Banking on the American Dream

Owning one’s home has long been part of the American Dream. Unfortunately, events of the past fifteen months have turned that dream into a nightmare. Our economy has teetered on the edge of collapse after a series of stunning lapses in fiduciary responsibility, judgment and integrity in the financial services sector. Banks and other financial firms have written down over $500 billion in loan losses and securities impairments following years of underwriting liar’s loans with teaser rates and negative amortization mortgages. As a result, liquidity has dried up. Credit is tight. Home sales are at record lows, and foreclosures are at all-time highs. Auto loans and leases are becoming increasingly difficult to secure. Student lenders have pulled back, as have prospective employers’ interest in hiring recent graduates.

In March 2008 Bear Stearns, whose stock once traded at $173 in January 2007 and $93 just weeks before, signed an agreement to merge with JPMorgan Chase in a stock swap worth $2 per share (later renegotiated to $10 per share). In the blink of an eye Bear Stearns disappeared due to “lack of confidence,” not lack of capital. Quite simply, counter-parties didn’t “trust” that Bear Stearns was safe to do business with. At IndyMac Bank, which was taken over by the FDIC in July, we saw lines of people waiting to take their money out, not trusting that even the FDIC would stand behind their deposits.

For sure, there’s plenty of blame to be shared. Wall Street underwriters, mortgage lenders, bond insurers, hedge funds, governing bodies, rating agencies and regulators all had front row seats watching this slow-motion train wreck unfold. While these seismic economic events rattled world markets, we watched the former CEOs of Citigroup and Merrill Lynch, and the current CEO of Countrywide Financial, testify before congress about their extraordinary compensation and retirement benefits in light of the extraordinary losses at their institutions.

At Countrywide Financial favorable mortgage terms, not available to the general public, were given to numerous powerful and famous individuals. The former chief executive, CFO and controller of Fannie Mae returned over $30 million in a settlement with their regulator, OFEO, for their role in improper accounting and earnings manipulation.

In France, Société Générale lost over $9 billion due to a massive compliance failure and lack of internal controls. Red flags, first discovered in November 2007, went substantially undetected until January 2008. Moody’s, S&P and Fitch Ratings have been accused of conflicts-of-interest, as well as failing to identify risks in sub-prime mortgage investors.

Fidelity Investments paid $8 million in fines on charges that its stock traders improperly received gifts and entertainment, including private jet travel to golf and gambling outings and illegal drugs, from brokers seeking the firm’s business. Among those named included the firm’s Vice Chairman and former star fund manager, Peter Lynch, who used traders to secure tickets to golf tournaments and concerts.

Four former top executives at General Reinsurance, and one former AIG executive, were found guilty of conspiring to commit fraud and inflate AIG’s reserves. Meanwhile, Hank Greenberg, the legendary former Chairman of AIG, may face civil charges for his role in the scheme. In May seven people were indicted over alleged kickbacks involving stock lending. To date eighteen people have pleaded guilty to criminal charges for laundering millions of dollars in fake finders fees from brokerage firms in connection with stock loan transactions where no services may have been rendered.

In February a former Credit Suisse executive was found guilty of leaking confidential information on several major deals as part of an insider trading scheme. The SEC’s Director of Enforcement, Linda Thomsen, told a compliance conference that she is “quite dismayed” over recent increase in insider trading cases. “The tippers and tippees have been in senior positions of trust and confidence”, she said.

In June two former hedge-fund managers at Bear Stearns were indicted for misleading investors. Also that month a former UBS banker pleaded guilty in a scheme to help a client avoid taxes by hiding assets. In July, Britain’s Financial Services Authority (FSA) arrested eight people as part of an insider trading investigation.

In August Merrill Lynch, Citigroup and UBS agreed to buy back over $36 billion in auction-rate securities, and Citigroup thus far agreed to pay millions of dollars in fines for deceptive sales practices.

Citigroup also agreed to pay 2500 current and former female financial advisors $33 million to settle a discrimination lawsuit at their Smith Barney subsidiary. At Morgan Stanley a federal monitor was appointed to oversee the negotiated terms of a $46 million diversity settlement with female financial advisors.

In the midst of this crisis, the Federal Reserve Bank has taken unprecedented actions by lowering interest rates 325 basis points, facilitating the sale of Bear Stearns while assuming some of the less liquid assets in the transaction, lending to investment banks, and making capital available to other central banks. Meanwhile, the Treasury has been working with congress, which recently passed a bill protecting Freddie Mac and Fannie Mae from failure. And the SEC stepped in to limit short sellers of certain financial stocks.

Issues of integrity are not new to the financial services industry. Just a few years ago ten Wall Street firms agreed to pay $1.2 billion to settle conflict-of-interest charges regarding analysts who were paid by the bankers. Numerous mutual fund firms paid hundreds of millions of dollars in fines for market-timing and late trading practices. With Marsh McLennan as the poster child, insurance brokerage industry paid substantial fines to settle bid rigging schemes. Numerous securities brokerage firms settled charges for receiving back-end payments from investment firms for steering clients.

For sure, other industries are not immune to scandals. But why do financial firms seem to always be front and center during times of great moral crises? Alan Greenspan spoke of “irrational exuberance,” while Paul Volker referred to it as “uninhibited self-interest.” Clearly, there’s so much money it becomes intoxicating, leads to a collective arrogance, which creates organizations that believe they’re immune to bad news. No organization can be honest with the public if it cannot be honest with itself.

Banking is an industry built on trust. Investors and depositors bring their life savings to financial institutions trusting that the fiduciaries and managers will act in their best interest. However, when executives place their self interest above those of their investors and other stakeholders, that trust is easily shattered.

Ambition is a normal desire. It is expecting the best of oneself. It is the desire to make a difference. Arrogance, on the other hand, is the belief you are better than others, the world owes you something, and then doing whatever you can to take it. Someone once wrote, “Ambition without arrogance, and the involuntary encounter with one’s own limitations, leads to unique achievements, i.e. the capacity to resist the corruption of success, the defamation of character, intentions and principles that wealth, power and fame seem to bring.”

The American Dream was founded on ideals – life, liberty and the pursuit of happiness. Today it is defined in almost entirely materialistic terms, i.e. money and the symbols of status that money can buy. Money, however, is merely a medium of exchange of value. The real question is, therefore – what do we value? It seems to me that we have become unhinged from our values, financially as well as in human terms. We suffer from a deep amnesia about what’s most essential in ourselves and in others.

The soul of corporate America is at stake today and, so too is the price of our vitality. We must remind the decision makers in our organizations, as well as ourselves, of the difference between ambition and arrogance, between success and greed.

Keith Darcy is Executive Director of the Ethics and Compliance Officer Association, the largest association of ethics and compliance professionals in the world with over 1400 members across six continents. Mr. Darcy spent over 30 years in the financial services industry, is a director of E*Trade Bank, and teaches ethics and leadership at the Wharton School, University of Pennsylvania.