By Monika Mitchell
Greed was named the culprit for the 2008 financial crisis. In an article by William Cohan entitled: “Did Psychopaths Take Over Wall Street Asylum,” greed is defined as the “single-minded pursuit of their own self-enrichment and self-aggrandizement to the exclusion of all other considerations.“ Cohan draws from an academic paper published in “The Journal of Business Ethics” from Nottingham Business School Professor Clive Boddy that concludes that sociopathic behavior of industry leaders “largely caused the crisis.” Boddy asserts that “corporate psychopaths” climbed to the top of the biggest financial institutions of the world and were “able to influence the moral climate of the whole organization.” That moral framework had already been established by two generations of professionals who believed that greed was good. On Wall Street from 1987-2008, you were only as good as your “number.”
Making money the old-fashioned way (by earning it) had largely gone out of fashion by the time the esoteric mortgage markets made their way into the mainstream. The once productive residential MBS market disintegrated into a simple child’s game of how to outfox your neighbor. A senior structured finance manager at Bank of America (BAC) explained to a young analyst in 2006: “This is a game of musical chairs. We sell garbage. Whoever is stuck with the garbage when the music stops, sinks.” The former analyst, now Yogi, explained: “The greed wasn’t necessarily malicious. It was simply automatic. There was no specific person in mind at the other end.” (Share prices of BofA currently trade at $6.61 from a November 2006 high of $54.77.)
Lack of sympathy or empathy for other people defined common business practices in the institutional debt markets particularly during the years 2004-2007. Basically all hell broke loose in the securitization model when the lid that kept the markets restrained was lifted at the SEC on April 28, 2004 with asset to debt ratios skyrocketing from 12 to 1 to as high as 45 to 1 at the biggest shops (net capital rule). Structured products couldn’t be created fast enough for hungry investors and securities firms pressured banks to make more loans.
Sociopaths (synonymous with psychopaths) are defined as persons “having no moral responsibility or social conscience.” Boddy claims that 1% of the general population is psychopathic. So the question becomes: if Boddy is right, was that 1% concentrated in the mortgage lending and securitization industry? The laws of probability make that doubtful. Yet it is clear there was little or no social conscience industry wide in the quality of the loans given and securities created. There was little moral responsibility expressed towards the poor dumb, and perhaps greedy themselves, borrowers who signed their future-access-to-credit away with no doc, no down payment interest-only loans.
As the market exploded in the fall of 2008, my partner in an institutional debt recruiting firm and I began to ask the tough questions of senior managers: “How did banks give a loan to someone who has no shot at paying it back?” A bond trader explained: “The early vintages of subprime products had a lot of value.” Loans were geared to borrowers who had experienced temporary hardships like job loss or illness and needed a second chance at owning a home. These securities had higher returns and demand by investors grew substantially. As demand grew, industry standards diminished.
As one Lehman trader put it, “The industry lost its purpose.” The purpose of the mortgage securities market was to allow credit and capital to flow to working and middle class people and help them make the biggest purchase of their life: their home. Profits were derived from a clear social purpose.
What became evident as we interviewed scores of displaced mortgage industry professionals was that market makers (99% of which were men) were more often than not hard-working ethical people: good husbands, devoted fathers and dedicated philanthropists. A pattern of anti-social behavior was exhibited among non-sociopathic individuals. Despite one’s personal morality, operating successfully in the industry required one to detach from moral responsibility and social conscience.
How could this happen? Didn’t they understand that underwriting, trading and selling these “esoteric” (toxic) securities would harm the American public? No, they clearly did not: As one star trader put it: “The human element was too far removed.” How did banks take a fundamentally human industry like mortgage lending and successfully dehumanize it?
One of the most popular codes in finance is found in the simple but powerful belief that business is not personal. The concept was common long before Michael Corleone uttered the words in “The Godfather.” Discussing a plan to gun down his competitors in cold-blood, Michael tells his brother: “It’s not personal Sonny, it’s strictly business.” While that might have worked for fictional mafia, how it made its way into the mainstream marketplace is curious. The adage is repeated so often, we rarely question its validity. The foreclosure and housing crisis that emerged in the wake of irresponsible lending practices reveals that business is indeed personal when it involves your home, assets, retirement and income.
Perhaps the doctrine had roots in the 1970 seminal essay by University of Chicago economist Milton Friedman, “The Social Responsibility of Business is to Increase Profits.” Friedman claimed that businesses have no social responsibility because they are not people. “A corporation,” he said, “is an artificial person and therefore has artificial responsibilities.” Remarkably, Friedman saw a “corporation” not as a group of people transacting business together, but as a nonhuman facsimile. At the time, his sociopathic treatise was radical and shocked the post-1960s moral conscience. But gradually it became the norm.
There is no way to express the enormous impact that Friedman’s doctrine had on the American financial system -twelve years later it surfaced in the market deregulation favored by Reaganomics. Reagan’s Federal Reserve Chairman Alan Greenspan was a devoted Friedman colleague and supervised monetary policy for two decades. Like his peer, Greenspan believed “the market corrected itself,” despite the fact that the market was dictated by out-of-control human behavior. In the end before a 2008 Congressional committee, Greenspan confessed his thinking was “flawed.”
Even if industry professionals possessed a social conscience as many of them did in the lead up to the crisis, the system itself did not support it. Many individuals wanted to stop the toxic mortgage machine; some tried valiantly to stop it. Yet they were prisoners of a system that had systematically dehumanized one of the most basic human activities: enterprise. It was a veritable brainwashing. The business of home loans is nothing if not personal.
That good people do bad things is not a mystery. History is full of stark examples. And none of us are immune to them. In the United States our founders understood slavery to be morally reprehensible. Slave owners like America’s third president Thomas Jefferson wrote scathing criticisms of the practice. Yet neither he nor his peers could resolve the moral dilemma posed by the economic institution until a century later. When it came to money over morality, it seems that money won. Were our founders psychopaths? Or were they merely caught in an economic system that had successfully dehumanized labor in the minds of profiteers?
And how did they accomplish that? By convincing themselves that socially repugnant behavior was acceptable and justifying it with repetition and rhetoric. Slavers in 18th and 19th century America, otherwise law abiding morally upright citizens, claimed that owning human beings was their natural property right – never mind its inherent brutality. It proves that we can convince ourselves of anything, even that a fundamentally human activity like business is not personal.
In the 21st century, we are poised for major social transformation from an exclusive sense of self to an inclusive sense of the whole. How does what I do for profit affect the society that supports me? That is the question for modern business and finance. Banking is one of the core elements of our financial system. Given its essential purpose in the general economy, its obligation to society is even greater than other less essential services.
Traditionally, the answer lies in laws – even ill-conceived ones such as the bureaucratic nightmare that is Dodd-Frank. But laws are made to be broken as they say and a cadre of brilliant legal minds can outmaneuver a law any day of the week. So that leaves our internal moral compass to guide us. To change the system, we must change the for-profit model that the robust mortgage industry was based on from “anything goes” in the pursuit of profit to an economic partnership that recognizes its direct connection to society.
The continuing economic conundrum both inside and outside the industry necessitates a deep ideological shift. Main Street misery and Wall Street woes post 2008 reveal that the financial industry has a direct impact on public welfare and therefore a solid responsibility toward it.
History shows that good people will indeed do bad things when society allows it. Yet it also shows that good people will inevitably do good things when society expects that of them. Perhaps it is time to banish a no-longer-hot Gekko from our psyche. In its place, a clearly defined Social Contract can be structured between Wall Street and Main Street. A contract based on integrity and transparency where if you win, I win, we all win. Because after all, doing good business is personal.
This blog first appeared in February 2012 in Seeking Alpha. Monika is the co-author of “Conversations with Wall Street.” A book about the human-side of Wall Street’s securities industry. A true story from inside the mortgage markets where the actions of good people and not-so-good people collectively led to the economic crisis – with solutions on how to change the model so it works for the 100%.
From “Conversations with Wall Street” Epilogue “The Social Contract”
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