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Saturday, March 15, 2008

The Reality of Morality

It seems several bloggers are going in the same direction at once. As an adjunct to my post of yesterday, see Steve Waldman:
One thing to remember is that there is no such thing as "capitalism". In the real world, there are actual practices and institutions, the details of which bear consequentially on both moral and economic outcomes. There are infinity of possible capitalisms, and at any given moment we are living just one. A stylized graph of supply and demand always hides more than it reveals.

The capitalism we are living right now is rather a nightmare, due to a credit, um, event. So it seems a propos to remember that credit analysis traditionally includes an explicitly moral component.
and Naked Capitalism chimes in:
Although Waldman makes a good case, the barriers to the return of character in commerce are more profound than he lets on.
What makes it possible to have values is enforcement mechanisms, which usually boil down to prevailing standards. In a small town, if a store owner is unpleasant, tries to short change customers, or kicks his dog, word gets out and business suffers.
both referenced by Tanta at Calculated Risk:
...I was in some meeting of the CRA Committee (Community Reinvestment Act), wherein we were examining the proposed guidelines for a low-income lending initiative. There was some resistance to the loan program based on the fact that borrowers with incomes as low as 50% of the area median could qualify. Grumbling about having to make loans to "poor people" ensued. My boss pointed out that over half the rank and file in his department who would be actually handling these loans--reviewing the loan files, preparing them for the servicing system, delivering them to custodians and investors--were paid 50% of the area median or less.
It is always a surprise to those not in the field of banking to learn that most of the consumer lending enforcement falls under the rubric of "safety and soundness". The reason you will get written up if you are writing abusive loans will be because it is unsafe to do so. If you are working over desperate customers, you are creating a risk to the bank. It's that simple. Write abusive loans, and you create a situation in which sooner or later you will be taking some pretty heavy losses. It's somewhat easy to write abusive loans that don't violate statutes and regulations, but it is still risky to do it.

Obviously non-bank mortgage companies don't get examined in the same way, which is one reason why the mortgage mess got so dire. Not only did extremely low standards of customer treatment predominate in those businesses - those businesses did so well that it was hard for banks not to start doing the same thing. In the late 1990s banks gained the ability to buy and run non-bank financial corporations through the effective repeal of Glass-Steagall. The ability of the big banks to buy and operate non-bank financial subsidiaries and to sell the resulting loans to some dingbat investor somewhere removed a lot of the legal justification that the agencies had for enforcing decent loan standards. The banks could and did claim that the risk had been successfully offloaded. Obviously it hadn't been - it had just been tossed out into a giant risk agglomerating machine which is now regurgitating chunks of it and taking down good businesses with good business practices.

It is a commonly held belief among non-businessmen that morality and making a profit are contravening goals. In my experience, I think it is hard to make a consistent profit without basically running a moral business. This is why I love the community banking area. The majority of community bankers truly believe this. They believe that if they impair their customers their business will suffer.

Of course this extends beyond banking. If you routinely work your suppliers over when you have the upper hand, sooner or later you will find that your suppliers are willing to deal with others on better terms, that they'll deliver to others first, and that your business is impacted. The more power you exert, the greater the eventual backlash. WalMart, frankly, is an example. If you routinely short others on contracts, you are not going to be anyone's first choice.

Bear Stearns is probably dead, and one of the reasons is that Bear Stearns has a history of non-cooperative behavior stretching back to LTCM and beyond.

Unfortunately in our culture we have become fixated on sexual morality (at the same time we pretend that there are no reasons for it), but sexual morality is only one piece of workable moral standards. The not lying, cheating, and stealing parts are just as important. All workable ethical systems focus on effect and result, which is why the Golden Rule is constantly re-evolved in various cultures. Treating each other as we would like to be treated demands that we
In business, especially when we are dealing with parties such as consumers who are presumed to have less understanding of various transactions, writing contracts that have hidden risks creates huge risks for everyone. The systems of regulation and supervision, plus the restrictions on banking activity, were evolved as the result of pretty consistent cycles of economic chaos culminating in the Great Depression.

I will get back to the inflation question, but I found it striking that so many people are attempting to convey the same information. I hope you will read the links. Steve Waldman ends his post with "
Perhaps the art is to come up with a system, however imperfect, under which being good is the best way to succeed." I agree with the sentiment, but I believe that the only way to achieve durable, sustainable success is to be good. It is easy to create short-term profits but much harder to create a situation in which short-term profits don't become long-term losses. All our "capitalistic" experience has demonstrated that regulation of financial operations is necessary to prevent a rolling cycle of financial panics. In the absence of effective regulation, bad money chases out the good.

I entirely agree that Moral behaviour is more successful over the long term.However when success is measured by the quarter and unethical behaviour provides big rewards quickly then you can have a situation where bad behaviour drives out good and the ethical people go broke or leave.
Of course. As an example, in the worst markets the ethical appraisers got out of the business.

That's why regulation and enforcement is needed. It shifts the horizon from the short to the long.
In the short term badness wins. The raider raping and pillaging gets an immediate return. The liar gets more sexual partners and money. The dishonest business man gets more profit. The take no prisoners GOP operative wins.

Eventually the raider has no victims, the liar has one to go to, the dishonest business man goes broke and the Dems develop backbone as the public gets sick of it all.

It takes a while.

The wonder of the Great Depression is that it broke the political powers that were by in large busting economically the powers that were.

The same clearing function is being done today.
This is an excellent, excellent post. Thanks.
Excellent post. The Fed, the SEC, the FDIC, the regulatory agencies -- these exist for important reasons. One need only examine the economic history of the US in the 19th century (think frequent financial panics) to understand that certain minimum standards must be enforced -- because the alternative of letting the market enforce standards leads to massively expensive disasters.

I think we should have a policy of ZERO inflation. In a non-inflationary environment, there is no need to "invest" in folly just to maintain purchasing power.

By lowering interest rates and creating inflation, the fed is encouraging spending and/or investing. It just isn't working.

It may be a surprise to many, but prior to the founding of the federal reserve in 1913, there was essentially no CPI inflation in the U.S. (1690 - 1912). It took from 1690 to 1971, for the first trillion of credit to be created in the U.S. The last trillion was created in the only 10 months. What have we accomplished in the last 10 months?
Good memory on Bear, Sterns not playing nicely with others. When I was putting on my short broker positions which were soon to bring me fame and fortune (ok just fortune) I stayed away from Bear having remembered what a tight ship they had always seemed to run in the past. Oh, well.

Leverage is an expensive mistress.

Off to London tonight. I'll try and see if the Union Jack is still flying at the airport...
I am pretty sure it will be. Have fun. It will be expensive!

PS: Unless you get to the Cathedral of Westminster.
Good post.
Agree, enforcement mechanisms must be in place and available for use.

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