October 5-11, 2008 Issue |
Posted 9/30/08 at 1:00 AM
In 1987, Michael Douglas starred as
banker Gordon Gekko in Oliver Stone’s Wall Street. At one
point in the film, Gekko addresses a group of shareholders and says, “Greed is
good.
“Greed is right. Greed works. Greed
clarifies, cuts through, and captures the essence of the evolutionary spirit.”
Wall Street was only
a movie, but Gekko’s bravado, it would seem, was mirrored in a reckless
corporate strategy by many U.S. finance firms. However, as with any of the
deadly sins, though the initial impact is heady, sooner or later you pay for
the transaction. For a large portion of the U.S. financial services industry,
September 2008 will be remembered as the month when the accounts came due.
How much? Something in the nature of
$700 billion to $1 trillion, according to estimates. To raise that amount of
money, the federal government would need to borrow from itself and pass the
bill on to taxpayers for generations to come.
Karen Walker, founder and managing
partner of the Catholic Business Journal, said she found
the bailout “alarming,” and worried that
“it is a quick-fix, knee-jerk ‘solution’ by the same entity, the federal
government, whose bad financial decisions more than eight years ago encouraged
ill-qualified buyers to take on mortgages beyond their means.”
What happened?
Our modern finance industry, not
unlike oil, is an integral but often messy feature of our economy. Companies
large and small rely on the borrowing of money for everything from covering
payroll to developing products and expanding their markets.
Banks and mortgage companies also
borrow money from firms like Morgan Stanley and Goldman Sachs, and then make it
available to businesses and would-be home owners in the form of small loans and
home mortgages.
Completing the credit cycle, large
mortgage finance firms like Fannie Mae or Freddie Mac buy up mortgage loans,
bundled together in what are called mortgage-backed securities, and thus
encourage the lending of these loans by your corner bank or strip-mall mortgage
company. With fees for every transaction, our finance industry generates money
— lots of money — without creating a single product.
How much money? Consider that in the
early 1980s, the U.S. financial services industry generated about 10% of all
U.S. corporate profits. As of 2008, according to The
Economist, the industry was generating about 40% of all U.S.
corporate profits. These numbers are even more striking when one considers that
the financial services industry employs only about 5% of the U.S. corporate
workforce.
But why did companies like Fannie,
Freddie, Merrill and others buy so many mortgages and take on so much risky
debt? The answer to this question, according to Gina Emrich, director of
marketing and research at Epiphany Funds, is the same one Gordon Gekko gave:
greed.
“Some of these finance companies,”
Emrich said, “had taken on 50 times more debt than they had in assets. Why
would anyone think that this was a good idea?”
(Epiphany Funds, offered by
Texas-based Trinity Fiduciary Partners, carefully screens all companies and
makes investment decisions based on the social justice teachings of the
Catholic Church.)
Martijn Cremers, a Catholic, is an
associate professor of finance at the Yale School of Management. He cited
market reasons for the crisis, but acknowledged that virtue and vice played
their roles.
“Yes, I do think that this can be
partly explained by ‘greed,’ but also by a whole plethora of human weaknesses
that almost everyone shares — laziness, overconfidence, opportunism,” he said.
“And the current crisis would not have happened without the steep rise and then
fall in house prices, for which there is plenty of blame to go around. Briefly
put: The general trust in the mortgage-backed securities market broke down,
liquidity dried up, and now no one really knows what all this stuff is worth.”
Throughout the 1980s and 1990s many
passengers enjoyed the ride on the financial services gravy train. From Wall
Street CEOs who received huge salaries and bonuses to ma and pa investors who
held stock in the finance companies, millions of Americans borrowed, spent, and
borrowed some more, all assuming that somehow the “buy now, and pay later”
party would never end.
But it did.
Starting in 2001 with the burst of
the dot-com bubble and the Sept. 11 attacks, the U.S. economy slowed — a lot.
The increase in housing values waned, and the worth of the real property behind
billions in loans began to decline.
The financial services industry,
however, kept pushing debt, buying mortgages and giving out more credit to
consumers, creating a whole new class of American debtor: the subprime mortgage
holder.
“What has really been missing in
corporate America,” said Emrich, “is a fundamental sense of humility. For the last
decade, corporations and individuals alike have demanded a whole lot for very
little. On a scale of one to 10, with 10 as the highest, the overall wise
behavior of corporations and individuals in the last 10 years would, in my
opinion, rank at about three.
“Some of the blame,” Emrich
continued, “for the overborrowing in our finance industry must be placed at the
feet of the American investor.”
Over the last decade, lenders of all
sizes offered loans that featured little to no interest at first, but then
ballooned or “adjusted” to double-digit interest rates later, resulting in
monthly payments beyond the ability of the borrowers to pay.
When a critical mass of homeowners
could not pay their mortgages and defaulted, the housing crisis of 2007 and
2008 began. As the mortgage-default rate spread, large companies like Fannie
Mae and Freddie Mac, which were holding billions in mortgage-backed securities,
collapsed and were taken over by the federal government.
A number of other large finance
companies were also holding billions in mortgage loans, all enjoying the
interest from these loans, and all assuming that the principal on the loans
would be repaid.
As a panic over the falling value of
mortgage-backed securities spread, some of these companies, like Lehman
Brothers, filed for bankruptcy and are gone. Others, like Merrill Lynch and
AIG, only just escaped disintegration. Merrill Lynch sold itself to Bank of
America, and AIG, after losing 95% of its value in the first six months of
2008, received an $85 billion emergency federal loan.
By the third week of September 2008,
global banks actually stopped lending each other money, with many unsure about
who could repay a loan or if there were any real assets behind the loans in the
first place. A U.S. or global economy without a free flow of loans is like a
fast-running engine without oil — certain to overheat, fail and then stop,
leaving millions without paychecks, store inventory or even, as is the case for
U.S. agriculture, seed to put in the ground.
What does the Catholic faith teach
about all this?
Walker called the financial world a
form of stewardship.
“From a Catholic ethical
perspective, we are called as individuals to be good stewards of what we have
and not to envy what we don’t have,” she said. “We are called to help and serve
each other in Christ’s name. That involves conducting our business affairs in a
savvy and ethical manner. If we fail, if we make bad choices, we learn from
them.”
Jeff Gardner is CEO of
CatholicRadioInternational.com
You can reach him at
(JavaScript must be enabled to view this email address)
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