a2ethics.org Goes To Ethos Week: What The Bankers Forgot

The Eastern Michigan University College of Business "corporate headquarters" is in the Gary Owen building in downtown Ypsilanti. It is not difficult to find as it has a logo that strikingly weaves an E for ethos into it, to reinforce for students and presumably anyone who passes by, the emphasis on ethics in EMU's business school. This focus is thanks, in part, to the Ernest and Jeanne Merlanti Business Ethics Initiative, begun in 2001, and to the efforts and leadership of the program's first director John Waltman (now retired) and the current dean of the business school, David Mielke. 

From March 9 to March 13, the school sponsored its most unique event: the Annual Ethos Week. This year marked its third program, which offers a wide variety of activities of the ancient virtue type, including banner-signing, oath-taking and "strength and honoring."  Moreover, it provides enthusiasts with opportunties for some quality ethics schmoozing and booyahing, which is all capped off with a luncheon featuring a nationally known or syndicated business ethics writer, consultant or moral life motivator. 

For us at a2ethics.org, Ethos Week is  a fun and informative state ethics trade show, highlighting the year in business ethics, its trends, innovations, products, services, and most tellingly, its triumphs, challenges and its failures. Needless to say, 2008 was, as puppet friends Bert and Ernie of 'Sesame Street,' often sang about in one of their most popular episodes,  "A Different Day." Except that Bert, and especially Ernie the entrepreneur and risk-taker between the two, wished for a different day. Most people in business, on the other hand, wish to forget 2008 ever happened.

That is why in this special reporting role for a2ethics.org, I gravitated to the talk, "Ethics and Banking and Finance." After all, bankers have been portrayed as the central villains in the Great Recession. I wanted to know how bankers were going to explain themselves, not only to their mirrors, but to the ethics banner-signers and oath-takers attending the event, not to mention members of the public who have lost almost 50% of the value of their stock portfolios (and in the case of most financial sector stocks, much more), their houses and their jobs. In addition, I wanted to know how they were holding up. Because, I am not totally unfamiliar with the banking business (in contrast to the business of supply chain managers, another Ethos Week offering), and come from a family that includes many bankers, I know not all bankers are the bad guys and that many are as upset and troubled by the actions of several of their colleagues and their institutional practices as everyone else is.

Finally, I wanted to know then, what it was that many bankers forgot, that is what knowledge, learning and experiences about their ethical responsibilities and community obligations that they no longer followed, and in some cases have never followed, so much so that we are now living in a democratic society with large and widening income gaps between us and the potential for handing off to our children and the next few generations a much poorer standard of living. And potentially, a life less well-lived in the ethical sense.

These expectations were too much to be sure. Nevertheless, the speaker, Joseph Reid, the chairman and CEO of Capitol Bancorp, Limited, a $5.7B bank holding company headquartered in Lansing (Ann Arbor Commerce Bank is one of its chartered banks and subsidiaries), offered a candid appraisal of his experience and several challenging ideas that I have been thinking about ever since.

Let me put on my reporter's hat. (For the visual among you, it is an unobtrustive and functional red ski cap that keeps my ears warm.) The main points I took away from Mr. Reid's description of banking ethics and the recent failures in the direction of the finance world's moral compass are:

1. Business and ethics do not have the same motivations, incentives and ends. As a result, it is very difficult and always a struggle to create and sustain self-interested, market-based incentives, for example, to ensure that business practices will be used for socially beneficial ends. Mr. Reid summarized the very different purposes of business and ethics as follows: 

        Business is about "making money;" and
        "How can caveat emptor and social responsibility co-exist?"

2. At the same time, if business people think about ethics more carefully, they soon discover there is value in being ethical in business. In fact, put in those terms, business people may begin to think about ethics differently, for the simple reason that value is a word that all business people can easily understand. One broad example of the value of ethics in business is that a set of values (ethical principles, rules or customs of civility) afford a predictable set of behaviors that, in turn, provide efficiency and seamless interactions between business people, including customers and business owners.

3. Within the banking realm, the fundamental tension between business ends and ethics purposes is usually resolved by building into the banking system a set of predictable behaviors that establish self-interested, market-based  incentives and most importantly, value in acting for socially beneficial ends. Among these incentives are behaviors that monitor and put checks on excessive, irresponsible risk-taking. And though Mr. Reid gave several examples, the ones most relevant to banking were those that create methods, tools and other ways to guard the bank vaults, the handlers, the money keepers and the money seekers.

4. So, how is it then that the values and sets of behaviors (some of them traditional and customary, others legal and regal)  that ensure incentives to bankers  to prevent and proscribe malicious, greedy, arrogant, reckless, negligent and careless risk-taking (all ethical vices) broke the locks and trespassed the security firewalls of the vaults and enabled, what I call (and not Mr. Reid) the Great Looting?

5. There are two parts to the answer Mr. Reid outlined. One is that he appeared to have some problems with a system of risk in banking institutions that interlocked and interconnected all banking transactions and relationships.  Such a system has become so intertwined that it has set in stone the now familiar "too big to fail" dilemma we are tired of hearing about and have become even more suspicious of because it seems to reward only those who have failed the most.

While normally we might think that connections and relationships bind and bond institutions together (you know the three musketeering "one for all and all for one") are the right thing to do, such a system also poses moral dangers. Among the most significant:  if one of the institutions critical to the system, in this case the banking system, goes down, then everyone else goes down with it. What does this mean if we translate this into "ethicese?" 

It means that we have built COLLECTIVE responsibility into a system in which the people taking risks that are INDIVIDUALLY greedy, reckless and IRresponsible, will cause some of the others working in the system taking responsible risks and acting ethically in the responsibility department to be morally and financially obligated for actions they had no knowledge of or any role in.

Whew! But the moral dangers of  the above defined "systemic risk" and the too big to fail musketeering approach related to the current financial system mess, are not what Mr. Reid focused on.

Instead, he focused his comments on the second part of the answer to the question about what went morally wrong with the banks, by locating its source on the removal of risk to almost everyone plying their products, skill and skin in the too big to fail system.

6. What?? The failure of the banks and the breaching of the vaults was caused by too little risk? This is not a game.

But yes, as it turns out for many working in the system, it was  and still remains a game. For Them. And according to Mr. Reid, the problem was an ethical one of ultimately having "no skin in the game." Let me explain it in game language first. And then I will get to the example, Mr. Reid used, from the banking system itself. 

Ok, you go to an EMU-Michigan football game at Michigan stadium. You are sitting in seats at field level. Someone decides to pass up one of your friends. So you and some of your other friends begin the game. You pick up your friend and pass him along. Everyone else in the seats behind you also passes your friend up.  Until he gets to the top row.

So here's the ethics issue. In this game, once you have passed your friend up the row, you are no longer responsible for lifting, holding on or carrying your friend to make sure he doesn't drop. In other words, your risk (of dropping) is no longer a factor.  In fact, you no longer have any "skin in the game."  No responsibility and no risk.  With no responsibility or risk, there is no incentive for you to think of any consequences to you. They are the next passers' problem. Just so.

And that is what happened to the banks with respect to their systemic risk procedures.

As you can imagine, the example Mr. Reid used to illustrate the pass up and on responsibility and no "skin in the game" loss of risk is: the mortgage and loan system used by banks and the accompanying incentives that helped to precipitate the housing bubble that burst in 2007.

The central players in this banking and finance system "game" have been described in so many media accounts that I will not define them here. Mr. Reid provided us with a very nice graphic starting with the homebuyer and then moving us through the originate-to-distribute, selling off and passing up and on responsibility system that was created and included the following main players:  the mortgage lenders (commercial banks, mortgage companies etc. think IndyMac), the federal government sponsored enterprise mortgage guarantors (Fannie Mae and Freddie Mac),  the ratings agencies (Moody's is one), the  securitizers (investment banks like Bearns Stearns, global commercial banks such as Citibank and Royal Bank of Scotland, for example, with their off balance sheet structured investment vehicles), and at the end or the top, the bond insurers (among them the now notorious credit default swapbucklers from AIG) and finally the investors.

Similar to the passing up and on game at the stadium, the players in this vast mortgage and loan system established an interlocking and dense web that became both risk and responsibility free for them.  How? This was more simple. They sold off their mortgages and loans to the others in the system and everyone in the passing up and on system received fees for turning over the risk. Most importantly, what ensured the no responsibility, no risk system and no skin game was that almost every player in the game made money, in some cases amazing and unfathomable amounts of money, thus fulfilling the business prophecy and purpose of....yes, making money.

Remember Mr. Reid only had a hour to talk. So, in the end, what has been the outcome of all this responsibility ducking and risk passing up and on? The financial mess we are now in, that is also an ethics mess.

To his credit, Mr. Reid had no moral at the end of his house story or his engaging talk on the "Ethics and Banking and Finance."

But I have one. The stadium game of passing up and on initially suggests three ends. One is that those in the top rows decide to throw the person (and your friend) over, risking injury or death. The second is that the players in the top rows and at the top of their game pass the person on down again or keep passing the person up and down over and over again.

Or finally, some or even a few players could just stop playing the passing up and on game. As a result, they may well learn from the experience that those in the top rows (and those at the top of their games) do not have all the choices. And that, when you give up and pass on all responsibility, you also risk letting others take control of who wins and loses the game.

For information on the EMU College of Business Third Annual Ethos Week podcasts go to: http:// www.cob.emich.edu/.