Who is my neighbor: A global perspective
Part 1: Piecemeal re-regulation
By Margaret Edgell
I had been thinking about some components of the recent economic crisis before the crisis hit, but it took hindsight for me to perceive the bigger picture. I certainly was not alone; many participants in our economy saw pieces of the picture that made them worry that the lucrative economic boom might end abruptly. Some tried to warn the rest of us. I think of my property manager and my personal financial planner. Both predicted that the real estate bubble would pop—and they spoke up long before Federal Reserve chair Alan Greenspan.
Few among us saw enough of the big picture to worry that a real estate bust might implode the entire financial system. My personal big-picture heroine is Brooksley Born, President Clinton’s chair of the Commodity Futures Trading Commission. She bugged Congress and Greenspan about regulating derivatives, including the masses of mortgages that were turned into securities. Her reward: Congress scooted her out of her job.
Others tried to extract as much profit as possible before the boom ended. We operated in an economy where a mortgage broker could make $1 million in a year and retire early, before any of her mortgages failed. I wondered at the time if a Christian upbringing and Christian values made a difference in how market participants behaved. I consider both my financial planner and my property manager to be good stewards, because they care for the interests of others. Interestingly, one is a self-described Christian, and one is not.
For this three-part reflection I will begin, in part one, by telling the story of how certain components came together to bring us to the point of crisis. In part two, I will describe aspects of our economy and society that I consider salient to the crisis. Last, in part three, I will offer a path to revival, not recovery: the reapplication of the core economic values and virtues of professionalism.
I begin by confessing my part in the general responsibility for the financial crisis. First, I was not an activist shareholder. I chose a socially responsible fund in TIAA-CREF, but for the rest of my portfolio, I rarely read a prospectus. My silence let those who ran the companies in which I invested assume that I wanted maximum quarterly returns more than sustainable business practices.
Second, I was supplied what I now believe was an Alt-A mortgage by a broker. I just barely missed qualifying with Washington Mutual, but my mortgage broker managed to qualify me and sell my mortgage to—Washington Mutual.
My biggest contribution to the crisis was that I pursued the global re-regulation of banks. As an economist implementing international banking policy for the U.S. Treasury in the 1980s, I worked passionately to make the world safer for commerce by supporting multilateral agreements in Basel, Switzerland. Our core objective was to increase the capital requirements of banks around the world. My motivation was to keep U.S. banks globally competitive in that safer world by making sure that capital requirements rose globally.
This is a story of unintended consequences. In late 2003, I presented my Calvin colleagues with shocking data from The Economist magazine on the growth of financial assets held by insurance companies and other nonbank financial companies.1 The article raised the concern that insurance companies manage risk differently from banks and may not be equipped to manage their growing majority of U.S. financial risk. Other worries were that the securities markets were growing exponentially, but regulators did not have enough data to assess risk in these booming markets.
By banks, I mean commercial banks like Washington Mutual, not investment banks like Goldman Sachs. The basic structure of commercial banking creates pressures that readily drive markets toward securitization. High regulation and many years of low interest rates make banking profit margins very thin. Banks’ stockholders still seek returns of 15 percent or better, so banks seek other sources of profit. Higher profit entails higher risk. At the same time, the banking sector has the special role of providing liquidity to the entire economy. Much of consumption and business expansion is fueled by debt, which is often supplied by banks. Add to this crucial role a serious weakness: Banks fund long-term loans with short-term liabilities like overnight interbank loans and deposits that can all be withdrawn in a panic. A central goal of the government bailout was essentially psychological: to prevent a general panic.
My part in the crisis was not my passion to re-regulate the commercial banks. It was the lack of coordination of my work with regulators of the insurance industry and investment banking. Commercial banking is so highly regulated that innovative, unregulated and profitable products, like derivatives, are very attractive to bankers. If insurers are willing to accept the risk, and they are regulated by the states—whose officials are not required to harmonize state insurance regulations with international and federal bank regulators—the re-insurance of mortgage-backed securities in effect falls into the regulatory crack between banking and insurance.
Risk poured into the insurance sector from the banking sector in ways that were so opaque that, even if state insurance commissioners wanted to re-regulate by doubling capital requirements to levels typical in banking, regulators had the wrong kind of risk management data to analyze. Rating agencies like Standard and Poor’s and Moody’s had great difficulty, because the information on insurers was nothing like the reams of data required of bankers.
The problem boiled down to this: Insurers are not bankers. Even so, they started accepting the risk of bankers without ready means to evaluate or manage it. They accepted the expert analysis of the bankers and the (supposedly) independent ratings of agencies like Moody’s and Standard and Poor’s. Alan Greenspan stated in a May 2003 speech that spreading banks’ risk across other institutions in the financial services sector made the banking sector itself more resilient. True, this was good for banks, but he ignored the potential ill effects on the insurance sector. I think that the crux of the problem was that banking regulators with the right risk-management focus and training to evaluate mortgage-backed securities were watching the banks, not the insurance companies.
The central point here is that the system incentivized making a quick million, stretching legal and regulatory boundaries to do so and blaming the system for any negative consequences. We listened to experts without demanding better information. We lacked a systemic, big-picture perspective on how our individual decisions came together across our economy. We saw the results as a function of “the market.” We didn’t recognize that the market is us. The economy is us. We decide every day what kind of economy and society we will give to the next generation. A biblical perspective makes clear that we are each responsible to God for our actions in this life.
Questions for reflection:
- How can you see the big picture of your impact on the economy? Which areas are most important to you (for example: supporting sustainable entrepreneurs, developing renewable energy, finding socially responsible investment funds)? How can you work with others on these?
- What concerns you enough that you want to know more about it? How can you begin to do your own research and analysis? When data is not available, whom do you trust for advice?
- What kind of economy and society do you want to pass on to the next generation of stewards? What advice would you give to them as you hand it over?
—Margaret Edgell, Associate Professor of Business, Calvin College
1 “Who’s Carrying the Can?” The Economist (August 14, 2003): 59-61.