Ethics Resource Center

Column
By Patricia J. Harned, Ph.D., President, ERC

Financial Crisis: Living With the Legacy

A financial blow-up of, say, AIG dimensions is nasty for the company involved, its employees and its shareholders.  It’s the legacy of the blow-up that the rest of us have to live with.

Along those lines, the U.S.-led global financial crisis and subsequent cratering of the world economy were gut-wrenching, no question.  As we’re now learning from books like "In Fed We Trust" by David Wessel, economics editor of the Wall Street Journal, things were even more serious and frightening behind the scenes – and behind Fed chairman Ben Bernanke’s stony-calm exterior.  But scary as it may have been to be skating so close to the precipice, it’s the legacy of all that mess that will be percolating through American business and banking for a long time to come.  And the outlines of that legacy – legislative and regulatory – are only now beginning to come into focus here in the nation’s capital.

It’s going to be fascinating (maybe morbidly fascinating) this fall to watch Congress and the Administration struggle to fashion remedies for the kind of outlandish, untethered-from-reality risk-taking that caused the sub-prime housing industry to implode, followed by the derivatives markets and those, like AIG, who insured them. Isn’t global connectedness fun?  Even though we all understand now that banking and financial markets are super high-tech and trading occurs at lightning speed and with off-the-charts sophistication, what will be unfolding inside the Beltway this fall – this too-late closing of the barn door – is a cyclical ritual in Washington.  Let’s hope that, like the physician, Congress and the regulators will first do no harm.

To give credit, there are serious proposals afoot, led by the Administration’s 101-page brief for financial regulatory reform.  And we can stipulate, for the sake of discussion, that there is room to tighten up the law and the regulations.  There usually is. But it would be refreshing if officials acted thoughtfully here because they will be writing the legacy that the rest of us have to deal with until the next economic or financial fiasco.

History tells us the entire thrust of the federal government’s approach will be compliance-based.  It’s what lawmakers and regulators do. Part of the ritual is to write new rules that this time will really stick it to the bad actors.  As soon as Congress returns from its August recess, the House and Senate will begin work on major re-writes  of the entire financial regulatory corpus ("re-reg" is the term of art), including an entire title, or chapter, in the Senate version devoted to corporate governance measures such as "say-on-pay."
Executive branch agencies, meanwhile, have been in high enforcement mode for months.  Three guest speakers from the Administration at the July meeting of the ERC Fellows Program all emphasized tougher rules, higher compliance standards and a dedication to transparency and accountability in the distribution and spending of taxpayer bailout and stimulus money.

The catch is that strict reporting of financial data tells only part of the story.  And it follows that a lot of heat and light in making the rules more expansive and enforcement ever-tighter does not take us to the heart of the problem.  Of course, there is no foolproof system, humans being human.  But there is a better way than relying entirely on objective reporting of financial details.

ERC research shows that a rules-based ethics program is essential in an organization.  A principles-based ethical culture also demonstrably reduces misconduct. When a company or agency combines the two, they do themselves a big favor.  The same idea should be informing any action coming out this fall from the Hill and the regulators. The lack of focus on measurable ethical culture activities is a chronic blind spot in the government’s perspective.

In ERC's experience, an ethical culture is one in which the directors and top management take ethics seriously and work to embed ethical values in the organization; middle management supervisors reinforce and respect the values, and peers on the factory floor get the message that "that’s how it’s done around here."

Ethical culture metrics, then, should track the danger of conflicts of interest at the board and senior management levels – especially now that taxpayer dollars are flowing in the veins of many a bank, auto maker, mortgage company and stimulus recipient.  Metrics should help uncover corporate systems that encourage excessive risk-taking by CEOs and other top executives, rewarding short-term gains and a boost in the stock price at the expense of long-term stability and growth.  Measures should be taken of whether the culture encourages whistle-blowing or permits retaliation against those who report wrongdoing.

Collecting and analyzing survey data on ethical culture, as well as traditional auditing and accounting safeguards, is an idea whose time needs to be coming soon.  If it does, it may help tamp down the fire next time.

In This Issue

• Financial Crisis: Living With the Legacy
  Column By Patricia J. Harned, Ph.D. President, ERC
• Bring Your Code of Conduct to Life
  
• The Ethics Recession Reflections on the Moral Underpinnings of the Current Economic Crisis: Book Review By Frank J. Navran
  
• Ethics During Difficult Financial Times: A Conversation with Steve Miranda, Chief Human Resource, Strategic Planning and Diversity Officer, Society for Human Resource Management