Quite often it is being said that the present economic crisis is connected to a moral crisis. Such a crisis is a situation in which conventional morality no longer is acceptable as a general guideline. Alternative sets of norms and values are being discussed while the traditional norms and values have lost their force. At the university we study morality. This discipline is called ethics. Ethics is thinking and writing about the background of good or bad behavior, ethics is a discussion about acting and behaving out of good intentions or obligations, and ethics is a discussion on wrongs, on situations of injustice, and on moral reasons for change in society. In short, ethics is about everything that might encourage or discourage a good society.
There are some quite opposing views about the road towards a good society: some hold that freedom and free citizens would bring the best results for the citizens, personally, and the society as a whole. Others, however, would accentuate the role of the state and alls sorts of state institutions as necessary on the road to a good society. Liberal thinkers share the first view. They propose that free markets should bring their fruitful effect if the market traders are trying to outdo each other by lowering the prices. Liberals, following the thoughts developed by the Enlightenment thinker Adam Smith, would claim that the general prosperity would surely benefit from such market arrangements. Anti-trust laws which promote competition are a result of this kind of thinking. The alternative view does not expect very good results from unregulated markets unless market authorities do function as umpires who promote fairness in the market place. The same alternative view is not averse from cooperation between companies in the same market as long as their agreements are being reported to the authorities. The two views are being seen as opposites. Yet, they may be seen as complimentary as well. A good society may be achieved thanks to the good conduct of each of its members and, complimentary to the good individual behavior, thanks to good governance, good functioning democratic institutions, the state of law, and a number of public institutions.
Since 2007 there has been an economic setback. First it was called a crisis in the interbank money market, then it was called a credit crisis, and later it got officially the label of an economic recession. Early 2009 all growth forecasts were adjusted. There is, for the first time in years, a decline in economic growth. First, downward figures around 2% and 3% were mentioned, later 5% and more. What has this economic setback to do with ethics?
The two opposing views, just mentioned, were used alternately in the media for analyzing and solving the present economic crisis. The first example is an illustration about individual behavior as a possible cause to the crisis. The second example is an illustration of an institutional and interventionist cause of the crisis.
Greed and the credit crisis
We live since the 1980s in a liberal age. So, it will not surprise that the first, i.e. the liberal view, dominated the discussion. In most media the crisis became associated with bad behavior, especially with greed of bankers. They supposedly were lured by huge bonuses to behave and to act irresponsibly. Some commentators went as far as to say that immorality, engineered by the bonus system, was the cause of this crisis. A good banker should act in harmony of a code of decent and proper behavior. Instead, the bankers were heavily influenced by the possibility of receiving higher bonuses. Consequently the present-day managers of the banks were not acting as good bankers should do.
The bank manager or deal maker of today no longer acts similarly as the banker of the past. The profession of a banker had its own professional ethical codes of practice. Professional ethical codes in the past were standards for independent professionals such as doctors, notaries, lawyers. These professionals had their own small and private practices and they could maintain the standards of their profession just by personally behaving as a good and proper medical doctor, notary public, or lawyer was required to do. The medical specialists of today are practicing their branch of the medical profession in medical centers with nursing and other facilities. Notaries and lawyers are offering their services in partnerships which are being managed and where turnover quotas exist. Their professional independency is a thing of the past. And this applies to more professions. The way professions are being practiced is no longer guided by a code of conduct but, more so, affected by the setting of a wider or larger organization with its budgeted turnover, its profit goals, its chosen specialization and its targeted category of customers, its designed image and its desired share in the market, etc.. Therefore, it does not surprise at all that a code of conduct for professionals in situations as if they are working independently does not cover the dilemmas, moral problems, and professional challenges these doctors or lawyers face in a situation where, in fact, they are employees or partners in a larger setting managed by directors motivated by economic figures. Thus, the ethical rules of the organization in which professionals work should become important as well. The quality of surgery and the good care in a hospital are not only dependent on the physician or the head nurse but on an operating team or a nursing staff. Likewise is the processing of a legal file in a law firm dependent on a staff which may include a trainee. Only the overall responsibility lies with the medical doctor, the head nurse or the lawyer. The same story applies to banks.
Rendering professional services in an organizational setting is, thus, adding new moral problems to the traditional code of professional behavior. It is misleading to think that the ‘deal’ in a bank completely depends on a partner or director who at the end of the year may receive a bonus of a few million Euros or Dollars. The deal has been made possible thanks to a staff of underpaid young economists and lawyers who had to work immensely for that deal. The accrued bonuses of the people who work in banks are not so much unjust in connection with the overall remuneration; they are unjust because they reflect an unfair remuneration structure. So the question is how to get a fairer remuneration structure?
There are basically two ways of solving this problem of an unjust remuneration structure: externally imposed norms or internally developed norms. Let me start with the first possibility. If we want to improve an existing unjust remuneration structure with help of an external intervention, it is usually parliament or government changing or redefining the remuneration structure in a legal manner. There may be, for instance, a debate in the parliament about obvious and unjust high salaries and bonuses which may result in new laws, new standards or new institutions. Will the people involved accept the new rule or standard as a norm? When the government sets a norm, the Balkenende-norm for example, there is still room for more public debate. The Balkenende-norm is meant to put a limit on the salaries of managers in institutions and enterprises in the public domain. The limit is the salary of the Prime Minister, today Mr. J.P. Balkenende. The question may be raised whether the Balkenende-norm indeed became a norm. The second possibility is an appeal to the boards of private companies to formulate minima, ceilings and standards of their remuneration policies and account for them in their annual reports to shareholders. The norms are to be expected to be developed from the inside whereas the first possibility expects the solution to the problem by imposing new norms from the outside.
As said earlier we live in a liberal, individualized age. So, developing norms from the inside probably will be earlier effective than remedies with outside or external interventions. I may illustrate this by the story of two nationalized banks. Two banks, ABN-AMRO (Netherlands) and Fortis Netherlands, were nationalized in September 2008 due to a run on Fortis Bank which was perceived by the public as being in trouble as a consequence of financing its takeover of a third of ABN-AMRO Bank in 2007. The costs of nationalization and the costs of keeping both banks afloat are being bore by the tax payer, so to speak. Soon parliament debated the salaries and remunerations of the directors of both banks. Yet, again and again the Minister of Finance mentioned that he would not be able to impose the Balkenende-norm on both banks. The State is the owner of all outstanding shares but that does not mean that a minister of the State is able to change at will the terms of employment of the directors and the employees of these banks. All kinds of legal arrangements prevent that. However, it is not merely a matter of obstacles but it is also a matter of time needed for persuasion. If you want to impose moral standards, you have to talk with the people involved. Try to convince them, to persuade them with arguments. Merely enforcing legal rules is insufficient. When rules are being supported then they may become internalized norms. That is a process which takes time.
An intervention by the State and the credit crisis
There is very different way of looking at the crisis. Now we do not look to vices or virtues of individual bankers but we look to laws, to institutions, to legal obligations. The origin of the credit crisis may have been an ideal, namely affordable housing for low-income families in the USA. Some 15% of the 300 million Americans live below and another 10 to 15% just above the poverty line as defined by American standards. The USA do have some social housing project in the big cities. By and large there is in the USA nothing similar as the social building associations in the Netherlands or other European countries which offer rental homes and apartments to roughly one third of the population. Affordable housing as an ideal was being discussed time and again in US Congress. When in the summer of 1999 the House and the Senate each passed different versions of a bill that allowed mergers, takeovers and consolidations among banks, insurance companies, and securities companies politician were trying to build a broad coalition to endorse this bill. Members of House and Senate worked a few months in a so-called Conference to find a compromise. Other political wishes creped into this process. Some wordings on a non-discriminatory access to financial services were incorporated. The Community Reinvestment Act, originally of 1977, was amended. In November House and Senate passed within a few days the Gramm-Leach-Bliley Act and President Clinton signed it. This law, officially known as the Financial Services Modernization Act of 1999, opened up the financial markets. The banking industry had lobbied since the 1980s for this modernization. This law repealed parts of the famous 1933 Glass-Steagall Act. Many commentators applauded the move to give as much freedom to USA banks as European bank already enjoyed since the 1980s. The commentators easily overlooked the price paid: a pledge to give more economic opportunities for the disadvantaged and more access to the financial services by lower-income classes. The banks in low-income areas started brisk, new lending practices.
Mobility is characteristic of many an American family. Blue collar families were leaving neighborhoods built in the middle of the twentieth century and put up their houses for sale. Affordable housing initiatives conceptualized schemes to assist families now renting apartments so they could own their own house. We know them by their acronyms: Fannie Mae stands for the Federal National Mortgage Association, FNMA, chartered in 1968, and Freddy Mac stands for Federal Home Loan Mortgage Corporation, FHLMC, set up in 1970. Lacking a tradition of grand scale housing corporations social ethicists, religious leaders, and representatives from lower-income districts backed up these schemes of easy access to mortgage financing as a solution to the ideal of affordable housing.
The subprime market involved an income category of some ten million American families with a living above the poverty line, not dependent on social security, but actually not wealthy enough to buy a home in a normal market situation. The subprime mortgage market offered the less affluent but not really poor households an opportunity to acquire post-war houses from families with slightly more income, slightly more opportunities for development and more flexibility to make s step backward when necessary. Flexibility is a quality the subprime market mortgage lenders were missing. Think about a single-parent family: it lacks flexibility. The road back to the tenement houses is unattractive and therefore put off as long as possible. The mortgages, often with lower costs in the early years, sooner or later became an unbearable burden for more families than was estimated at the time the terms for the mortgage were set.
The banks had probably seen these problems coming all along. They had timely ensured that a large share of the risk got securitized and was channeled through the international capital markets to buyers overseas who appeared to be unfamiliar with the risks of these high yielding financial products. The credit crisis started in 2006 and 2007 when the refinancing of short-term mortgages (circa three years) in the subprime mortgage market in the U.S encountered difficulties. The subprime USA mortgage market had swelled enormously as a consequence of the Gramm-Leach-Bliley Act, which allowed banks, actually more or less obliged them, to provide mortgages to families with an income that, in fact, was too modest to pay back the mortgage unless the mortgaged property would enormously rise in value and consequently could be sold within a few years time.
Worldwide the derivatives were traded, repackaged, and used as collateral to new lending activities. In 2006 and 2007 it became clear that the underlying mortgages of certain derivatives could not fulfill their interest obligations. Auditors at banks or other financial institutions recommended writing off on these toxic assets; that meant red figures for the banks. The total value of the potentially not so easily collectable subprime mortgages is estimated at $ 3.5 trillion. The credit crisis was born.
Ethics and economics
These two examples show that there is a relationship between “morality” and “economy” and they show that the origins of the present credit crisis may be viewed from two opposite standpoints. When we search along the lines of objectionable individual behavior we will find culprits: bonus driven bankers. When we search along the lines of reprehensible institutional and political interventions we will find misused subsidy schemes, taxation holes, and national institutions.
Yet, it is too easy to blame the bonus system or the political compromises as the prime movers in the credit crisis. It is too simple to say that the credit crisis is a moral crisis. There are serious moral flaws. Bankers forgot that they had to remain acting as a good banker in all circumstances and that lending to families with restricted budgets asks for wisdom and restraint. Politicians forgot that lobbyists seek realization of their respective interests but that representatives and senators have to remain acting as good politicians and those politicians are obliged to forward primarily the public interest. Moral leaders forgot that lofty ideals such as affordable housing easily may become a flag covering a totally different cargo.
The credit crisis has its moral aspects. Mostly is it a crisis in complying with codes of behavior and with norms. Bankers, politicians, lobbyists, and moral leaders forgot their proper functioning. Lofty ideals should not too easily being translated in rules and laws, unless there is a minimal moral awareness with the population concerning the ideals involved. The same holds for the companies which should not misuse or circumvent but respect and interpret properly the laws and the norms.
Therefore we need an active civil society wedged between the government and the citizens. Under the civil society is understood the whole of non-governmental and non-commercial organizations, such as schools, universities, care institutions, churches, public libraries, unions and employers organizations. The civil society may influence the morality of the citizens deeply and lasting.
Remuneration systems may change if there is a base for such a change in the civil society. Societal organizations have a large and close group of followers. The stronger the commitment between the organization and its followers, the greater the moral influence. Practical economic ethics, therefore, focuses on intermediary institutions between the state and citizens. Practical economic ethics is thus also evidently organizational ethics or business ethics. This does not only imply good bankers or good business people, but mostly “good” banks and good companies.
In the near future we need an ethics dealing with the moral problems of the organization: societal, governmental and commercial organizations alike. We need an ethics of the entire company. We need reflection on what the moral consequences are of corporate action in the sense of acting by business people in an organized manner. Organizational ethics should deal with the organizational instruments, such as the salary and bonus system, the safety system, or the reporting system. Until now, the salary was related to a function, to the performance of an individual, and to his or her responsibility.
That is in itself fine, but ethics draws attention to the fact that within organizations responsibilities are borne by many people. The top has no knowledge about a myriad of things and questions. Companies should not grow further than for which they can be responsible. The span of control is a concept that ethically could be developed further.
What the crisis and ethics have to do with one another, lies not in the past, but in the future. Organizations must develop their moral self-awareness. Legislative measures of governments are necessary but can never do it alone. Without moral support, beautiful lofty moral norms and laws do not lead to a desirable – good – society. Organizations are the main intermediaries.
Eduard Kimman
This post is tagged Ethics, financial crisis, Moral crisis