven by short-term interests, paid too little to no attention to managing risk accumulation.
Short-term speculation dominated, with part of the market enriching itself by betting on and contributing to the destruction of wealth via short-selling. Not only did the regulators fail to halt the growth in systemic risk, some of the contributing market activity and behavior was allowed to remain unregulated.
This global financial crisis has further exacerbated the very low levels of trust which the global community places in business. The fact that the profits were in effect privatized to those who created the crisis through excessive rewards, and the losses are now being socialized to taxpayers has further outraged the community. Though justly perhaps, the shareholders of the ‘failed’ financial institutions responsible for the crisis have lost most of their ownership wealth.
This is not the first time that market capitalism has so failed. Less than a decade ago, global markets lived through the bust of the dot-com and telecom bubble in equities and the accounting scandals of Enron and World-Com. Before that, world financial markets were upset by currency collapses in Thailand, Malaysia, Indonesia and Russia. And before that, the United States lived through the savings and loan/junk bond bubble and bust.
More fundamentally, the current crisis represents the latest, albeit the most severe, fallout from the systemic erosion within the corporate world of the importance of ethics and responsibility in business decision-making. Ideological commitments to laissez-faire free market fundamentalism, social darwinism philosophies, and shareholder primacy at the expense of other stakeholders, have divorced business leadership from standards of good faith, wise stewardship and care for the public interest.
As a result, capitalism’s immune system of market discipline fails every so often and the cancer of “irrational exuberance”, greed and narrow self interest metastasizes. The object of reform, obviously, should be either to eliminate this deep cancer within capitalism once and for all or to boost society’s market immune system of accurate pricing, risk management and valuation transparency in order to keep the cancer in long-term remission.
At the core of all these market shortcomings were the boards of directors of the corporations involved. They were not sufficiently encased in an environment of accountability and transparency and ultimate accountability. The market failure, therefore, was ultimately a failure of governance.
With respect to the current crisis in financial markets, there are no clear remedies on the table. Business leaders are largely silent; academics have little to say beyond the immediate; and politicians, regulators and central banks are putting out fires. No one is focused on designing a sustainable future that removes once and for all the underlying problem.
Interestingly, the recent movement promoting corporate social responsibility via CSR standards, monitoring, reporting and ratings, has not proved adequate in preventing these failures of capitalism. It is now apparent that much of the CSR movement remains on the fringes and too removed from core of business risk management and strategy. Compounding the problem, business education has been lacking with a general absence of teachings in responsible and ethical business practices.
Uniquely, the Caux Round Table (CRT) Principles for Business provide strategic ethical guidance which, had it been followed, would have kept those institutions that have triggered the crisis more faithful to their obligations of stewardship, good governance and stakeholder risk management. The CRT Principles go to the heart of constructive and ethical behaviors that enhance risk assessment and stakeholder management, boosting bottom-line valuations of business success and sustaining responsible long-term wealth creation for society.
The way forward to free markets that are consistently reliable in their capacity for robust wealth creation is through the imposition of higher standards of good governance and transparency. Lack of good governance and transparency, again and again, leads market capitalism down wrong roads. Such opacity and lack of accountability has long been a fundamental flaw in institutions of private enterprise.
The following remedial steps to take responsible capitalism from the fringes of the business model and firmly entrench it in the heart of corporate strategy deserve priority attention:
• First, the principle of “enlightened shareholder value” should be codified in company law via non-prescriptive minimum standards for responsible decision-making and good governance. (The UK Companies Act 2006 provides an example of such legislation.)
o Directors should be required to document and defend their stewardship over company affairs via specific disclosure of:
the principle risks and uncertainties likely to affect the future development, performance and position of the company’s business; and
material risks and impacts relating to environmental matters, employees, customers, suppliers and social and community issues.
• Second, members of corporate boards should be trained corporate governance including Board oversight of the full spectrum of financial, social and business risks.
o Business is not without consequence for society and should, therefore, be attentive to the demands for responsible execution of its private office of trust and profit.
o The CRT risk assessment process of Arcturus provides an example of what can be required of companies in regard to stakeholder, social and environmental risks.
• Third, corporate boards should establish a dedicated sub-committee responsible for strategic risk consideration across the full range of stakeholder, responsibility and sustainability issues.
o The environmental, social and governance risk assessment processes and outcomes, should be subject to third party assurance.
o Boards should make annual disclosures of the material financial, environmental, social and governance risks assessment in easily understood prose that is meaningful to stakeholders.
• Fourth, executive compensation must be reformed to ensure incentives are aligned to the achievement of long-term wealth creation and reward prudent risk management rather than excessive risk taking.
• Fifth, equity and capital market regulation and taxation should be reformed to incentivize sustainable value creation and to penalize / ban market manipulation, short-selling and other value destruction.
• Sixth, derivative markets need to be regulated, including the introduction of a fully regulated exchange for credit derivatives.
• Seventh, opportunities for companies and individuals to illegally hide income by utilizing tax havens and secrecy jurisdictions should be eliminated.
These reforms will not only address the causes of the current crisis, they will have a salutary effect on a broader and longer basis. Such reforms to eliminate the underlying, systemic flaws in the system should have as an objective promotion of global social responsibility on the part of all companies.
End
CRT Principles for Business and the Financial Crisis of 2008
The best test of a principle, perhaps, lies in its effects, not always in its aspirations. Does it lead to constructive action? Can it influence and shape behaviors for the better, especially dysfunctional behaviors?
On the one hand we can judge the quality of a principle according to a moral calculus of abstract standards of right and wrong. But, on the other hand, we can also assess the practical worth of a principle by its power to achieve ethics in the field. This might be considered the inherent potential of a principle to obtain compliance with its preferences for better outcomes. As Karl Marx said in his Theses on Fuerbach, “Up to now philosophers have only interpreted the world. The point, however, is to change it.”
This seems especially relevant in the arena of corporate responsibility and business ethics.
Overcoming the functionality of greed and short-term self-interest is the goal of those who promote responsible decision-making in business. And a daunting task they have.
The Caux Round Table published a set of ethical principles for business in 1994, the first such set of principles for guidance of global business and the only set of such principles yet designed by experienced business leaders.
The current massive disruption of financial markets initially brought on by the collapse of the sub-prime mortgage market in the United States provides an opportunity to assess the relevance of the CRT Principles for Business.
weIf they had been followed, are there reasonable grounds to believe that the crisis could have been avoided, or at least mitigated in scope and intensity?
I think the answer is, yes, the CRT Principles might have made a difference had they been infused in strategic and tactical decisions on the part of those financial institutions which contributed to the current crisis.
First, let us consider the implications of the first CRT Principle for Business:
“The value of a business to society is the wealth and employment it creates and the marketable products and services it provides to consumers at a reasonable price commensurate with quality. To create such value, a business must maintain its own economic health and viability …”
Since the crisis is about the failure of major financial houses and banks such as Bear Sterns and Lehman Brothers, the sale of others such as Merrill Lynch and Washington Mutual, and the government rescue of Freddie Mac, Fannie Mae, AIG, Fortis, and others, we can quite quickly conclude that these companies failed to meet the ethical requirement of maintaining their own economic health and viability.
Their decision-making was wrong-headed in the accumulation of too much debt and in setting imprudent values on certain financial assets such as sub-prime home mortgages and CDOs. In their collapse, these firms caused a contraction of markets, thus erasing wealth and employment in violation of what the CRT advocates as the primary obligation of business firms.
Second, the current crisis was caused by a failure to provide quality products at a price commensurate with their inherent worth.
Sub-prime mortgages were priced inappropriately for many borrowers. Excessive and imprudent borrowings were offered to home owners. In the many cases where credit standards were waived or overlooked lenders and mortgage brokers knew or should have known as professionals that the borrowers were highly likely to default if economic conditions changed.
Borrowers were effectively sold defective financial products. Such mortgages were also sold in excessive quantities, creating an asset bubble that gave rise to perverse incentives on the part of home buyers to assume unreasonable risks of future default and foreclosure.
Similarly, the terms of many CDOs sold were not of the value that was represented to buyers. They carried more risk than was reasonable for the investment goals of those who purchased them. They were also issued in excessive amounts that undermined their long-term value.
This requirement to serve customers with respect for their needs is reinforced in Section 3 of the CRT Principles for Business with the requirement that businesses “provide their customers with the highest quality products and services consistent with their requirements.”
The first CRT Principle also holds that:
“Businesses have a role to play in improving the lives of all their customers, employees, and shareholders by sharing with them the wealth they have created.”
Here has been the greatest harm done by those who create the unsustainable markets in sub-prime mortgages and CDOs – they destroyed wealth and made worse the lives of many customers, employees, owners, creditors and communities.
Principle No. Three of the CRT Principles holds that:
“… businesses should recognize that sincerity, candor, truthfulness, the keeping of promises, and transparency contribute not only to their own credibility and stability but also to the smoothness and efficiency of business transactions, particularly on the international level.”
The current crisis in financial markets was caused by a lack of sufficient transparency in CDOs valuations which eventually undermined the smoothness and efficiency of international markets for credit and liquidity.
Principle No. Four of the CRT Principles holds that:
“[Businesses] should recognize that some behavior, though legal, may still have adverse consequences.”
It appears that in general, the provision of the financial products that gave rise to the crisis was legal. No laws were violated in lending to sub-prime borrowers or securitizing those mortgages and selling off interests in them through CDOs and in providing guarantees of payment through credit default swaps. Individuals here and there are being investigated for fraud in the sale of such products, but the products themselves were legitimate in concept. What went wrong was selling them to excess on unsustainable terms. That behavior, though legal, had adverse consequences that should have been foreseen and avoided.
With respect to their owners, those responsible for the credit crisis failed to meet other responsibilities set forth in the CRT Principles for Business. For example, they failed to “apply professional and diligent management” and to “conserve, protect and increase the owner’s/investors assets”. These failures lay at the heart of the dynamic that caused the crisis. There was strategically poor judgment exercised in the development of these markets. Risk was exacerbated to the point of destabilization; it was not properly foreseen or managed.
And, finally, those who caused this crisis failed to meet the CRT standard of enhancing community environments and standards of living. Where homes go into default when mortgages can’t be paid, communities suffer disinvestment and even blight as home prices fall and homes are abandoned to the lenders.
Had the boards of directors and senior managers of Bear Sterns, Lehman Brothers, Merrill Lynch, Citibank, Morgan Stanley, Goldman Sachs, Washington Mutual, Freddie Mac, Fannie Mae, and others who thrived for a while off the issuance of sub-prime mortgages and CDOs taken their CRT responsibilities more seriously – and insisted on products and sales strategies consistent with those practices – there would have been less risk injected into the global financial system and less provision of unsustainable financial products.
As I wrote a few years ago in Moral Capitalism, “Directors and corporate officers are hired to be agents not just for their fidelity but also for their skill. Their responsibility is to guard against high risk and imprudent courses of action.”
In that book, I also pointed to the intertwining of interdependencies and the need for trust in transactions. Capitalism breeds interdependencies through the specialization of function and the division of labor. Reliance and trust are essential for capitalism to thrive. Destruction of either leads to trouble in markets. People lose confidence and withhold their ideas, labor, and capital from productive exchange. The economy then contracts. That is what is happening now. The current crisis is really only a crisis of confidence; trust has been lost.
But how do you restore trust when it has been abused?
I wrote in Moral Capitalism that “where mistrust prevails, people fear entering into dependency relationships. Mistrust always raises the risks of enterprise. Who would invest where risks are excessive and returns uncertain?”
This dynamic explains the collapse of value in Bear Sterns, Lehman Brothers and Washington Mutual – they had billions of dollars of assets on their books but no one wanted to buy their shares. The value of Bear Sterns was $80 per share on the books, but only $2 per share in the market. Lehman Brothers went bankrupt and its owners could not realize the value of the company’s book assets as no one wanted to buy those assets encumbered as they were by debt and uncertainty.
I also noted in Moral Capitalism the sometimes negative effect of desire for money. “The interest of owners and investors in making money introduces a challenge to moral capitalism. Money is easily idolized, provoking heresy by turning us away from the things of God to the things of Mammon. There are times when we may sell our souls to gain what money promises in way of power and license. This is especially true in today’s culture of consumerism, where we have sanctified appetite over character.”
How much did this dynamic contribute to the current crisis?
I close these thoughts with a quote from an ancient Chinese text, the Annals of Lu Bu Wei, who wrote about 250 BCE
“In making judgments, the early kings were perfect, because they made moral principles the starting point of all their undertakings and the root of every thing that was beneficial. This principle, however, is something that persons of mediocre intellect never grasp. Not grasping it, they lack awareness, and lacking awareness, they pursue profit. But while they pursue profit, it is absolutely impossible for them to be certain of attaining it.”
On the one hand we can judge the quality of a principle according to a moral calculus of abstract standards of right and wrong. But, on the other hand, we can also assess the practical worth of a principle by its power to achieve ethics in the field. This might be considered the inherent potential of a principle to obtain compliance with its preferences for better outcomes. As Karl Marx said in his Theses on Fuerbach, “Up to now philosophers have only interpreted the world. The point, however, is to change it.”
This seems especially relevant in the arena of corporate responsibility and business ethics.
Overcoming the functionality of greed and short-term self-interest is the goal of those who promote responsible decision-making in business. And a daunting task they have.
The Caux Round Table published a set of ethical principles for business in 1994, the first such set of principles for guidance of global business and the only set of such principles yet designed by experienced business leaders.
The current massive disruption of financial markets initially brought on by the collapse of the sub-prime mortgage market in the United States provides an opportunity to assess the relevance of the CRT Principles for Business.
weIf they had been followed, are there reasonable grounds to believe that the crisis could have been avoided, or at least mitigated in scope and intensity?
I think the answer is, yes, the CRT Principles might have made a difference had they been infused in strategic and tactical decisions on the part of those financial institutions which contributed to the current crisis.
First, let us consider the implications of the first CRT Principle for Business:
“The value of a business to society is the wealth and employment it creates and the marketable products and services it provides to consumers at a reasonable price commensurate with quality. To create such value, a business must maintain its own economic health and viability …”
Since the crisis is about the failure of major financial houses and banks such as Bear Sterns and Lehman Brothers, the sale of others such as Merrill Lynch and Washington Mutual, and the government rescue of Freddie Mac, Fannie Mae, AIG, Fortis, and others, we can quite quickly conclude that these companies failed to meet the ethical requirement of maintaining their own economic health and viability.
Their decision-making was wrong-headed in the accumulation of too much debt and in setting imprudent values on certain financial assets such as sub-prime home mortgages and CDOs. In their collapse, these firms caused a contraction of markets, thus erasing wealth and employment in violation of what the CRT advocates as the primary obligation of business firms.
Second, the current crisis was caused by a failure to provide quality products at a price commensurate with their inherent worth.
Sub-prime mortgages were priced inappropriately for many borrowers. Excessive and imprudent borrowings were offered to home owners. In the many cases where credit standards were waived or overlooked lenders and mortgage brokers knew or should have known as professionals that the borrowers were highly likely to default if economic conditions changed.
Borrowers were effectively sold defective financial products. Such mortgages were also sold in excessive quantities, creating an asset bubble that gave rise to perverse incentives on the part of home buyers to assume unreasonable risks of future default and foreclosure.
Similarly, the terms of many CDOs sold were not of the value that was represented to buyers. They carried more risk than was reasonable for the investment goals of those who purchased them. They were also issued in excessive amounts that undermined their long-term value.
This requirement to serve customers with respect for their needs is reinforced in Section 3 of the CRT Principles for Business with the requirement that businesses “provide their customers with the highest quality products and services consistent with their requirements.”
The first CRT Principle also holds that:
“Businesses have a role to play in improving the lives of all their customers, employees, and shareholders by sharing with them the wealth they have created.”
Here has been the greatest harm done by those who create the unsustainable markets in sub-prime mortgages and CDOs – they destroyed wealth and made worse the lives of many customers, employees, owners, creditors and communities.
Principle No. Three of the CRT Principles holds that:
“… businesses should recognize that sincerity, candor, truthfulness, the keeping of promises, and transparency contribute not only to their own credibility and stability but also to the smoothness and efficiency of business transactions, particularly on the international level.”
The current crisis in financial markets was caused by a lack of sufficient transparency in CDOs valuations which eventually undermined the smoothness and efficiency of international markets for credit and liquidity.
Principle No. Four of the CRT Principles holds that:
“[Businesses] should recognize that some behavior, though legal, may still have adverse consequences.”
It appears that in general, the provision of the financial products that gave rise to the crisis was legal. No laws were violated in lending to sub-prime borrowers or securitizing those mortgages and selling off interests in them through CDOs and in providing guarantees of payment through credit default swaps. Individuals here and there are being investigated for fraud in the sale of such products, but the products themselves were legitimate in concept. What went wrong was selling them to excess on unsustainable terms. That behavior, though legal, had adverse consequences that should have been foreseen and avoided.
With respect to their owners, those responsible for the credit crisis failed to meet other responsibilities set forth in the CRT Principles for Business. For example, they failed to “apply professional and diligent management” and to “conserve, protect and increase the owner’s/investors assets”. These failures lay at the heart of the dynamic that caused the crisis. There was strategically poor judgment exercised in the development of these markets. Risk was exacerbated to the point of destabilization; it was not properly foreseen or managed.
And, finally, those who caused this crisis failed to meet the CRT standard of enhancing community environments and standards of living. Where homes go into default when mortgages can’t be paid, communities suffer disinvestment and even blight as home prices fall and homes are abandoned to the lenders.
Had the boards of directors and senior managers of Bear Sterns, Lehman Brothers, Merrill Lynch, Citibank, Morgan Stanley, Goldman Sachs, Washington Mutual, Freddie Mac, Fannie Mae, and others who thrived for a while off the issuance of sub-prime mortgages and CDOs taken their CRT responsibilities more seriously – and insisted on products and sales strategies consistent with those practices – there would have been less risk injected into the global financial system and less provision of unsustainable financial products.
As I wrote a few years ago in Moral Capitalism, “Directors and corporate officers are hired to be agents not just for their fidelity but also for their skill. Their responsibility is to guard against high risk and imprudent courses of action.”
In that book, I also pointed to the intertwining of interdependencies and the need for trust in transactions. Capitalism breeds interdependencies through the specialization of function and the division of labor. Reliance and trust are essential for capitalism to thrive. Destruction of either leads to trouble in markets. People lose confidence and withhold their ideas, labor, and capital from productive exchange. The economy then contracts. That is what is happening now. The current crisis is really only a crisis of confidence; trust has been lost.
But how do you restore trust when it has been abused?
I wrote in Moral Capitalism that “where mistrust prevails, people fear entering into dependency relationships. Mistrust always raises the risks of enterprise. Who would invest where risks are excessive and returns uncertain?”
This dynamic explains the collapse of value in Bear Sterns, Lehman Brothers and Washington Mutual – they had billions of dollars of assets on their books but no one wanted to buy their shares. The value of Bear Sterns was $80 per share on the books, but only $2 per share in the market. Lehman Brothers went bankrupt and its owners could not realize the value of the company’s book assets as no one wanted to buy those assets encumbered as they were by debt and uncertainty.
I also noted in Moral Capitalism the sometimes negative effect of desire for money. “The interest of owners and investors in making money introduces a challenge to moral capitalism. Money is easily idolized, provoking heresy by turning us away from the things of God to the things of Mammon. There are times when we may sell our souls to gain what money promises in way of power and license. This is especially true in today’s culture of consumerism, where we have sanctified appetite over character.”
How much did this dynamic contribute to the current crisis?
I close these thoughts with a quote from an ancient Chinese text, the Annals of Lu Bu Wei, who wrote about 250 BCE
“In making judgments, the early kings were perfect, because they made moral principles the starting point of all their undertakings and the root of every thing that was beneficial. This principle, however, is something that persons of mediocre intellect never grasp. Not grasping it, they lack awareness, and lacking awareness, they pursue profit. But while they pursue profit, it is absolutely impossible for them to be certain of attaining it.”
Momento Mori: on Wall Street’s Death by Negligence
What we have known as "Wall Street" is now stunningly no more.
Manhattan’s great investment banks are gone. The last two – Goldman Sachs and Morgan Stanley - are converting into banks, submitting to more intrusive government regulation in return for more secure sources of capital.
Communism couldn't kill this Wall Street; capitalism, however, did. Adam Smith won out over Karl Marx.
This "Wall Street" died at its own hands in a form of negligent suicide. It lived by the sword of extreme market capitalism and died by that same sword. It overdosed on toxic behaviors as did John Beluchi, Jimi Hendrix, Janis Joplin, and Jim Morrison.
The epitaph, I suppose, for "Wall Street’s" mighty rise and astonishing fall should be "Sic Transit Gloria Mundi" - "thus passeth worldly glory".
Street talk for what killed Wall Street’s investment bank titans is that it was “greed” that did them in. As in a Greek tragedy, excess and hubris worked through a cycle of boom and bust to humble even the best and the brightest. It’s an old story, really, new in its techniques of subprime mortgages, CDOs, and credit default swaps, but very old in its moral fundamentals.
But I don’t think it was greed precisely that was the cause of the losses and bankruptcies.
Greed - understood as seeking a profit, as pursuing one’s interest in business transactions – has not always been so terribly dysfunctional and hurtful to the common good. Indeed most of our modern life was devised, produced, distributed and sold by capitalist behaviors and motivations. There was a baby in Wall Street’s bathwater to be sure.
Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Sterns and their predecessors brought companies to life by raising capital for them. America’s growth and resulting economic well-being rested on robust capital markets. Without them there would have been no railroads, steel mills, General Motors, Ford, Boeing, Microsoft, or all the other Fortune 1,000 and smaller companies that ever sold stock or debt securities to finance their businesses.
So what went wrong? When did this “Wall Street” of once sound investment banking houses start walking on the wild side towards perdition?
The short answer is too much leverage – too much debt. Lehman Brothers, as an example, was leveraged 30 to 1 when it failed. When its chickens came home to roost in questions about how it was going to pay off its debt as the market turned sour, Lehman had insufficient capital of its own to be credibly self-reliant in down markets.
This answer raises a further question: why the need for so much leverage?
The answer to this question gets us closer to the culprit. Lehman wanted to buy securities and other tradable assets to resell them for a profit. It borrowed money to buy assets. It was not raising capital for other companies and taking a fee for the service. That was the traditional role for investment banks. No, Lehman had become a big trader on its own account as well. Lehman and the other investment banks were buying and selling any number of assets – short sales, currencies, options, puts and calls, stocks, bonds, many sorts of derivatives – to speculate on price movements.
When done well, such trading earned huge returns and permitted lavish bonuses and life styles on the part of its owners and employees.
The point to note is that trading is not real investing. It is playing in the space left open by other buyers and sellers. Trading is short term; it is not designed to hold rights to the income or the capital appreciation of companies over the long haul. The time frame for trading is “right now”.
Trading is not a special, distinct part of capitalism with its genius for engineering modern economic growth. Trading has been with us since the dawn of time. Markets predate capitalism by millennia. Capitalism is a recent evolution in human social practices, substantially starting in Holland and England only in the 1600’s.
In the ancient Chinese state of Qi before the time of Confucius, there was a famous Prime Minister, Quan Zi. His lord, Duke Huan, loved purple cloth but grew annoyed when the price for such beautiful cloth rose too high even for him. A shrewd judge of human nature, Quan Zi advised his Duke as follows: since the dye used to make the cloth purple left a smell, the next time someone approached the Duke wearing purple clothes, the Duke should hold his nose as if the smell was repugnant to him. The Duke did so and all the courtiers, suddenly fearful of offending the Duke by wearing purple, sold all their purple clothes. The price of purple cloth in the markets of Qi immediately dropped. Quan Zi bought up all the purple cloth for a song and gave it to his now very happy Lord.
Such trading in markets has a long history throughout human history. But capitalism seeks patient capital to invest over the long haul in companies that need the cash for working capital, wages, raw materials, plant, equipment, etc. For capitalism to succeed, the right kind of investment capital markets is very necessary. But it must be a market that attracts investment, not speculation. A market in speculation is a casino.
From the beginning of capitalism, old trading habits were brought over to finance and trade the new possibilities created by the new, emerging economic system. But trading habits loosed inside capitalism have been disruptive.
The first boom and bust irrational exuberance in capitalism was the tulip mania in Holland in the early 1600’s. That mania for buying tulip bulbs was not systematically different in its origins, dynamics or eventual losses from our current boom/bust cycle in buying certain financial products.
Trading and investing thrive on different and inconsistent incentives. Traders like to take a fee from every trade; investors look to dividends and the sale of appreciated ownership shares as a company becomes successful in its business for their returns.
Trading is akin to speculation: you pay money for a chance to win. You don’t always win so your winnings over time need to compensate for your losses and the risks associated with the gambles taken. Trading and speculation are inherently short term and limited in their consideration of consequences. Their spirit is at odds with the motivations and perseverance needed to grow a business.
Capital markets exist to accommodate traders and trading in financial instruments. Investment capital is raised by selling equity and debt contracts. We can’t, as far as I can tell, eliminate trading from capitalism. Providers of capital and companies need the liquidity which the ability to sell into a robust market of buyers permits; trading sets prices, which give vital information on values and trends, successes and failures.
But the goose that lays the golden eggs is not one that lives on trading alone. Firms need patient capital - investors, not speculators renting stock for a while in order to profit from market movements. Speculators can easily divert management’s attention away from long term strategies to short term manipulations of stock prices.
The most important role of financial intermediaries is to provide capital; therefore, short term trading in capital contracts should be subordinate to the mission of finding ways to raise money for companies so that they can create jobs, products and services – and, in consequence, the precious commodity of real economic growth.
From here on out, I suggest, that financial markets be so structured that trading beyond a certain band is burdened with responsibilities that will reduce the appeal of more and more speculative trading and so bring incentives in financial markets back to the provision of patient capital.
We need a trading regime that performs useful services without spinning out of control and throwing us into spasms of wasteful excess.
We might want to consider having different kinds of markets – one for trading and one for investing, or pricing arrangements that add to the purchase price of the trade as the risk associated with each new, incremental trade gets bigger and bigger. If risk were properly priced, the demand for financial instruments would contract as risk conditions change adversely given the growth of excessive supply. Too much supply financed with debt leads to a boom, which sets us up for the ensuing bust.
But, this strategy would require taking into account up front all the external consequences – both positive and negative - for consumers, society, workers, lenders, investors, suppliers, government – that will flow from the activities funded by the extension of credit.
Manhattan’s great investment banks are gone. The last two – Goldman Sachs and Morgan Stanley - are converting into banks, submitting to more intrusive government regulation in return for more secure sources of capital.
Communism couldn't kill this Wall Street; capitalism, however, did. Adam Smith won out over Karl Marx.
This "Wall Street" died at its own hands in a form of negligent suicide. It lived by the sword of extreme market capitalism and died by that same sword. It overdosed on toxic behaviors as did John Beluchi, Jimi Hendrix, Janis Joplin, and Jim Morrison.
The epitaph, I suppose, for "Wall Street’s" mighty rise and astonishing fall should be "Sic Transit Gloria Mundi" - "thus passeth worldly glory".
Street talk for what killed Wall Street’s investment bank titans is that it was “greed” that did them in. As in a Greek tragedy, excess and hubris worked through a cycle of boom and bust to humble even the best and the brightest. It’s an old story, really, new in its techniques of subprime mortgages, CDOs, and credit default swaps, but very old in its moral fundamentals.
But I don’t think it was greed precisely that was the cause of the losses and bankruptcies.
Greed - understood as seeking a profit, as pursuing one’s interest in business transactions – has not always been so terribly dysfunctional and hurtful to the common good. Indeed most of our modern life was devised, produced, distributed and sold by capitalist behaviors and motivations. There was a baby in Wall Street’s bathwater to be sure.
Goldman Sachs, Morgan Stanley, Merrill Lynch, Bear Sterns and their predecessors brought companies to life by raising capital for them. America’s growth and resulting economic well-being rested on robust capital markets. Without them there would have been no railroads, steel mills, General Motors, Ford, Boeing, Microsoft, or all the other Fortune 1,000 and smaller companies that ever sold stock or debt securities to finance their businesses.
So what went wrong? When did this “Wall Street” of once sound investment banking houses start walking on the wild side towards perdition?
The short answer is too much leverage – too much debt. Lehman Brothers, as an example, was leveraged 30 to 1 when it failed. When its chickens came home to roost in questions about how it was going to pay off its debt as the market turned sour, Lehman had insufficient capital of its own to be credibly self-reliant in down markets.
This answer raises a further question: why the need for so much leverage?
The answer to this question gets us closer to the culprit. Lehman wanted to buy securities and other tradable assets to resell them for a profit. It borrowed money to buy assets. It was not raising capital for other companies and taking a fee for the service. That was the traditional role for investment banks. No, Lehman had become a big trader on its own account as well. Lehman and the other investment banks were buying and selling any number of assets – short sales, currencies, options, puts and calls, stocks, bonds, many sorts of derivatives – to speculate on price movements.
When done well, such trading earned huge returns and permitted lavish bonuses and life styles on the part of its owners and employees.
The point to note is that trading is not real investing. It is playing in the space left open by other buyers and sellers. Trading is short term; it is not designed to hold rights to the income or the capital appreciation of companies over the long haul. The time frame for trading is “right now”.
Trading is not a special, distinct part of capitalism with its genius for engineering modern economic growth. Trading has been with us since the dawn of time. Markets predate capitalism by millennia. Capitalism is a recent evolution in human social practices, substantially starting in Holland and England only in the 1600’s.
In the ancient Chinese state of Qi before the time of Confucius, there was a famous Prime Minister, Quan Zi. His lord, Duke Huan, loved purple cloth but grew annoyed when the price for such beautiful cloth rose too high even for him. A shrewd judge of human nature, Quan Zi advised his Duke as follows: since the dye used to make the cloth purple left a smell, the next time someone approached the Duke wearing purple clothes, the Duke should hold his nose as if the smell was repugnant to him. The Duke did so and all the courtiers, suddenly fearful of offending the Duke by wearing purple, sold all their purple clothes. The price of purple cloth in the markets of Qi immediately dropped. Quan Zi bought up all the purple cloth for a song and gave it to his now very happy Lord.
Such trading in markets has a long history throughout human history. But capitalism seeks patient capital to invest over the long haul in companies that need the cash for working capital, wages, raw materials, plant, equipment, etc. For capitalism to succeed, the right kind of investment capital markets is very necessary. But it must be a market that attracts investment, not speculation. A market in speculation is a casino.
From the beginning of capitalism, old trading habits were brought over to finance and trade the new possibilities created by the new, emerging economic system. But trading habits loosed inside capitalism have been disruptive.
The first boom and bust irrational exuberance in capitalism was the tulip mania in Holland in the early 1600’s. That mania for buying tulip bulbs was not systematically different in its origins, dynamics or eventual losses from our current boom/bust cycle in buying certain financial products.
Trading and investing thrive on different and inconsistent incentives. Traders like to take a fee from every trade; investors look to dividends and the sale of appreciated ownership shares as a company becomes successful in its business for their returns.
Trading is akin to speculation: you pay money for a chance to win. You don’t always win so your winnings over time need to compensate for your losses and the risks associated with the gambles taken. Trading and speculation are inherently short term and limited in their consideration of consequences. Their spirit is at odds with the motivations and perseverance needed to grow a business.
Capital markets exist to accommodate traders and trading in financial instruments. Investment capital is raised by selling equity and debt contracts. We can’t, as far as I can tell, eliminate trading from capitalism. Providers of capital and companies need the liquidity which the ability to sell into a robust market of buyers permits; trading sets prices, which give vital information on values and trends, successes and failures.
But the goose that lays the golden eggs is not one that lives on trading alone. Firms need patient capital - investors, not speculators renting stock for a while in order to profit from market movements. Speculators can easily divert management’s attention away from long term strategies to short term manipulations of stock prices.
The most important role of financial intermediaries is to provide capital; therefore, short term trading in capital contracts should be subordinate to the mission of finding ways to raise money for companies so that they can create jobs, products and services – and, in consequence, the precious commodity of real economic growth.
From here on out, I suggest, that financial markets be so structured that trading beyond a certain band is burdened with responsibilities that will reduce the appeal of more and more speculative trading and so bring incentives in financial markets back to the provision of patient capital.
We need a trading regime that performs useful services without spinning out of control and throwing us into spasms of wasteful excess.
We might want to consider having different kinds of markets – one for trading and one for investing, or pricing arrangements that add to the purchase price of the trade as the risk associated with each new, incremental trade gets bigger and bigger. If risk were properly priced, the demand for financial instruments would contract as risk conditions change adversely given the growth of excessive supply. Too much supply financed with debt leads to a boom, which sets us up for the ensuing bust.
But, this strategy would require taking into account up front all the external consequences – both positive and negative - for consumers, society, workers, lenders, investors, suppliers, government – that will flow from the activities funded by the extension of credit.
Thursday, September 18, 2008
Lehman Brothers, Merrill Lynch, AIG - what might it all mean?
Markets are unforgiving; they expose truth and drive out chaff. As the Tao Te Ching says of Heaven itself, markets “treat all things as straw dogs”. They have no emotions, shedding no tears for losers and taking no pride in winners, for today’s winner may be tomorrow’s loser. And, markets refuse to subsidize idealisms.
Over time, free markets reject fraud, abandon products that have no sound purpose or accommodating price, and undermine false or misleading valuations.
That Bear Sterns with balance sheet assets worth $80 pre share was sold for $2 and then for $10 per share, that Lehman Brothers with billions in assets nonetheless went bankrupt, wiping out owner’s equity, and that Enron as an enterprise was gone within months of revelation regarding its true debt obligations and real income flows, testify to the cruel discipline of markets at work.
True, markets create liquidity and asset bubbles; but then they turn and destroy them if they are bubbles. Bubbles can’t last forever. Only well-supported valuations are sustainable.
It is better, I think, to say that market makers create bubbles and also that market makers break bubbles. Perhaps market makers are more irresponsible in making than in breaking bubbles for the breaking can only occur if bubbles have been created. And, the breaking gets us back closer to the reality of sustainable values, a salutary step towards truth.
But, in the breaking of bubbles, people get hurt as we see happen all around us in the continued destruction of wealth and value flowing from the subprime mortgage/CDO/credit default swap bubble and bust of the past 5 years.
The teaching of market makers when they lose faith in valuations and so refuse to buy more at that price, or sell to unload risk, or suddenly refuse to extend credit or guarantee an obligation, is that the valuations at play in the market have become unreliable. Prices will thereafter drop until valuations become more acceptable.
The bubble stretches credulity about valuations (“irrational exuberance” some call it) until confidence is lost and the search for “quality” and security begins.
So, in some sense the current crisis of American financial institutions is necessary and just. It is correcting a past injustice. Only, the pain of correction does not fall fairly on those who made the mistakes in the first place. They have most likely taken the money and run.
Prices go down, wealth is un-created, and the economy contracts. People lose jobs; families suffer.
The lesson of this current financial retraction is perhaps keener still. It may be telling us that the share of global cash flows appropriated by the financial services industry in general was excessive and unsustainable.
The value of the mortgage brokers, the investment banks, insurance companies like AIG, depended on their making hay while the cash was flowing. High fees, charges for all kinds of intermediation, huge bonuses, were converted into capital values. But such substantial and systematic extraction of commissions from the economy could not last if the financial intermediaries collectively were not providing real value-added to investors and players in the real economy.
And, perhaps the failed Wall Street intermediaries were not contributing enough to justify their returns. So, losing them – in the long run – is just treating them like “straw dogs” - useless playthings that will burn and disappear.
Some coldness is required to let companies and their fortunes decline and fade away as casualties of poor risk management and imprudent forethought.
Over time, market makers turn to second thoughts about values, then to third thoughts, and then to an endless series of different thoughts. It takes real worth to survive all these market-maker changes of attitude and desire more or less intact as Goldman Sachs and Morgan Stanley seemed to have done. Though they too were shopping themselves to avoid liquidation and loss of equity for their owners.
But the un-creation of value is not what we want from free markets and capitalism. We should hold the system and its leaders to the powerful capitalist standard of wealth creation on a grand scale so that the positive synergies of investment and production will flow throughout the economy improving lives for all.
The first Principle of the Caux Round Table Principles for Business sets this standard:
the purpose of a business is to create wealth, not destroy it. Other CRT Principles and stakeholder considerations add ethical obligations to the manner in which such wealth is to be created and its benefits distributed.
I would assert that the titans of financial intermediation which took the lead in building the investment bubble in subprime mortgages and subordinate contracts did not live up to this CRT ethical principle. Had they done so, the bubble would have been smaller and so its bursting would have caused less harm to society and far fewer financial losses to investors and owners.
If the CRT Principles for Business are to be assiduously implemented, there should be no bubbles at all – not ever - just a sustainable rise in valuations as a rising tide floats all boats. Such a sustainable rise would rest on sound, real value-adding, business activities of tangible, non-illusory benefit to stakeholders.
Over time, free markets reject fraud, abandon products that have no sound purpose or accommodating price, and undermine false or misleading valuations.
That Bear Sterns with balance sheet assets worth $80 pre share was sold for $2 and then for $10 per share, that Lehman Brothers with billions in assets nonetheless went bankrupt, wiping out owner’s equity, and that Enron as an enterprise was gone within months of revelation regarding its true debt obligations and real income flows, testify to the cruel discipline of markets at work.
True, markets create liquidity and asset bubbles; but then they turn and destroy them if they are bubbles. Bubbles can’t last forever. Only well-supported valuations are sustainable.
It is better, I think, to say that market makers create bubbles and also that market makers break bubbles. Perhaps market makers are more irresponsible in making than in breaking bubbles for the breaking can only occur if bubbles have been created. And, the breaking gets us back closer to the reality of sustainable values, a salutary step towards truth.
But, in the breaking of bubbles, people get hurt as we see happen all around us in the continued destruction of wealth and value flowing from the subprime mortgage/CDO/credit default swap bubble and bust of the past 5 years.
The teaching of market makers when they lose faith in valuations and so refuse to buy more at that price, or sell to unload risk, or suddenly refuse to extend credit or guarantee an obligation, is that the valuations at play in the market have become unreliable. Prices will thereafter drop until valuations become more acceptable.
The bubble stretches credulity about valuations (“irrational exuberance” some call it) until confidence is lost and the search for “quality” and security begins.
So, in some sense the current crisis of American financial institutions is necessary and just. It is correcting a past injustice. Only, the pain of correction does not fall fairly on those who made the mistakes in the first place. They have most likely taken the money and run.
Prices go down, wealth is un-created, and the economy contracts. People lose jobs; families suffer.
The lesson of this current financial retraction is perhaps keener still. It may be telling us that the share of global cash flows appropriated by the financial services industry in general was excessive and unsustainable.
The value of the mortgage brokers, the investment banks, insurance companies like AIG, depended on their making hay while the cash was flowing. High fees, charges for all kinds of intermediation, huge bonuses, were converted into capital values. But such substantial and systematic extraction of commissions from the economy could not last if the financial intermediaries collectively were not providing real value-added to investors and players in the real economy.
And, perhaps the failed Wall Street intermediaries were not contributing enough to justify their returns. So, losing them – in the long run – is just treating them like “straw dogs” - useless playthings that will burn and disappear.
Some coldness is required to let companies and their fortunes decline and fade away as casualties of poor risk management and imprudent forethought.
Over time, market makers turn to second thoughts about values, then to third thoughts, and then to an endless series of different thoughts. It takes real worth to survive all these market-maker changes of attitude and desire more or less intact as Goldman Sachs and Morgan Stanley seemed to have done. Though they too were shopping themselves to avoid liquidation and loss of equity for their owners.
But the un-creation of value is not what we want from free markets and capitalism. We should hold the system and its leaders to the powerful capitalist standard of wealth creation on a grand scale so that the positive synergies of investment and production will flow throughout the economy improving lives for all.
The first Principle of the Caux Round Table Principles for Business sets this standard:
the purpose of a business is to create wealth, not destroy it. Other CRT Principles and stakeholder considerations add ethical obligations to the manner in which such wealth is to be created and its benefits distributed.
I would assert that the titans of financial intermediation which took the lead in building the investment bubble in subprime mortgages and subordinate contracts did not live up to this CRT ethical principle. Had they done so, the bubble would have been smaller and so its bursting would have caused less harm to society and far fewer financial losses to investors and owners.
If the CRT Principles for Business are to be assiduously implemented, there should be no bubbles at all – not ever - just a sustainable rise in valuations as a rising tide floats all boats. Such a sustainable rise would rest on sound, real value-adding, business activities of tangible, non-illusory benefit to stakeholders.
Tuesday, September 16, 2008
Catholic and Muslim Moral Commonalities
How infrequently it seems that people find common ground across lines of religion, race and ethnicity. What do you suppose drives members of our species to accentuate the differences? To build walls and fight off whoever is on the “other side”.
Is this a recessive trait of primitive tribalism where the other is presumed to be taboo and a threat to our totems and our ancestors?
Even in the 21st century the fault lines within humanity are many and active: Tibet and China, Israel and Palestine, Christian and Muslim, Sunni and Shi’a, Basques and Spaniards. In the United States we have cultural trench warfare between the Blue states and the Red states. Muslim immigrants in France, many excellent speakers of French, don’t feel welcome in the land of liberty, equality and fraternity. Barach Obama’s candidacy for president in the United States only highlights the pervasive power of racism there for over 200 years. Jesus had a parable about the “good” Samaritan to set before us the issue of who deserves honor is it group loyalty or individual character?
We give privileges and rights to those we like and trust, mostly people who are like us. Modern jurisprudence gave us the concept and status of “citizen” where all who lived under a common sovereign authority were considered equal and the principle of non-discrimination would apply across the board.
Now we really can’t homogenize all humanity’s different value patterns, cultures, foods, styles of dress, modes of music, languages, senses of humor. And we shouldn’t. That would be discrimination and degradation of what is precious in individual lives. Our identities as persons are bound up in our ties to small communities of kin, religion, region, clan, trade, avocation, or what-have-you.
So how can we square the circle? How do we get to non-invidious discrimination? Can we live in paradox where differences abound but, at the same time, they aren’t really so serious as grounds for fear, suspicion, rejection, alienation, prejudice, or subordination?
Isn’t it a mark of the mature human person that wisdom and good sense prevail over thoughtless stereo-typing and self-referential standards of right and wrong?
I always like a plea of Oliver Cromwell when faced with a contumacious parliament. He exploded: “Gentlemen, I beseech thee; in the bowels of Christ, consider that ye may be mistaken.”
An admirable trait taught by so many religions is self-command and humility. Religion, which ties us to that which is more important than our own daily passions, irritations, quarrels and diversions, puts in context our tendency to think that we are more important than we are, or more righteous than reality can tolerate.
This past weekend I had the good fortune to participate in a surprising seminar at the International Institute of Islamic Thought and Civilization here in Kuala Lumpur.
In the presence of a Cardinal from the Roman Catholic Church, a number of distinguished Islamic scholars discussed with great erudition and much good humor the substance of Islamic ethics. It turned out that such Islamic ethics were really not very far from some core principles of Catholic Social Teachings.
Catholic ideas about the dignity of the human, the moral obligation to use private property responsibly, the need to trust family and social and civil organizations and not subject them to an all-powerful state, and the solidarity with others that is necessary to protect and promote their dignity resonate with many points of guidance given by the Holy Qur’an.
In our discussions it turned out that Catholic social thought and Islamic social thought are not that far apart.
This is a discovery of great importance for the world. Where we can see common concerns among different faith traditions, believers in one religion need not be so resentful of those who follow a different liturgy or read a different scripture.
In fact, both Catholics and Muslims share basically the same understanding of human purpose in that both faiths see human persons as created from God’s spirit and so animated with something transcendent in order to make this a better world.
We far short of what we are intended to perform and much suffering results from our failures to be our best. But the common teaching of both Catholics and Islam that we should aspire to do our duty as God intends could become a point of mutuality and solidarity between the faithful of both religions.
Great efforts must be made to inspire and guide humanity towards a future that will demonstrate greater submission to the fact of human dignity. But those efforts are well worth making. And the sooner the better.
Is this a recessive trait of primitive tribalism where the other is presumed to be taboo and a threat to our totems and our ancestors?
Even in the 21st century the fault lines within humanity are many and active: Tibet and China, Israel and Palestine, Christian and Muslim, Sunni and Shi’a, Basques and Spaniards. In the United States we have cultural trench warfare between the Blue states and the Red states. Muslim immigrants in France, many excellent speakers of French, don’t feel welcome in the land of liberty, equality and fraternity. Barach Obama’s candidacy for president in the United States only highlights the pervasive power of racism there for over 200 years. Jesus had a parable about the “good” Samaritan to set before us the issue of who deserves honor is it group loyalty or individual character?
We give privileges and rights to those we like and trust, mostly people who are like us. Modern jurisprudence gave us the concept and status of “citizen” where all who lived under a common sovereign authority were considered equal and the principle of non-discrimination would apply across the board.
Now we really can’t homogenize all humanity’s different value patterns, cultures, foods, styles of dress, modes of music, languages, senses of humor. And we shouldn’t. That would be discrimination and degradation of what is precious in individual lives. Our identities as persons are bound up in our ties to small communities of kin, religion, region, clan, trade, avocation, or what-have-you.
So how can we square the circle? How do we get to non-invidious discrimination? Can we live in paradox where differences abound but, at the same time, they aren’t really so serious as grounds for fear, suspicion, rejection, alienation, prejudice, or subordination?
Isn’t it a mark of the mature human person that wisdom and good sense prevail over thoughtless stereo-typing and self-referential standards of right and wrong?
I always like a plea of Oliver Cromwell when faced with a contumacious parliament. He exploded: “Gentlemen, I beseech thee; in the bowels of Christ, consider that ye may be mistaken.”
An admirable trait taught by so many religions is self-command and humility. Religion, which ties us to that which is more important than our own daily passions, irritations, quarrels and diversions, puts in context our tendency to think that we are more important than we are, or more righteous than reality can tolerate.
This past weekend I had the good fortune to participate in a surprising seminar at the International Institute of Islamic Thought and Civilization here in Kuala Lumpur.
In the presence of a Cardinal from the Roman Catholic Church, a number of distinguished Islamic scholars discussed with great erudition and much good humor the substance of Islamic ethics. It turned out that such Islamic ethics were really not very far from some core principles of Catholic Social Teachings.
Catholic ideas about the dignity of the human, the moral obligation to use private property responsibly, the need to trust family and social and civil organizations and not subject them to an all-powerful state, and the solidarity with others that is necessary to protect and promote their dignity resonate with many points of guidance given by the Holy Qur’an.
In our discussions it turned out that Catholic social thought and Islamic social thought are not that far apart.
This is a discovery of great importance for the world. Where we can see common concerns among different faith traditions, believers in one religion need not be so resentful of those who follow a different liturgy or read a different scripture.
In fact, both Catholics and Muslims share basically the same understanding of human purpose in that both faiths see human persons as created from God’s spirit and so animated with something transcendent in order to make this a better world.
We far short of what we are intended to perform and much suffering results from our failures to be our best. But the common teaching of both Catholics and Islam that we should aspire to do our duty as God intends could become a point of mutuality and solidarity between the faithful of both religions.
Great efforts must be made to inspire and guide humanity towards a future that will demonstrate greater submission to the fact of human dignity. But those efforts are well worth making. And the sooner the better.
Monday, September 1, 2008
thoughts in the Roman Forum
Last Friday and Saturday I was in Rome. Not Rome New York, but the real Rome, the original Rome, the Rome that gave us so much of Western Civilization from words like “republic” and “senate” to the traditions of the Holy Roman Catholic Church.
CRT Chair Lord Brennan and I were there to call on Jean Paul Cardinal Tauran, the president of the Pontifical Council on Inter-religious Dialogue. A member of our World Advisory Council, Theodore Cardinal McCarrick had suggested the meeting so that we might brief the Council on our very exciting and constructive work on Qur’anic guidance for good governance with scholars at the International Islamic University Malaysia.
After our call on the Cardinal, John Dalla Costa very kindly came down from Tuscany where he is writing so that we could visit and catch up. John has been very helpful to the CRT and has written wonderfully insightful books on ethics and business.
John took me to see a bronze statute of St Francis of Assizi near the Basilica of St John in the Lateran. Then we went to walk around the old Forum of Rome. John wanted to see the mural on the Arch of Titus where Roman soldiers after sacking Jerusalem are marching off with a sacred menorah. We reflected on all the sadness that has flown from that event, down to today’s bitterness, violence, and intransigence in the Holy Land.
We walked along the Via Sacra towards the Capitoline hill and stood by the Senate building. We walked where Cicero had walked and Ceasar, Pompey, Crassus, Cato, Brutus and Mark Antony too. In that building Cicero had called out Catiline and delivered his damning speeches on Antony’s brutal vulgarity and excessively covetous ambition.
We stood where, the story goes, Ceasar’s body was burned and riots broke out seeking vengeance against his assassins.
We stood where the Roman Republic was born and where it died.
Cicero in a casual letter to his friend Atticus put his finger on the cause of death. It was July 59 BC; the Republic was not yet dead, but the political cancer of military dictatorship that would finally kill it was already metastasizing among the Romans. Cicero in writing to Atticus pointed to a cultural change that opened the door to the growth of that cancer. He said that Romans were still free in their thoughts and words to criticize abuses of power, but that their “virtue was in chain” – virtutem adligatatem.
They had lost efficacious will and the resolve to stand up and do what needed to be done. The energy nourishing civic virtue was evaporating.
Loss of virtue is a disease of our time as well. The WTO can’t get agreement on elimination subsidies for agriculture; the G8 leaders can’t act on global warming; the EU is powerless in front of Russia’s hegemony over Abkazia and South Ossetia. Financial intermediaries have given us another round of turmoil, losses, and crisis in global credit markets.
Lord Brennan said to me in Rome that the developed world seems overcome by greed and the developing world by corruption.
So, how do we invigorate civic virtue? How do we keep our own personal virtue “unchained”?
The Caux Round Table can only succeed in a world where such virtue counts for something. Interest and material prosperity can only go so far as moral causes and they must, by the nature of their superficiality, fall short of giving us a foundation for genuine leadership.
Rome gave me some needed clues about the source of virtue. We get it through religion.
In the Forum John and I passed the temple of Vesta, the cult of a patroness founded by Numa Pompilius, Rome’s founding king who grounded community identity and culture on something divine. Religion, a cult, liturgy, prayers, flames guarded day and night by virgins from elite families, confidence, something to value and protect – Numa set in place a complex of reassurance, motivation, guidance through the use of religious inspiration and imagery.
So too the Athenians in their heyday had the cult of Athena in the Parthenon; Hammurabi grounded his code of laws on divine inspiration. More and more examples of similar human dynamics came to my mind as I looked at the surviving ruins of Numa’s little round temple.
Later Roman religiousity sustained the theme. Walking back to my hotel, I popped in and out of several great churches, including St Peter’s. Statues and pictures of Christian martyrs glorified in these churches somehow stood out in my mind. It was their religious faith that gave them purpose, courage and sustaining willfulness. The tomb of the founder of the Jesuit order seemed another case in point on the link between faith and dedication to service.
This conclusion is far from satisfactory. Religion is divisive; it gives rise to intolerance, to obscurantism, to the eclipse of reason and common sense; it seduces us into pride and hubris that we are righteous and select – saints chosen by our God to do his or her work here on earth.
Moreover, today, conversations about religion are uncomfortable and avoided. For some good reasons, may I add. Those who need virtue in lay and secular undertakings – say, business, politics, government, journalism, academia – are more and more cut off from public affirmation of the deepest and best source of meaning and purpose. We live with disenchantment and suffer for it.
I wonder what Cicero would recommend under the circumstances? After all, his efforts to save his republic came to naught.
CRT Chair Lord Brennan and I were there to call on Jean Paul Cardinal Tauran, the president of the Pontifical Council on Inter-religious Dialogue. A member of our World Advisory Council, Theodore Cardinal McCarrick had suggested the meeting so that we might brief the Council on our very exciting and constructive work on Qur’anic guidance for good governance with scholars at the International Islamic University Malaysia.
After our call on the Cardinal, John Dalla Costa very kindly came down from Tuscany where he is writing so that we could visit and catch up. John has been very helpful to the CRT and has written wonderfully insightful books on ethics and business.
John took me to see a bronze statute of St Francis of Assizi near the Basilica of St John in the Lateran. Then we went to walk around the old Forum of Rome. John wanted to see the mural on the Arch of Titus where Roman soldiers after sacking Jerusalem are marching off with a sacred menorah. We reflected on all the sadness that has flown from that event, down to today’s bitterness, violence, and intransigence in the Holy Land.
We walked along the Via Sacra towards the Capitoline hill and stood by the Senate building. We walked where Cicero had walked and Ceasar, Pompey, Crassus, Cato, Brutus and Mark Antony too. In that building Cicero had called out Catiline and delivered his damning speeches on Antony’s brutal vulgarity and excessively covetous ambition.
We stood where, the story goes, Ceasar’s body was burned and riots broke out seeking vengeance against his assassins.
We stood where the Roman Republic was born and where it died.
Cicero in a casual letter to his friend Atticus put his finger on the cause of death. It was July 59 BC; the Republic was not yet dead, but the political cancer of military dictatorship that would finally kill it was already metastasizing among the Romans. Cicero in writing to Atticus pointed to a cultural change that opened the door to the growth of that cancer. He said that Romans were still free in their thoughts and words to criticize abuses of power, but that their “virtue was in chain” – virtutem adligatatem.
They had lost efficacious will and the resolve to stand up and do what needed to be done. The energy nourishing civic virtue was evaporating.
Loss of virtue is a disease of our time as well. The WTO can’t get agreement on elimination subsidies for agriculture; the G8 leaders can’t act on global warming; the EU is powerless in front of Russia’s hegemony over Abkazia and South Ossetia. Financial intermediaries have given us another round of turmoil, losses, and crisis in global credit markets.
Lord Brennan said to me in Rome that the developed world seems overcome by greed and the developing world by corruption.
So, how do we invigorate civic virtue? How do we keep our own personal virtue “unchained”?
The Caux Round Table can only succeed in a world where such virtue counts for something. Interest and material prosperity can only go so far as moral causes and they must, by the nature of their superficiality, fall short of giving us a foundation for genuine leadership.
Rome gave me some needed clues about the source of virtue. We get it through religion.
In the Forum John and I passed the temple of Vesta, the cult of a patroness founded by Numa Pompilius, Rome’s founding king who grounded community identity and culture on something divine. Religion, a cult, liturgy, prayers, flames guarded day and night by virgins from elite families, confidence, something to value and protect – Numa set in place a complex of reassurance, motivation, guidance through the use of religious inspiration and imagery.
So too the Athenians in their heyday had the cult of Athena in the Parthenon; Hammurabi grounded his code of laws on divine inspiration. More and more examples of similar human dynamics came to my mind as I looked at the surviving ruins of Numa’s little round temple.
Later Roman religiousity sustained the theme. Walking back to my hotel, I popped in and out of several great churches, including St Peter’s. Statues and pictures of Christian martyrs glorified in these churches somehow stood out in my mind. It was their religious faith that gave them purpose, courage and sustaining willfulness. The tomb of the founder of the Jesuit order seemed another case in point on the link between faith and dedication to service.
This conclusion is far from satisfactory. Religion is divisive; it gives rise to intolerance, to obscurantism, to the eclipse of reason and common sense; it seduces us into pride and hubris that we are righteous and select – saints chosen by our God to do his or her work here on earth.
Moreover, today, conversations about religion are uncomfortable and avoided. For some good reasons, may I add. Those who need virtue in lay and secular undertakings – say, business, politics, government, journalism, academia – are more and more cut off from public affirmation of the deepest and best source of meaning and purpose. We live with disenchantment and suffer for it.
I wonder what Cicero would recommend under the circumstances? After all, his efforts to save his republic came to naught.
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