Is it time to bring back Glass-Steagall?
On September 10, 2008, one day after Lehman Brothers Holdings Inc. stock lost nearly half its value amidst investor concerns about the firm’s ability to raise capital in the aftermath of an accounting fraud, the investment bank reported an expected quarterly loss of $3.9 billion after writing down its assets by $5.6 billion. This event ultimately culminated in a 90 percent loss in its stock value from its highest ever price of $86.18 in February 2007.
Lehman filed the largest corporate bankruptcy in U.S. history on September 15, 2008. This was despite reporting record-breaking revenues and net income year after year since 2003, and despite a stronger than expected earnings report for the first quarter of 2008 which lead to a 46 percent increase in its stock price on March 18, 2008.
Lehman’s bankruptcy caused the Dow Jones Industrial Average to drop by more than 500 points in a few hours, costing 26,000 employees their jobs and triggering a 50 percent decline from the DJIA’s October 2007 all-time high. The consequent chain reaction in the stock market obliterated nearly $10 trillion dollars of wealth for investors and plunged the global economy into what has become known as the Great Recession.
Fast forward to On November 19, 2013, when JPMorgan Chase agreed to a $13-billion settlement with the U.S. government over selling faulty mortgage investments. The nation's largest bank admitted to knowingly selling the toxic securities that helped lead to the housing bubble. The settlement is the largest made by any single American company in history.
Now, Wall Street is being warned again about its risk-taking practices. In a November 5, 2015 symposium on ethics at the Federal Reserve Bank of New York regulators suggested that Wall Street executives who continue to ignore the various cultural flaws at their firms do so at their own peril.
It seems that this time really is different: If Wall Street doesn’t take steps to prevent some of the behavior that has led to $230 billion in fines against American and European banks in the last six years, principal regulators appear quite determined to do it for them, promising to break up the big investment banks if they need to. And that will not be an outcome that will appeal to anyone running a powerful Wall Street firm.
The U.S. Federal Reserve Bank has been behind the curve on this topic. Most of the pressure to change practices on Wall Street has been coming from regulators such as Mark J. Carney, the governor of the Bank of England and Christine Lagarde, the managing director of the International Monetary Fund. In February 2013, Mr. Carney said that the sacred trust between bankers, their clients and the public had been broken in the aftermath of the financial crisis.
“Virtue cannot be regulated,” he said. “Even the strongest supervision cannot guarantee good conduct. Essential will be the rediscovery of core values, and ultimately this is a question of personal responsibility. More than mastering options pricing, company valuation, or accounting, living the right values will be the most important challenge” for Wall Street.
In May 2014, in the wake of continuing financial scandals, Ms. Lagarde berated the industry. “While some changes in behavior are taking place, these are not deep or broad enough,” she said. “The industry still prizes short-term profit over long-term prudence, today’s bonus over tomorrow’s relationship. Some prominent firms have even been mired in scandals that violate the most basic ethical norms.”
She spoke of the need for a Wall Street culture of “greater virtue and integrity” and for banking to revive the idea of telos: “Its purpose and broader responsibility to society.” After all, she continued, “the goal of the financial sector must be not only to maximize the wealth of its shareholders, but to enrich society by supporting economic activity and creating value and jobs — to ultimately improve the well-being of people.”
Her prescriptions for how to improve Wall Street’s culture only seem the slightest bit fantastic, or idealistic, because the industry seems to have lost its way in recent decades. The fact is that Wall Street chiefs need to seize the day. Not a single one has suggested a new approach to running a financial firm that takes into account some of the ethical considerations that Ms. Lagarde and Mr. Carney have been advocating.
Why is it so hard for Wall Street to behave as Kant recommended? “Act in such a way that you treat humanity, whether in your own person or in the person of any other, never merely as a means to an end but always at the same time as an end.” It’s inspiring advice.
Lagarde spoke of the importance of individuals taking responsibility for their actions and of being held accountable for them. She spoke of the necessity of leadership from the top, where chief executives and boards can reward ethical behavior that benefits the collective good, not just the deals of an individual rainmaker. She lamented the fact that banks in the U.S. and Europe had paid $230 billion in fines with nary an individual at any firm being held responsible for what went wrong.
Wall Street greed has been going on for decades. In the 1980s it was insider trading by the likes of Ivan Boesky. Also, racketeering and securities fraud charges were lodged against Michael Milken. In the late 1980s and early 1990s we all were shocked by the scale of failures at savings and loan institutions that made risky mortgage loans. Where did we here that one before? In the 1990s banks such as Bank of Credit and Commerce International (BCCI) were charged with fraud, money laundering and larceny. Now in the 2000s we are still recovering from the damage and destruction wrought by the biggest Wall Street investment firms. When will it stop?
Reinstituting the Glass-Steagall Act that limited commercial bank securities, activities, and affiliations within commercial banks and securities firms may be a necessary step to bring back discipline to the securities markets. At least the Presidential candidates should seriously discuss the issue during the debates.
Blog posted by Dr. Steven Mintz, aka Ethics Sage, on December 22, 2015. Professor Mintz is on the faculty of the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at: www.workplaceethicsadvice.com.