Business Ethics be Damned…A Receipe for Disaster Led To This Banking Bailout Bandaid!

October 16, 2008

We ain’t seen nothing yet!  As a business ethics speaker, as I write those words I feel tension building in my shoulders and neck.  Stress for sure.  But unfortunately the worst is yet to come and for many, especially younger adults, it will be the first time you will have witnessed a severe financial correction.  This will not be a mild recession but a full blown catagory 4 storm, if you will.

Recessions:

Let’s first explore a little of the history of recessions.  A great article that is simple to read an understand was written not long ago which outlines the recessions in our past and the depth of their pain in months.  A portion of that article is reprinted here for reference:

The National Bureau of Economic Research, or NBER, is considered the official arbiter of recessions, but it doesn’t define a recessions by the school book measure of two or more consecutive quarters of economic contraction as measured by GDP. It states that “a recession is a significant decline in economic activity spread across the economy, lasting more than a few months.

The last recession, so declares NBER, was from March 2001 through November 2001.   Now most of us remember that time but not because of a declared recession, but because of 9/11.  The tragedy of 9/11 was so focused that we forgot how the economy felt and where we were before then – assuming that all that happened economically was a direct result of the 9/11 incident.

Now, when a country is in a recession there is a cry from the population to get it over with an get back on the track to economic health.  That is, in essence, just what we attempted to do.  However, we got so caught up in HEALTH that we looked past practical sensible medicine and pushed too hard.

What We Did:

Just like a doctor has skill, training, and tools to help restore health, from an economic perspective so does the government along with the Federal Reserve.  So, Dr. Fed to the rescue.  Surely we could not and would not stay in this ’91 recession long.  Our pride was hurt along with our pocket books and we needed fast action.

#1 – in response to the 9/11 attacks our country went to war.  Now, within reason, up to that point there was a widespread concern about the national deficit.  However, that disappeared from the political scene, as we elected to go to war.  Do not assume I am against this action, I am looking at it, however, from an economic standpoint.  War changes perspectives and allows the government to increase spending and debt without much cry from the populous.   War increases productivity and we all witnessed many companies showing record profits.  Government spending changed dramatically – essentially an economic stimulus.

#2 – the Federal Reserve reached in its bag of goodies and began a systematic dramatic and unprecedented drop in interest rates.  Never in its history had the Fed dropped the interest rate to 1% – NEVER.  Over time it almost became “free” money.  Artificially low interest rates became a powerful economic stimulus.

#3 – not only does the Federal Reserve have the ability to set interest rates, but they also control the flow of money.  In other words, they control the printing press or just how much money is in circulation.  Another powerful tool to fight “recession” – access to money makes economic growth easier.  More money in circulation became an economic stimulus.

#4 – tax law change was also a factor that changed the face of our economic growth.  In the past when a person sold their home, they were taxed on the gain unless it was reinvested into something of equal or higher value.  In the mid nineties, that changed effectively eliminating tax on most home sale gains.  No taxes proved to be another economic stimulator.

How We Responded:

Now, while some would disagree – that is where the breech of ethics occurred. Let me us an example:  If you are a star baseball player and practice everyday – honing your skills and lifting weights, etc. in order to be your best, well that would be ethical.  Agree?  If, however, you do all of those things and take performance enhancing drugs, that would be unethical.  Agree?

How we responded was in a sense like doing all the right things, but too excess and assuming that there would be no consequence.  That assumption is unethical stupidity.

So we:

(1) took our eye off of living with a balanced budget, allowing the government to stimulate the economy through the war effort;

(2) we borrowed at a record pace (after all if there is free money wouldn’t you take it)?  We, as consumers, increased our credit card debt dramatically falling for most ever zero percent offer that was placed before us.  And, with that new found credit, we bought items that in the prior decade we might have postponed.  In fact, we believed that we didn’t have to pay the borrowed money back, all we had to do was “transfer balance” it.; and

(3) we used our homes as a credit card.  Up until then, there were reasonable rules in place for borrowing to buy a home.  But during that time, with lots of money in circulation and low rates, we were encouraged to borrow…borrow…borrow believing that our home was safe.

(4) now the straw that broke the camels back was unrealistic appreciation.  In many (not all) parts of the country we saw home prices skyrocket.  Heretofore, home prices increase at a steady 1% to 3% per year.  Our home was sacred.  Now, with double digit increases, homeowners and builders began to believe that with no taxes on the gain, there could not be a better investment.

Every choice has a consequence:

The example of the ball player up above ties into this perfectly.  If he/she had done the right things in moderation, they would have an outstanding career and perhaps make it in the baseball hall of fame.  But, once discovered for performance enhancing drugs, they would likely be banned from the sport or suffer some humiliating consequence that would cost them dearly.

That is just where we are today.  Ethically, the Fed knew better.  The economy needed to be stimulated only so much.  Those are sharp folks and I don’t believe for a minute that they could not have seen this coming.  Fairly enough, they did begin to raise rates several years ago, but by then the bubble was set to pop.  And pop it did!

Likewise, our financial institutions knew better.  You don’t make loans to people that you honestly know can’t repay them, just to turn a quick profit in order to meet analystists expectations on Wall Street.  That, to me, is unethical.  Nonetheless, it was done – DAILY!

Builders, gorged with profit, continued to build knowing that the supply was outstripping the demand based on any reasonable demographic study.  In one area in NC near Raleigh, on average 1.5 homes were sold per month, yet 6 new builders flocked to the area and began building multiple spec homes.  There were no buyers and today they sit on them – some having been on the market well over 600 days.  That is greed outstripping ethical sense.

What Now?

#1 – the government is scrambling to figure out what to do.  My prediction is the $700 Billion dollar bailout is more like $2 Trillion.  The US Government will use our money (wrong borrowed money) to buy up bad loans (doesn’t give me the warm and fuzzies inside) and they will buy equity interests into our banks.  To me that is historic – it appears almost like a nationalization of the banks -scarry…!

#2 – the Federal Reserve, will once again, lower interest rates in hopes that they will stimulate BORROWING so the economy will again move forward.  Sorry, but I don’t think we need more debt!

#3 – the housing market will see double digit declines in home prices.  What goes up must come down (at least to reasonable levels) and many home owners who bought at the top will find themselves foreclosed on and have ruined credit.

#4 – builders will go belly up and banks will be in the physical real estate business – something they no little about.

#5 – credit will freeze.  No longer will you see the “free money” ads from your credit card company.  In fact, when you pay your card off…they may reduce your credit limit – taking a more conservative approach.

#6 – Consumers faced with increased medical costs, gas costs and utility cost, will spend less and this Christmas buying season will be dismal.  Retailers will be forced out of business and the pain will be heard world wide.

#7 – many smaller banks will shut their doors with the FDIC taking them over; and

#8 – the market will go much lower than it is today.  There will be minor up turns, but the down will outweigh the up and we will see another loss of 20% before it is over.  As a result, we will be less wealthy as our retirement funds decrease.

Conclusion:

Every choice has a consequence.  We chose the route of performance enhancing programs to stimulate our economy (an unethical choice in my opinion) and today and for the near term we will face the consequences – painful as they may be.


Goldman Sachs and Morgan Stanley Survive! On The Back of Taxpayer Deposits?

September 21, 2008

Now let me state from the outset – I don’t claim to be a financial wizard, but I find it curious that in order for the last of our country’s investment banks to survive they must become – well – regular banks.

If somehow we haven’t gotten it thus far – AMERICA IS IN FINANCIAL CRISIS!  The scope of the crisis is truly unknown to the average citizen and while I am no doomsayer – it is not over.

The borderline unethical financial practices of these institutions are the root cause of their demise.  When you loan money to people who can’t practically pay it back in the interest of profits – you are, in my opinion, acting without sound business ethics.  But here’s the deal – if it were you or I, we would be conviced of some fraud or conspiracy.  That would mean jail time.  But when your crime (yes I said crime) is so large that it shakes the foundation of our financial markets – you get bailed out and make no mistake the Fed’s action today (on a Sunday) is a bail out.

Think about it – over the course of the past three weeks our government in one form or another has spent up to nearly 1 TRILLION of our taxpayer dollars to shore up our financial institutions so that we would not experience another GREAT DEPRESSION.  Wise or not remains to be seen.  All I report on here are the facts.

Goldman Sachs and Morgan Stanley are the remaining two investment backs surviving.  Lehman Brothers filed for bankruptcy and will be sold to Barclays and Merrill Lynch was purchased by Bank of America.  Fascinating that little NCNB (former North Carolina National Bank) became Bank of America and now is the largest bank in the US with the Merrill acquisition.  Who said the South would not rise again.  But I digress.

According to a report by CNN:

The Fed announced that it had approved the request of the two investment banks. The change in status will allow them to create commercial banks that will be able to take deposits, bolstering the resources of both institutions.

It is clear that this change of status is designed to use “deposit” as a means of leverage giving them a stable source of funding.  The question is – who would want to deposit funds into either institution.

Answer:  In the surprise announcement late Sunday, the central bank said that to provide increase funding support to Goldman (GS, Fortune 500) and Morgan (MS, Fortune 500) during the transition period, they would be allowed to get short-term loans from the Federal Reserve Bank of New York against various types of collateral.

So let me get this straight in my mind – the federal reserve is going to make loans to both Goldman and Morgan giving them cash to offset their poor loan portfolio making them appear to be safe.  To me that is like paint a rotten fence with white paint and calling it new.  This is nothing more than a disguised bail out.

According to MSNBC: After the collapse of Bear Stearns and its forced sale to JP Morgan Chase last March, the Fed used powers it had been granted during the Great Depression to extend its emergency loans to investment banks as well as commercial banks. However, that extension was granted on a temporary basis.

But as commercial banks, Goldman Sachs and Morgan Stanley will have permanent access to emergency loans from the Fed, the same privilege that other commercial banks enjoy.

So here are some questions to ponder – and feel free to respond!

Question 1: Should the Fed have taken the actions to allow Goldman and Morgan to survive by allowing “normal” banking deposits?

Question 2: Do you feel that the actions by the “investment banks” have been ethical or unethical?  Why?

Question 3: With the massive actions taken over the course of the past three or so weeks, do you feel more or less confident in our nations economy?

As a business ethics speaker, I can say that there has never been a time in my lifetime that demands more thought, focus and ethical consideration of actions taken than now.  Business is good and business done with right ethical intention can grow and prosper.  But, as I say in practically every presentation I make – Every choice has a consequence.  Now we are reaping the consequences of choices made – not so long ago.

For all our sakes let’s hope that we can weather the economic storm ahead.

Your comments are welcome!