According to a study by the Dallas Federal Reserve, the financial crisis of 2007-2009 “was associated with a huge loss of economic output and financial wealth, psychological consequences and skill atrophy from extended unemployment, an increase in government intervention, and other significant costs.”[1]The study’s abstract goes on to “conservatively estimate that 40 to 90 percent of one year’s output ($6 trillion to $14 trillion, the equivalent of $50,000 to $120,000 for every U.S. household) was foregone due to the 2007-09 [sic] recession.”[2]
Interestingly, the Huffington Post “reports” the study’s finding in the following terms: “a ‘conservative’ estimate of the damage is $14 trillion, or roughly one year’s U.S. gross domestic product. This is based on how much output was lost during the crisis and Great Recession, along with all the damage done to potential future economic growth.”[3] In fact, the article’s title claims that the crisis cost more than $14 trillion! Lest it be thought that the reporter and editor suffer from a learning or reading disability, the gilding here is notably in the direction of “selling more papers."
Ironically, the Huffington Post also published an article pointing to the lack of accountability in that “the executives that [sic] were in charge of Bear’s headlong dive into the cesspool of subprime mortgage lending hold similar jobs at the most powerful banks on Wall Street: JPMorgan, Goldman Sachs, Bank of America and Deutsche Bank."[4]
Interestingly, the Huffington Post “reports” the study’s finding in the following terms: “a ‘conservative’ estimate of the damage is $14 trillion, or roughly one year’s U.S. gross domestic product. This is based on how much output was lost during the crisis and Great Recession, along with all the damage done to potential future economic growth.”[3] In fact, the article’s title claims that the crisis cost more than $14 trillion! Lest it be thought that the reporter and editor suffer from a learning or reading disability, the gilding here is notably in the direction of “selling more papers."
Ironically, the Huffington Post also published an article pointing to the lack of accountability in that “the executives that [sic] were in charge of Bear’s headlong dive into the cesspool of subprime mortgage lending hold similar jobs at the most powerful banks on Wall Street: JPMorgan, Goldman Sachs, Bank of America and Deutsche Bank."[4]
The upshot is that those stakeholders who played a role in the crisis, most significantly the people running the government, the media, and the banks, have gone on, relatively unscathed, while the systemic risk remained or has actually become even greater. As a first step toward recovery, a systemic map depicting the interrelated parts in the systemic failure and a related ethical analysis can provide a basis for reforms sufficient to thwart another major financial crisis.
What contributed to the financial crisis? The most obvious players include the mortgage servicers and their underwriters who respectively produced and approved subprime mortgages as if handing out candy to all-too-willing children who also should have known better. As if this practice were not bad enough, many such mortgage-division managers suffered little if any negative consequences even from committing fraud.
For example, “AMBAC Assurance Corp., a company that guaranteed some of Bear’s mortgage bonds and went bankrupt in 2010, accused Bear of fraud in a . . . lawsuit that described actions by . . . six mortgage division leaders . . . . Yet all six continue to work at the top levels of their field, earning salaries and bonuses that have allowed them to live in luxury while the mortgages that made up the bonds they sold have defaulted at alarming rates.”[5]The home-owners foreclosed on were doubtlessly in a much worse financial condition than the “leaders” who continued to live in luxury. Besides the financial and psychological costs estimated by the Fed in Dallas, the ethical dimension is salient.
The ethical problem in fraud is obvious; the verdict can be gleamed simply from the label, “liars’ loans,” which applies to a good many of the sub-prime mortgage applications that the mortgage producers accepted. In terms of the consequences, a distinct ethical verdict can be applied using Rawl’s theory of justice. Rawls contends in A Theory of Justice that a system’s rules, or policies, should favor the least well-off most, for under Rawls’ “veil of ignorance” no one designing the system knows where in it her or she will be. For the wealthy mortgage bankers to continue to live in luxury while the poor who faced foreclosure pay the price turns Rawls’ “difference principle” on its head. In other word, the consequences themselves are very unethical in terms of the foreclosure policies and the lack of accountability on the bankers. The implication prescriptively is that the relevant white-collar crime laws and enforcement should be strengthened while the foreclosure laws should be changed from favoring the banks to taking into greater account the dire situations of the homeowners, particularly during a recession.
Besides the mortgage producers and the subprime borrowers, the investment bankers who securitized subprime mortgages into bonds referred to at Goldman as “crap” built a house of cards, which insurance companies like AIG and rating agencies like Moodys’ negligently disregarded. In the late 1990s, Clinton administration officials, including Larry Summers who would serve as Obama’s chief economic advisor, had lobbied Congress to keep financial derivatives unregulated. Meanwhile, Clinton himself signed off on repealing the 1933 law that had prohibited commercial banks from engaging in the more risky investment banking field. After the financial crisis, Congress and Obama did not close the circle.
First, the Dodd-Frank law allows commercial banks to continue their activities in investment banking. Hence the $6.2 billion “London Whale” trading loss at JPMorgan, with Jamie Dimon holding onto both the CEO post and the chair of the board tasked with holding the CEO accountable. Second, the law continued to allow rating agencies to be compensated by the parties issuing the securities to be rated. Third, the law allowed public accounting firms to continue to be paid by the audited companies. Moreover, Congress and the U.S. President looked the other way concerning at least two major institutional conflicts of interest. The system itself is thus still vulnerable, sort of like a bike tire with a weak spot that could cause a flat (my back tire has such a spot, which feels like a bump when I’m riding fast).
Besides the failure of Congress and the White House to enactsystemic reform requisite to obviating another such financial crisis, the media has continued to ignore the two conflicts of interest mentioned above. Moreover, as demonstrated above in the reporting by the Huffington Post, the media can be more interested in “selling papers” or scoring political points than investigatingand reporting. For example, the media was nearly silent on Paul Volcker’s recommendation that the $1 trillion plus banks be broken up. It is perhaps no accident that the media companies are intertwined with the financial sector in particular and the business world in general. That members of Congress and the U.S. President are too (Obama’s highest contribution in ’08 coming from Goldman Sachs) are also all too willing to do Wall Street’s bidding in exchange for campaign contributions essentially closes the loop on systemic reform being viable. The problem is that the system itself must be changed for there to be any chance of cutting off another financial crisis like that in 2007-2009. Ethically here too, the verdict is not good.
Whether an editor or an elected representative, forsaking social responsibility and the public interest, respectively, for private gain is unethical on utilitarian grounds. That is, “the greatest good for the greatest number” is violated.[6] It is also violated by a CPA firm or rating agency that puts its own profit above acting in the public interest. That the public relies on audits and ratings means that the egoism is that much more unethical.
In short, the stakeholders involved in the financial crisis have continued to be overly concerned about their own interests and welfare at the expense of the public good. Hence, the damaged system goes on as if it were whole rather than warped. Hence the question, who will look out for the system itself? In this regard, who has the incentive to do so? If the answer is “nobody,”then it might be asked whether incremental fixes to the parts are enough for the system’s design itself to be corrected.
1.Tyler Atkinson, David Luttrell, and Harvey Rosenblum, “How Bad Was It? The Costs and Consequences of the 2007-09 Financial Crisis,”Staff Paper No. 20, Federal Reserve Bank of Dallas, July 2013.
2. Ibid.
4.Lauren Kyger and Alison Fitzgerald, “Former Bear Stearns Executives Seemingly Unscathed by Financial Crisis They Helped Trigger,” The Huffington Post, July 31, 2013. The article was originally published by the Center for Public Integrity.
5.Lauren Kyger and Alison Fitzgerald, “Former Bear Stearns Executives Seemingly Unscathed by Financial Crisis They Helped Trigger,” The Huffington Post, July 31, 2013. The article was originally published by the Center for Public Integrity.
6. John Stewart Mill and Jeremy Bentham, two early modern philosophers, provide the basis of the ethical theory.
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