Business Ethics, Bank Failures and Government Bailouts – Are They Compatable?

October 5, 2008

Just last night I was having dinner with with the head of a company and two retired physicians, none of whom I knew before my wife and I were seated.  As one might expect, the conversation turned to career as we played the get to know you game.

“What do you do,” one of the retired physicians asked?

“I speak across the country to businesses and associations on ‘ethics’,” I replied.

“Well,” the business exec at the table spoke up immediately, “you should be booked solid now.  I’ve never seen it so bad.  Seems that those guys on Wall Street and in Washington need your service desperately.”

With those comments the table broke into a sad sort of laughter, although the comment made was no laughing matter.  Rarely, if ever, in my lifetime (and I’m 51) have we seen a time in our country where the choices that have been made have had the potential for a more disastrous outcome.

Before the month of October begins in earnest the headline late on a Sunday night on CNN is: U. S. bank failures almost certain to increase in next year. Based on all that we’ve seen in the short scope of the last two months I tend to agree.  And here’s what is more baffling – people much smarter than I must have known that we would one day face this outcome.  The writing was on the wall.  You can’t extend credit to someone who can’t afford to pay you back and assume that everything will somehow work out.

Every choice has a consequence.  That is a universal law (although it seems that many people would prefer to ignor its existence).  All we heard for the past several years is how robust the US economy was.  The housing market was strong in most sectors of the nation and it would appear that we were set to continue to enjoy long term economic prosperity.  Really?  Here’s a segment of the CNN story:

Weakened by huge losses on risky home loans, the banking industry is now on the shakiest ground since the early 1990s, when more than 800 federally insured institutions failed in a three-year period. That was during the clean-up phase of a decade-long savings-and-loan meltdown that wound up costing U.S. taxpayers $170 billion to $205 billion, after adjusting for inflation.

Now, like many who read this, I was around during the Savings and Loan crisis.  It wasn’t pretty and friends, I hate to say this, but this is no savings and loan crisis.  That economic hardship pales in comparison to what we could face based on bad choices and business ethics gone awry.  The government bailout – hum, let me rephrase – the taxpayer bailout may preserve some of the “stronger” institutions, but there is a substantial belief that many more will fail, buried under the weight of their poor choices.

The following quote from the CNN article is very accurate:

“I don’t see why things will be that much different this time,” said Joseph Mason, an economist who worked for the U.S. Treasury Department in the 1990s and is now a finance professor at Louisiana State University. “We just had a big party where people and businesses overborrowed. We had a bubble and now we want to get back to normal. Is it going to be painless? No.”

I think it is interesting his choice of words, “people and businesses overborrowed.”   That statement is factual, but the more significant underlying question is how did that occur and why?  The answer to that is where – ETHICS – comes into play.

Now let me simply define ETHICS for the purpose of this discussion:  “Ethics is the discipline dealing with what is good and bad and with moral duty and obligation.”

So let me get back to the comment “people and businesses overborrowed.”  While the comment is true neither people or businesses had control of the purse strings.  People were “unethically” encouraged to overborrow.  Rarely a day would go by without the mailbox being filled with credit offers.  “Zero percent this and transfer balance that.”  We saw big burley viking men touting Capital One and God knows my college aged son received more offers for credit than he could count – even though he had no source of income.

While there is plenty of blame to go around, YOU CAN’T BLAME THE PEOPLE.  People did what people do – they responded to effective marketing campaigns and accepted offers made by many of those very banks who soon will be buried in the business grave yard of failure.  Poor business choices combined with poor business ethics will equal business failure.

We hear all too much about the mortgage crisis again with many stating that people over borrowed.  That may be true, but the bank or financial institution again controlled access to the money.  Now if a bank is so overzealous to prop up growth and earnings that they make loans to unqualified individuals or loan against property that is overvalued, I contend that is unethical.

Banks have more than a duty to earn money and grow, their greater duty is to do both of those things and (most importantly) survive!  Their moral duty and obligation (their ethical duty) is to survive while achieving success.  I agree with my dinner mates, if there is ever a time for ethical reflection it is now!

Another comment from the article that has alarming numbers attached:

Using statistics from the S&L crisis as a guide, Mason estimates total deposits in banks that fail during the current crisis at $1.1 trillion. After calculating gains from selling deposits and some of the assets of the failed banks, Mason estimates the clean-up this time will cost the FDIC $140 billion to $200 billion.

The FDIC’s fund currently has about $45 billion, a five-year low. But the agency can make up for any shortfalls by borrowing from the U.S. Treasury and eventually repaying the money by raising the premiums that it charges the healthy banks and S&Ls.

Perhaps next is the issue of Goverment Ethics.  By all accounts, Alan Greenspan reported to Congress many years back – talking in “Greenspeak” about what was likely to happen and how it could be avoided.  Did the government take action?  NO!  The concern, it seems, for most politicians is staying elected or getting elected, not making ethical decisions.  The moral duty and obligation that our elected officials have (or should have) is to represent those they govern and protect them from the disaster we are now facing.

And, not to be a cynic, but when have you known any financial projection to come in at or under the budget or estimate.  In my lifetime – never!  So by guess is the $700 billion will be more like $2 trillion when it is over.  The bailout here and proping up the FDIC there, not counting what else will arise that is undisclosed at this time.  It all adds up and is dumped on our shoulders.  In reality all we, as a nation, are doing is on a bigger scale exactly what the “people and businesses” did – borrow to pay off what we could not afford in the first place.

So back to the question – Bank Failure and Government Bailouts – are they compatable?  Neither represent good business ethics and yet both will happen.  Perhaps the comment was right at dinner, I need to camp out in Washington and NY – although now it might be too little too late.

For information about my presentations visit my web site.  Your comments, by the way, are welcome.

Mortgage Fraud – FBI Expects Dramatic Rise of Unprecendented Scope! Mortgage Fraud Speaker Chuck Gallagher Comments!

April 21, 2008

Quoted as being far worse in scope than the Savings and Loan crisis of the 1980’s, the FBI is dealing with a flood of mortgage fraud cases of unprecedented scope.

The picture below is from the FBI’s web site – which show an actual property used in a Mortgage Fraud Scheme. No wonder the problem is what it is today…

An Associated Press report stated the following:

FBI Director Robert Mueller says there has been a “tremendous surge” in mortgage fraud investigations, and he expects it to keep growing.

At a Senate hearing Wednesday, Mueller estimated that the FBI has 1,300 investigations underway, 19 of them involving sub-prime lending practices by U.S. financial institutions.

That’s up from three months ago, when FBI officials said they were investigating 14 companies for possible fraud or insider trading violations.

Mueller says the number of inquiries has increased to a level that required shifting agents from other projects onto mortgage fraud.

The New York Times reported that losses from fraud are surging. “It’s looking like a record-breaking year already,” said Stephen Kodak, a spokesman for the FBI. Kodak said that in first half of the 2008 fiscal year, which ended last month, the FBI received nearly 30,000 “suspicious activity reports.” The 2007 fiscal year ended with 46,000 reports and 260 convictions.

The biggest surge in federal law enforcement activity has focused on “fraud for profit” schemes, in which mortgage insiders – appraisers, real estate agents, loan officers, and lawyers – often work in teams. They falsely inflate a home’s value, get a huge mortgage to buy it (usually using false identities), split the profits, and then disappear.

In an article for GC California Magazine, author David Bayless stated, “To put this situation into historical perspective, the savings-and-loan crisis of the late 1980s and early 1990s ultimately cost an estimated $160 billion and affected more than 1,600 U.S. banks insured by the Federal Deposit Insurance Corp. It was one of the worst financial scandals in history. But the S&L crisis, while costly, was limited to only a section of U.S. financial institutions. In contrast, the breadth and the depth of the subprime mortgage crisis will likely far exceed that of the S&L crisis. Standard & Poor’s has estimated that losses from securities linked to subprime mortgages will exceed $265 billion as financial institutions worldwide write down the value of their holdings. And the breadth and depth of regulatory investigations and private litigation, as discussed in this column, is unprecedented.”

Bayless stated further, “The current wave of government investigations and litigation surrounding the subprime crisis will not be short-lived. Companies should brace themselves and prepare for a prolonged wave of attacks and actively seek legal advice. More lawsuits can be expected, particularly against deep-pocket underwriters and financial institutions (and their officers and directors) involved in the securitization of subprime loans. More regulatory and criminal investigations are guaranteed. Many laws firms have set up subprime task forces or have coordinated their internal expertise in various practice areas to address issues affecting clients caught up in the crisis.”

Along with these reports, CNN reports today (April 22, 2008 full report here) that among the nightmares lurking around the corner for the already battered housing and credit markets would be a meltdown at mortgage financing giants Fannie Mae and Freddie Mac.

Although few are predicting an imminent need for a bailout just yet, credit rating agency Standard & Poor’s recently placed an estimated price tag on this worst case scenario — $420 billion to $1.1 trillion of taxpayer’s money.

This dwarfs how much it cost to help banks during the savings and loan crisis of the late 1980’s and early 1990’s. That cost taxpayers about $250 billion in today’s dollars.

As a speaker on business ethics and mortgage fraud, I hate to say, but this is just the tip of the iceberg of what is moving our way. Sadly, few voices were heard when it came to the ethics ramifications of making loans to people who obviously could not afford to pay for their purchase. Years before, no one would have considered making such a loan. Yet, as the market flourished the tide of easy money and greed took hold. Today, we are beginning to see the first phase of the dramatic cost of the choices made.

In every presentation I state boldly: Every choice has a consequence! The unfortunate cost here will affect many people in ways they never considered. It is easy to talk about the obvious, but the less obvious secondary costs will be staggering.

Here are some of todays headlines and links to the stories. If this won’t get your attention, I don’t know what will. And this is just the beginning.

Bank of America profit plunges 77%

National City to raise $7 Billion

Bad Quarter? Time to Swing the Job Ax?

With headlines like these – we can only assume that from every indicator possible, we might be in for a long ride. Perhaps, the reason I see inquiries for ethics presentations increase is due to the realization that we need something to get us back on the right track.

Business Ethics and Mortgage Fraud speaker – Chuck Gallagher – signing off…