Tag Archives: William K. Black

Fannie and Freddie’s Confused Futures

Posted on February 16, 2011 by admin | 3 comments

(cross-posted with Benzinga.com)

A few days after the Obama administration released its vague concepts for the future of Fannie and Freddie it issued budget estimates for Fannie and Freddie’s losses premised on the continued existence, indeed, expansion of Fannie and Freddie. The administration assumed that the cost of resolving Fannie and Freddie would drop by roughly one-half – by 2021. The predicted reduction in losses appears to come not from improvement in Fannie and Freddie’s bad assets, but rather from profits on Fannie and Freddie’s overall operations. These profits stem from Fannie and Freddie, which are now publicly-owned, being able to borrow funds at or near the governmental rate. That price advantage makes it impossible for any private entity to compete with them in the secondary market. This purported reduction in the cost to the public of resolving Fannie and Freddie’s failures is not really an economic savings – unless one ignores the implicit cost of issuing government debt to fund Fannie and Freddie. The nominal accounting savings, however, will be exceptionally attractive to politicians. Administration officials will have an overpowering desire to claim that their brilliance cut Fannie and Freddie’s costs in half. Collectively, this will provide powerful incentives to continue Fannie and Freddie as a huge governmental enterprise.

We need to understand why Fannie and Freddie became massively insolvent. It wasn’t because they were governmental, but because they were private. It is simple to run Fannie and Freddie in a safe and sound fashion. Fannie created the concept of prime loans and prime loans have exceptionally low credit risk. Fannie and Freddie can easily spot any degradation in credit quality by reviewing samples of the loans insisting on full underwriting. Fannie and Freddie can minimize interest rate risk by creating and selling MBS and hedging the pipeline risk. When Fannie and Freddie were governmental 25 years ago they did not deliberately take excessive risks. They did not understand how to hedge in a fully effective fashion, but we have learned a great deal in 25 years about how to hedge pipeline risk.

The risks to Fannie and Freddie are governmental, not financial. The government could decide to do extremely destructive things to Fannie and Freddie.

The risks to a privatized Fannie and Freddie (by whatever name) are even greater. If the existing systemically dangerous institutions (SDIs) became private label securitizers they would have all the perverse risks that come from modern executive compensation. They would pose a systemic risk if they were to fail – which is why regardless of how much the government promised not to bail them out no one would believe it. That is why they would be GSEs regardless of their official designation. The more they are perceived as GSEs the greater the political risk that Congress will demand dangerous actions from the private label securitizers.

It is not clear why the administration believes that securitization of mortgages is necessary or even desirable. Portfolio home lenders will face prepayment and interest rate risk, but those risks are simply transferred, not removed, by securitization. Given what we have learned from the crisis, the assumption that securitization leads to an efficient distribution appears baseless. Some banks will doubtless fail if interest rates increase sharply and remain high for many months, but hedging and macroeconomic policy can greatly reduce the failure rate among banks.

The first step, however, should be to make the existing disaster that is Fannie and Freddie fully transparent. We need to investigate fully what went wrong. If Fannie and Freddie put all their information on the web we could bring the wisdom of the masses to bear and determine the truth. There is no reason why Fannie and Freddie should have broad proprietary secrets.

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Posted in Policy and Reform, Uncategorized, William K. Black

Tagged Policy and Reform, Securitization, William K. Black

Wallison: Leader of the Financial Wrecking Crew

Posted on January 28, 2011 by admin | 4 comments

By William K. Black

The most theoclassical economists are often non-economists like Peter Wallison. His bio emphasizes the passion that has consumed his adult life.

From June 1981 to January 1985, he was general counsel of the United States Treasury Department, where he had a significant role in the development of the Reagan administration’s proposals for deregulation in the financial services industry….

[He] is co-director of American Enterprise Institute’s (“AEI”) program on financial market deregulation.

Wallison is back in the media because the Republican Congressional leadership appointed him to the Financial Crisis Inquiry Commission. The Commission has four Republicans and six Democrats. Three of the Republicans were architects of the financial deregulation policies that made possible the current crisis. The fourth, Bill Thomas, was an ardent Congressional supporter of those policies that helped make those policies law. Unsurprisingly, none of the Republicans is willing to support the findings of the Commission’s staff’s investigations of the causes of the crisis because deregulation, desupervison, and de facto deregulation (the three “des”) played a decisive role in making the crisis possible. Each of the Republican members of the Commission is in the impossible position of being asked to investigate his own policies, which the Commission’s investigations have shown to have had disastrous consequences.

Even within the Republicans, however, Wallison stands out for the zeal of his efforts to blame everything on the government and working class Americans. He decided that his Republican colleagues had been too weak in condemning the staff’s findings and wrote a separate, lengthy dissent to make his case. Wallison’s actions were predictable. He was famous prior to his appointment for creating the narrative that the government’s desire to help working class Americans purchase homes twisted Fannie and Freddie into the Great Satans that caused the crisis. He believes in complete deregulation – banks deposits should not be insured by the public and banks should not be regulated.

I have critiqued Wallison’s claims about the current crisis and explained why I think he errs. I will return to this task in future columns now that he has written a lengthy dissent. In this column I will discuss a portion of a shorter, even more revealing article that he wrote that exemplifies what I will argue are the consistent defects introduced by his anti-regulatory dogma in each of his apologies for a series of financial deregulatory disasters over the last 30 years.

Wallison wrote an article in Spring 2007 (“Banking Regulation’s Illusive Quest”) criticizing a conservative law and economics scholar, Jonathan Macey, who had written an article about financial regulation. Wallison was disappointed that Macey, who typically opposes regulation, concluded that banking regulation was necessary. Wallison wrote the article to rebut Macey. I’ll discuss only the portion of Wallison’s article that seeks to defend S&L deregulation.

Wallison begins his critique of Macey by asserting:

If the business of banking is inherently unstable, it would long ago have been supplanted by a stable structure that performs the same functions without instability.

Why? That assumes that there are banking systems that are inherently stable and that the market will inherently establish such systems. There is nothing in logic or economic history that requires either conclusion. Economic theory predicts the opposite. Indeed, the paradox of stability producing instability was Hyman Minsky’s central finding.

Wallison does not support his assertion. The accuracy of the assertion is critical to Wallison’s embrace of financial deregulation. If banks are inherently stable, then financial regulation is unnecessary. He assumes that which is essential to his conclusion. His closest approach to reasoning is circular and unsupported.

In the absence of regulation or deposit insurance, one would expect to see banks hold sufficient capital for this purpose, simply because instability would result without it and instability would make it difficult for banks to acquire deposits.

So, absent regulation and deposit insurance, bank instability cannot exist because instability would make banks unstable. Banks would want to be stable, so Wallison “expects” that they would hold “sufficient capital.” His “expectation” is his conclusion. One does not prove one’s conclusions by “expect[ing]” that they are true.

Wallison cited his (then) co-director of AEI’s deregulatory program, Charles Calomiris, who argued that early U.S. banks with broad branching authority had low failure rates. The study design could not prove Wallison’s argument about private market discipline. Mr. Calomiris’ attempt to employ his theories in the real world led to the failure in 2009 of the S&L he controlled. His brother, George, tried unsuccessfully to get Charles removed from his control of the S&L:

In 2004, after the company posted large losses, George Calomiris asked the board to replace Charles Calomiris and Amos with “qualified, experienced management,” he said in a letter to the board.

That request fell on deaf ears, George Calomiris said in an interview. “Since that time, I and everyone else who protested my brother’s total incapacity to do anything in the real world have seen the truth. … It’s been a total disaster.”

He said he has lost more than $1 million he invested in the bank. “This is not sour grapes. I’m not the only guy who has lost a fortune here.”

While calling his brother an esteemed professor, George Calomiris said “he hasn’t any idea how to run a bank.”

Several local banking experts and investors shared that sentiment, but declined to go on the record.

And that really is the central point of why Wallison, Calomiris, and AEI’s financial deregulatory efforts have caused so much harm to America. AEI’s financial deregulation efforts have been immensely influential even though they were run by individuals who had a “total incapacity to do anything” successful “in the real world.” Accounting and fraud happen in the real world and they turn these anti-regulatory dogmas into “a total disaster.” Indeed, they turn them into recurrent, intensifying disasters. That is why Tom Frank’s famous book title: “The Wrecking Crew” describes Wallison so well. He has led the financial wrecking crew. As his track record of failure has increased, so has his refusal to accept personal responsibility for those failures.

The dynamic Wallison relies upon, private market discipline, cannot be “expect[ed]” to be reliable. Even if we assumed that creditor and shareholders act in accordance with the rational actor model that Wallison implicitly relies upon (and economists and psychologists have proven that assumption is unreliable) it would not follow that private market discipline would be effective to make banks stable.

Private market discipline becomes harmful – not simply ineffective – in four common circumstances even if actors are purely rational. First, if creditors and shareholders believe they can rely on the bank having “sufficient capital” then control frauds will use accounting fraud to create fictional bank capital so that they can defraud the creditors and shareholders.

Second, given the risks of accounting control fraud to creditors and shareholders, creditors and shareholders will realize that reported net worth may be a lie. That uncertainty means that the creditors and shareholders may not be willing to lend to and invest in banks that are actually solvent. Indeed, the depositors may stage a run on a healthy bank. Capital does not save banks from serious runs.

Third, when the bank is an accounting control fraud its senior officers will use their ability to hire, fire, promote, and compensate to create perverse incentives that suborn its employees and internal and external controls (the appraisers, auditors, and credit rating agencies) and turn them into fraud allies. The perverse incentives create a “Gresham’s” dynamic in which bad ethics drives good ethics out of the marketplace. This produces what white-collar criminologists refer to as “echo” epidemics of fraud.

Fourth, banks engaged in accounting control fraud can generate Gresham’s dynamics and produce “echo” epidemics of fraud in “upstream” providers of loans. Bank control frauds create pay systems for loan brokers, and loan products, i.e., “liar’s” loans, that produce such intensely perverse financial incentives that they are intensely criminogenic. This produced endemic fraud in liar’s loans obtained by loan brokers.

Note that these failures demonstrate that deposit insurance does not end private market discipline. Fraudulent CEOs systematically pervert market incentives and use their power as purchasers and their ability to massively inflate reported income and capital to exert discipline and produce perverse behavior. Indeed, they create an environment so perverse that it becomes criminogenic.

Famous economists, Akerlof & Romer 1993 (“Looting: the Economic Underworld of Bankruptcy for Profit), the National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE) 1993 (which investigated the causes of the S&L debacle) and many of the nation’s top white-collar criminologists, Calavita, Pontell & Tillman 1997 (Big Money Crime), and a number of my works had explained how accounting fraud worked many years before Wallison wrote this article.

Wallison relies on the same circularity when he turns explicitly to the S&L debacle.

Because they were backed by the government, the s&ls were not required to hold capital that was commensurate with the risk they were taking, and depositors and other creditors were not concerned about this risk for the same reason.

His first clause merely asserts that the S&Ls would have been required to hold more capital absent deposit insurance. His second clause is even weaker. Why do “other creditors” – uninsured creditors at risk of suffering severe losses upon the failure of the S&L – should have exercised effective market discipline against the S&Ls. They never did so. Many S&Ls had subordinated debt. Anti-regulatory proponents like Wallison assert that subordinated debt provides superb private market discipline against banks. The purchasers of sub debt are not insured, they are supposed to be financially sophisticated, and they often buy large amounts of sub debt – all factors that are supposed to optimize private market discipline. The problem is that they have consistently failed to do so in reality. Deeply insolvent S&Ls were able to issue sub debt.

Neither Macey nor Wallison address the consistent failure of uninsured S&L creditors and shareholders – a failure that destroys their underlying assumption that deposit insurance is the cause of market discipline failures. But recall that Macey and Wallison were writing well after the S&L debacle. They were writing after the failure of the Enron-era accounting control frauds – frauds at firms that had no deposit insurance. Market discipline becomes an oxymoron in the presence of accounting control fraud. As Akerlof & Romer (1993) stressed, fraud is a “sure thing.” Creditors rush to lend to uninsured non-financial firms that report record (albeit fictional) income. The control frauds loot the creditors and shareholders. Despite having seen “private market discipline” fund rather than discipline hundreds of huge frauds, Macey and Wallison simply assumed that private market discipline would succeed absent deposit insurance.

Macey writes, “Without government regulation to substitute for the market discipline typically supplied by contractual fixed claimants, disaster ensued.” True enough, but regulation was clearly the underlying cause of the problem.

Wallison’s description of S&L deregulation is remarkably selective and disingenuous.

The deregulation that occurred was an effort to compensate for the earlier regulatory mistakes, but it was too late. Many in the industry were already hopelessly insolvent.

Deregulation was an expedient that came too late to halt the slide of the s&l industry toward insolvency.

And allowing undercapitalized or insolvent s&ls to continue to function — attracting deposits through use of their government insurance — guaranteed a financial catastrophe.

Only the last assertion is sound, but Wallison misinterprets even it, for it was a product of the deregulation that his department (Treasury) imposed on the Federal Home Loan Bank Board. Relatively few S&L were “hopelessly insolvent” as a result of the interest rate increases of 1979-82. NCFIRRE’s estimate is that $25 billion (of the $150 billion in total, present value cost ($1993) of resolving the debacle) was caused by interest rate increases. Interest rates began to fall later in 1982 and generally continued to fall. The great bulk of S&L failures – and the overwhelming bulk of the cost of resolving those failures – was caused by credit losses. Accounting control fraud was a major cause of those costs.

Wallison, understandably, focuses on the most benign aspects of S&L deregulation. Federally chartered S&L were permitted to issue adjustable rate mortgages (ARMs) and S&Ls were permitted to pay depositors higher interest rates. (S&L regulators had long supported both of those changes. Congress was the problem.) I quoted above from Wallison’s bio to show his emphasis on his leadership role in framing the Reagan administration’s financial deregulation.

The deregulation, desupervision, and de facto decriminalization of the S&L industry that the Reagan administration initiated (including the “competition in laxity” that federal deregulation triggered at the State level) was far broader than Wallison discusses and was a dominant contributor to the cost of resolving the debacle. The “three des” created an exceptionally criminogenic environment. Absent reregulation, which we implemented over Wallison’s virulent opposition, it would have caused catastrophic losses. Here are only the most destructive of the “three des” that the administration initiated.

• Reducing the number of Federal Home Loan Bank Board examiners and froze hiring

• Sought to prevent the agency’s decision to double the number of examiners

• Perverting the accounting rules to hide losses and cover up the industry’s mass insolvency – which created fake capital and income that made it far harder to act against the frauds. Covering up the mass insolvency of the industry was at all time the Reagan administration’s dominant S&L industry priority.

• Reducing capital requirements

• Increasing the permissible loan-to-value (LTV) and loan-to-one-borrower (LTOB) ratios to the point where a single large, bad loan could render the S&L insolvent

• Allowed acquirers to create massive fictional assets – goodwill via mergers that made real losses disappear from accounting recognition and created large, fictional income from mergers of two insolvent S&Ls

• Allowed acquirers to have intense conflicts of interest

• Allowed single acquirers, overwhelmingly real estate developers, to take complete control of S&Ls

• Ceased placing insolvent S&Ls in receivership

• Created hundreds of new S&Ls (de novos), overwhelmingly controlled by real estate developers

• Attempted to appoint (on a recess basis without the Senate’s advice and consent) two members to run our federal agency selected by Charles Keating – the most infamous S&L control fraud. The agency was run by three members, so this would have given Charles Keating effective control of the agency.

• Testified before Congress and in a deposition taken in support of a lawsuit by the owners of an S&L challenging the Carter administration’s appointment of a receiver for the S&L based on its acknowledged insolvency. A senior Reagan administration Treasury official testified that insolvency

• The OMB threatened to file a criminal referral against the head of the agency, Ed Gray, who was reregulating the industry, on the purported grounds that he was closing too many failed S&Ls

• Treasury Secretary Baker met secretly with House Speaker James Wright and struck a deal under which the administration would not re-nominate Ed Gray,

The overall effect of the “three des” was that the S&L control frauds were originally able to loot with impunity. Roughly 300 fraudulent “high fliers” grew at an average rate of 50% in 1983. Gray began reregulating the industry in 1983, roughly six months after he became Chairman. The S&L frauds were able to hyper-inflate a regional real estate bubble in the Southwest. Reregulation contained the crisis by promptly and substantially reducing the growth of the fraudulent portion of the industry. Had deregulation continued an additional three years the costs of resolving the crisis would have risen to over $1 trillion. Note that Gray reregulated over the opposition of the Reagan administration (including Wallison), a majority of the members of the House, the Speaker of the House, the “Keating Five”, the industry trade association, and (at first) the media.

Wallison consistently refuses to even discuss the failures of private market discipline caused by accounting control fraud. His lengthy Financial Crisis Inquiry Commission rebuttal, for example, mentions the word fraud once. That reference ignores the evidence before the Commission on the endemic fraud by nonprime lenders and their agents that and mentions only fraud by borrowers. Accounting control fraud is the Achilles’ heel of private market discipline. Effective private market discipline is the sole pillar underlying Wallison’s anti-regulatory policies. He is one of the principal architects of the criminogenic environments that were principal causes of the second phase of the S&L debacle, the Enron-era frauds, and the current crisis. The recurrent, intensifying crises his policies generate have left him with a full time job as apologist-in-chief for his deregulatory disasters.

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Posted in Regulation, Uncategorized, William K. Black

Tagged Control Fraud, deregulation, Financial crisis, fraud, regulation, William K. Black

William Black Interviewed on Parker & Spitzer

Posted on December 21, 2010 by admin | 1 comment

William Black was interviewed recently on the subject of unethical banking practices for Parker and Spitzer’s blog (cnn.com). The full interview is available here.

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Posted in L. Randall Wray, Uncategorized, William K. Black

Tagged Control Fraud, fraud, L. Randall Wray, William K. Black

William Black interviewed on Portland’s KBOO Community Radio

Posted on November 3, 2010 by admin | 1 comment

William Black was recently interviewed on KBOO’s ‘Old Mole Variety Hour’ regarding corruption in the banking industry.

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Posted in Uncategorized, William K. Black

Tagged Control Fraud, Financial crisis, fraud, William K. Black

William Black interviewed by GFS News

Posted on November 3, 2010 by admin | Comments Off

William Black was recently interview regarding the Obama administrations response to the financial collapse: “Obama has ignored the savings and loans crisis to this point. The position of the administration was that there were no lessons to be learned from the savings and loan crisis. I find that very bizarre.” See the full story.

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Posted in Uncategorized, William K. Black

Tagged Control Fraud, Financial crisis, William K. Black

NEP Blogger William Black Interviewed in NPR Report on Mortgage Fraud

Posted on October 18, 2010 by admin | Comments Off

NEP’s own William Black was recently interviewed by Chris Arnold for a report on mortgage fraud. The full story can be found here.

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Tagged fraud, Subprime mortgage crisis, William K. Black

“MORALITY AND BUSINESS – WHAT YOU CAN DO”

Posted on June 13, 2010 by admin | 11 comments

A DISCUSSION WITH BILL BLACK.

by: Brooke Allen

William Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City. He was the Executive Director of the Institute for Fraud Prevention from 2005-07. Bill is an outspoken critic of our regulators, banking, and business leaders. You may have caught him on Bill Moyer’s Journal, or in his congressional testimony where he stressed accountability and the fact that elites refuse to accept responsibility.

I recently attended a conference on institutional decision making and group behavior. Many academics presented experimental results and mathematical models to explain how we make bad decisions. Yet, when I asked about the role morality plays in individual decision making, I was told that little research has been done and therefore there was not much that can be said about the topic.

So, I called Bill Black. I caught him at a conference run by the Gruter Institute for Law and Biology.

Brooke: You coined a term, “control fraud.” Could you tell us what that is?

Bill: Yes, control fraud is when the people that control a seemingly legitimate entity, whether it is private, non-profit, or governmental, use it as a weapon of fraud.

Brooke: There seems to be a lot of that going on now.

Bill: Yes, way too much. And the FBI just announced that property crime had fallen to yet another all-time low, because we don’t count serious white collar crime. None of the major things that cause massive losses are even counted. And, if you don’t count it, at the end of the day, it doesn’t much exist [as far as they are concerned].

Brooke: I recently sat next to a young soldier coming back from Afghanistan; a wise man at age 20. I asked him, “What have you learned?” And he said, “I have learned to make apologies, not excuses. If your gun jams because you have not maintained it, and your buddy gets killed because you can’t cover him, you have to apologize to his widow, and it is not your gun jamming that caused his death.”

He also said, “I now see my country as a nation that cannot apologize, and that is full of excuses masquerading as reasons.”

How can we be excused just because we haven’t modeled morality mathematically therefore we can’t know anything about it? This young man knows something about it.

Bill: Brigadier S. L. A. Marshall found that small unit cohesion was the absolute key. You will do astonishing acts of bravery for your little group, and you will do it for members of your group who you actually hate. And they’ll do the same thing for you.

What you see from our elites is an almost complete unwillingness to take responsibility. We even have all these flakey apologies. To take the soldier’s statement, when he apologizes, he doesn’t say, “I am sorry if you have interpreted my comments in a manner that caused you distress,” which is the standard non-apology apology that people use today that puts it on you; there must be something flawed about you that led you to take offence at your husband being shot down because my gun jammed.

Brooke: I have an MBA in Finance, and I took an ethics class, which was all about how to stay legal, and not about ethics. The strongest impact for me was in a course called Managing Organizational Behavior where we talked about the Milgram Experiments. [A series of experiments conducted by Stanley Milgram of Yale University, where he showed that most people would go so far as to give people an apparently lethal shock when instructed to do so by an authority figure.] These experiments were presented in class as things that couldn’t be repeated again. We are obligated to mention them, but don’t worry about them because we can’t repeat the experiment. But, isn’t that experiment repeated all the time? I had a hard time sleeping after that because I saw it in all our behavior. It was not Germans in Germany who did what they did in World War II, but humans, just like the rest of us, and we are all capable of that. That, combined with small unit cohesion (you fight for your buddies, not your cause) is a combination that is extremely powerful and scary, isn’t it?

Bill: It’s weird, but I had the same experience. That is the single scariest thing I have ever watched in my life, and of course, I have seen much more horrific, graphic, violent things that are real – and that was an experiment. My fear was, my god, what would I have done? I know what I hope I would have done, but after you see that film, you have to wonder. [He continued with a discussion of the Stanford Prison Experiments.] That’s why you have to have immense restrictions on abusing people you have made powerless, because it is such a human thing to abuse them.

Perhaps psychologists consider running the Milgram experiments to be unethical these days, but reality TV producers do not. In 2006, a British TV station produced a show called The Heist in which illusionist, Darren Brown, began with 13 businessmen and women, and was able, in just two weeks, to persuade four of them to commit what they believed to be an authentic armed robbery. As part of the show, he reenacted the Milgram experiment as a test to identify his four most obedient participants. Darren got the same results Milgram did in 1963: over 50% of the subjects administered what they believed to be lethal shocks simply because a man in a white coat told them to. You can watch a report on the TV show here.

_____________________________________________________

Brooke: Are business schools doing a good job of teaching ethics?

Bill: When I am in a dispirited mood, I refer to them as “fraud factories.” They do a miserable job right now. We know empirically that in business schools and econ programs, when people enter they are materially less altruistic than their peers, and we know when they get done with the program, that is even more true. (See a paper by Gintis and Khurana.) So, through self-selection, training, and peer effect, we are turning out people who find it easier to cheat other people and to not care about other people. So, yes, we are teaching ethics, and we’re teaching it effectively, but it should be called “anti-ethics.”

Brooke: So, if you want to get a good ethics education, you should take diligent notes, and then negate whatever you are being told.

Bill: Yes, put a negative sign in front of most anything.

I refer to our prior conversation with Professor Mintzberg of McGill University, in which he said there is a clear moral obligation for colleges to disclose the flaws in their education, but not a legal one. Bill and I continued to discuss how a moral obligation is enough of a reason to refuse to do something that is wrong, and you don’t need to discuss it any longer.

Bill: That’s right. You’re done. Period. It doesn’t matter how fancy you make it, how many excuses you create, you’re done. End of story. It’s off the plate as an option if it’s unethical.

Bill explains how our simple social rules keep most of us from cheating each other. He continues,

Bill: What if you say my job is to maximize return to the shareholders, and, if it is not illegal, and short-term profitable, then am I supposed to do it even when it is immoral? If that’s the rule, then you have just developed a rule that will destroy America.

Brooke: A psychologist friend of mine says that many of her patients don’t have psychological problems; they have morality problems. They want to feel good about themselves while they cheat on their spouses, screw their business partners, or steal from their clients, and if she can’t help them with talk therapy, they want a drug. She says, “They don’t have an emotional problem. The problem is their emotions are working fine.”

Bill: Exactly. The problem is they are not listening to their body. There is something in their system that is telling them that what they are doing is very wrong.

We return to the question of whether ethics can be taught.

Brooke: A fellow applied for a job with me, and I asked if I hire him, could I introduce someone to the job he currently has because I am all in favor of helping improve employment, and when I hire someone away from another employer, I haven’t decreased unemployment, I’ve just transferred my problem to his prior boss.

He said, “I would never recommend anyone to my job because I am asked to do immoral things.”

So, I asked him why he had not quit.

He said, “What are you talking about? I need a job.”

I said, “Let me see if I have this straight. What you are doing is immoral and you don’t think anyone on the planet should do it, but you are willing to do it.”

How does this work? How can I teach someone that, if they have that feeling, they have to stop, and it doesn’t matter if they are getting paid to do it; they have to stop?

Bill laughed: Did he get it, once you talked to him?

Brooke: I might have succeeded in sending this guy home much more conflicted, because he came with an attitude that it was his employer that was causing his problem, and the solution was to get Brooke to hire him. I made it clear to him that he was not qualified to work for me. I said, “If I do something immoral, which can easily happen – I’m deathly afraid of that – I need you to tell me that I am doing something wrong. And if I don’t respond, you need to tell my boss, and Compliance, and if the organization doesn’t respond, you need to quit your job and you have to go to the regulators.” I need that because I do not think I am immune from what Milgram showed.

Bill: You expressed that it was an ethical issue where the individual had deliberately put scab tissue on to make sure he did not internally frame it as an ethics issue. All you can do with a person like that is make the point that they are acting immorally directly to their face, in a naked way, and you did it where there was an actual consequence of his unwillingness to take a moral stand.

Similarly, when you find somebody is unethical and you fire him you need to consider avoiding the advice you get from everyone and give him a negative reference. People have to take a willingness to get sued, and if that can’t work, then as a society, we have to give protection.

We must simply start teaching ethics in our own ponds with our own kids, or own friends’ kids, using our own behavior. You always look, as a parent, for teaching opportunities that are not didactic, so it was always great when someone gave me back too much change when my kids were present, because I simply made sure that they heard me giving it back, and that they were actually paying attention when I did it.

Brooke: Recently, I was on a train and sat with this young woman who is in her second week on the job working for a dubious corporation, that’s to say a large Wall Street firm, but I repeat myself.

I ask her, “What do you do if you are asked to do something unethical?”

She says, “What are you talking about? There are two sides to everything?”

I say, “But what happens when you are on the wrong side? Have you ever taken an ethics class?”

She says, “Of course. It was required. But, that’s what’s wrong with you old people, and how you guys used to be taught, because in our classes, we all get to discuss all sides, and everybody is entitled to their opinion.”

Do you think that is the right way to teach it?

Bill: I’ll give you my interaction with a young person who worked for a law firm who said, “What I like about my firm is that it is really ethical.”

You know, you don’t often hear that, so I said, “Wow, that’s great. How did you learn about that aspect of the firm?”

And she said, “Well, I know that my firm would never do anything against the interests of Israel.”

We both laughed. This would probably distress supporters of Israel, but Bill and I know that you can’t know in advance that Israel will be for all time on the right side of every issue.

Bill: I was dumbfounded. Frankly, I decided my powers of persuasion were probably impossible when dealing with somebody like that. It is bizarre what some people define as ethics.

The young woman you met was taught that ethics disappears because issues are complex, so there is never an answer, and we are not required to seek an answer.

Brooke: Many of our subscribers at http://www.noshortageofwork.com/ are in the New York area, used to work in finance, and are now unemployed.

One of the things I try to teach, which is probably the most useful thing from economics, is the concept of opportunity cost.

I say that when you’re unemployed, the advantage is that you can do anything because the opportunity cost is zero. You might have to struggle to get people to bid up your price, so it is a good idea to pursue things of value to others.

If you are not working at an unethical firm because you are not working at all, then you are not called upon to compromise your ethics. You will not have to say to yourself, “Oh, my god, if I don’t continue to do this, then I will lose my job, and I won’t have money to send my kids to college where they can take an ethics class.”

Perhaps, if you are on the street without a job, now you have time to reflect on those things.

Bill: That’s right. Reflect. Take the opportunity to read. And teach your children well.

—

Bill Black recommends To Kill a Mockingbird.

What do you recommend? If you have read a book lately of interest to No Shortage of Work readers, let us know. We will even try to arrange for you to interview the author, although I wouldn’t count on getting Harper Lee to take your call.

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“A Fed with broad regulatory authority”: Is it a good idea?

Posted on April 29, 2010 by admin | Comments Off

According to James Bullard (President and CEO, Federal Reserve Bank of St. Louis), Sandra Pianalto, (President and CEO, Federal Reserve Bank of Cleveland), and Richard W. Fisher (President and CEO, Federal Reserve Bank of Dallas) the answer is yes. Recently, they delivered their speeches at the 19th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies After the Crisis: Planning a New Financial Structure, held at the Ford Fundation on April 14-16, 2010, NY.

The following statements can be found on the conference’s website:

“A Fed with appropriately broad regulatory authority provides the nation with the best chance of avoiding a future crisis…Bottom line: Due to its narrow regulatory authority, the Fed had a severely limited view of the financial landscape as the crisis began.” James Bullard, President and CEO, Federal Reserve Bank of St. Louis emphasis in the original

“the Federal Reserve should continue to supervise banking organizations of all sizes and should take on an expanded role in supervising systemically important financial institutions” Sandra Pianalto, President and CEO, Federal Reserve Bank of Cleveland 2010 see here)

“Current proposals being discussed in Congress would shrink the Fed’s regulatory and supervisory responsibilities…leaving us either with no regulatory oversight or solely with regulatory oversight of LFIs. In my view, these proposals are misguided.” (Richard W. Fisher, President and CEO, Federal Reserve Bank of Dallas 2010:4 see here)

On the other hand, Prof. William K. Black, on his testimony on Lehman Bankruptcy (see here and here), opposed to the view that the Fed did not have the appropriate regulatory authority:

“The Fed’s defense of its disgraceful refusal to protect the public is meritless. It argues that it was not there in its regulatory capacity and that it sent only a few staffers that laced the capacity or the leverage to accomplish any supervisory goals. This is either a deliberate obfuscation or a confession of a core failure. As Senior Vice President and General Counsel of the FHLBSF I was always a regulator – even when I was providing involved in credit-side activities. As a lender, the FHLBSF often learned material information about the institutions we regulated because we engaged in effective underwriting of asset quality. My predecessor famously used the leverage of the FHLBSF as lender of last resort for the largest S&L in America, which was in a liquidity crisis, to force out the fraudulent CEO controlling the institution and to enter into a broad array of steps that greatly reduced the institution’s risk exposure and frauds. At its peak, we had roughly 50 FHLBSF credit personnel resident at the S&L. The fact that the FRBNY, which had far more resources than the FHLBSF, chose to send only a token crew to be on-site at a potential global catastrophe is a demonstration of failure, not a valid excuse for their failure to act to protect the public. The FRBNY has vastly greater leverage than the FHLBSF ever had and in the context of the Lehman crisis it had the leverage to force any change it believed was necessary, including an immediate conversion of Lehman to a bank holding company and a commercial bank.

The Fed has inherent problems even in safety & soundness regulation due to its structure. First, the regional FRBs have boards of directors dominated by the industry. Congress already made the policy decision, in removing all regulatory functions from the FHLBs in the 1989 FIRREA legislation, that this is an unacceptable conflict of interest.

Second, supervision is, at best, a tertiary activity at the Fed and regional banks. Monetary policy gets all the emphasis, the credit windows come second, and economic research and safety & soundness regulation vie for a distant third place. (Consumer regulation is a bastard step child at the Fed and most agencies.)

Third, the Fed is far too close to the systemically dangerous institutions. The SDIs are in an ideal position to exploit opportunities for regulatory “capture.”

Fourth, the Fed is dominated by neo-classical economists that have no theory of, experience with, or interest in the complex financial frauds that are the dominant cause of our recurring, intensifying financial crises. Bernanke appointed an economist, Patrick Parkinson, with no examination or supervision experience to head all Fed examination and supervision.

Fifth, the Fed is addicted to opaqueness and its senior ranks believe the bankers when they claim that the people must never be allowed to learn the truth about asset losses. One of the conflicts of interest that a banking regulator must never succumb to is the temptation to encourage or allow the regulated entity to lie about its financial condition for the purported purpose of preventing a run on the bank. Geithner, unfortunately, embraced that temptation and stated it openly to the Bankruptcy Examiner. It is very easy, psychologically, to believe that you are letting a bank lie to the public for a noble reason – protecting the public. The bankers always tell the regulators that the world will end if the banks tell the truth – but that is a lie. Regulators’ greatest asset is their integrity. I was one of the four FHLBSF regulators that met with the “Keating Five.” To this day, I have no idea what political affiliations, if any, my three colleagues hold. We simply insisted on honest disclosures and we always made a referral to our agency to alert the SEC (and the FBI) to any efforts we found to use accounting to deceive the investors or the regulators.”

Prof. William K. Black, has argued elsewhere that “The Fed refused to exercise that authority despite knowing of the fraud epidemic and potential for crisis”. He pointed out that:

“The Fed’s failures were legion, but five are worthy of particular note.

1. Greenspan believed that the Fed should not regulate v. fraud

2. Bernanke believed that the Fed should rely on self-regulation by “the market”

3. (Former) Federal Reserve Bank of New York President Geithner testified that he had never been a regulator (a true statement, but not one he’s supposed to admit)

4. Bernanke gave the key support to the Chamber of Commerce’s effort to gimmick bank accounting rules to cover up their massive losses — allowing them to report fictional profits and “earn” tens of billions of dollars of bonuses

5. Bernanke recently appointed Dr. Patrick Parkinson as the Fed’s top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS, a.k.a the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.

Each error arises from the intersection of ideology and bad economics.

The Fed’s regulatory failures pose severe risks today. Three of the key failed anti-regulators occupy some of the most important regulatory positions in the world. Each was a serial failure as regulator. Each has failed to take accountability for their failures. Last week, Dr. Bernanke asserted that bad regulation caused the crisis — yet he was one of the most senior bad regulators that failed to respond to the fraud epidemic and prevent the crisis. As Dr. Bernanke’s appointment of Dr. Parkinson as the Fed’s top supervisor demonstrates, the Fed’s senior leadership has failed, despite the Great Recession, to learn from the crisis and abandon their faith in the theories and policies that caused the crisis. Worst of all, the Fed is an imperial anti-regulatory seeking vastly greater regulatory scope at the expense of (modestly) more effective sister regulatory agencies. The Fed’s failed leadership is setting us up for repeated, more severe financial crises.” (see here)