A panel of Darden faculty offered context and explanations Sept. 24 for the ongoing turmoil affecting the financial markets and they managed to do it without once uttering the word “greed.”
Yet during their discussion it seemed obvious that the complex, cause-and-effect interplay of terrorist activity, Federal Reserve policy, relaxed regulation and creative mortgage financing in the last nine years created a climate of poor business leadership and loose ethics that fed a consuming desire for wealth.
The dialog also focused on the implications of the financial crisis of 2008, especially on how it may impact the career prospects of MBA students and graduates. Watch and listen to the panel discussion.
One panelist suggested that drifting from bedrock principles of sound leadership and ethical decision-making has triggered a financial implosion that may yet top a trillion dollars – with uncertain consequences for taxpayers who may be left footing the bill of a proposed federal bailout.
“If you lose sight of yourself and drift, it leads to the consequences we have now,” said Professor Alec Horniman. “It’s about having the courage to say, ‘this is the right thing to do,’ and then doing it. You and I had better understand the system that got us here.”
While Congress mulls a $700 billion bailout package, Professor Peter Rodriguez said he is not convinced the consequences would be catastrophic if lawmakers instead do nothing. Still, he predicted some form of near-term government intervention, saying, “I don’t think we want to stand here and play chicken with the Great Depression.”
The roots of the current crisis can be traced, in part, to the Federal Reserve’s efforts to stabilize the U.S. economy in the aftermath of 9-11. Historic lows in interest rates “super-oxygenated the housing market,” Rodriguez said, by fueling mortgage lending. Because the United States continues to be the world’s largest borrower, the rapid growth in lending coincided with a tremendous influx of international capital to finance increasingly exotic and high-risk mortgage products.
Professor Elena Loutskina, a finance expert, explained how the housing boom created unprecedented opportunity for financial services companies, which scrambled to develop new loan products while accelerating the securitization and sale of loan portfolios to other financial institutions. Investment banks took it a step further by wading into the
subprime markets and rapidly amassing portfolios of loans to risky borrowers. Despite the skyrocketing growth in lending, the markets still seemed safe, she said, because derivatives were backed by mortgages.
But as borrowers defaulted on their home loans, capital dried up and investors began demanding their money back. Financing companies were suddenly faced with no liquidity and no money to borrow – either to service debt or underwrite new mortgages.
“Now investors have no idea which part of the mortgage-backed securities market is good and which is bad,” Loutskina said.
Professor Brandt Allen, an accounting expert, said it is now clear that huge mistakes were made in assessing and pricing now-toxic securities. SEC and other regulatory intervention will likely occur to protect investors of mortgage-backed securities as companies attempt to write-down the value of their assets, the professor said.
The current spate of investment-bank implosions and unraveling portfolios of worthless securities is markedly different than a similar situation that occurred in the late 1980s. When investment bank Drexel Burnham Lambert failed in 1990, drowning in a quagmire of junk bonds, there was no talk of a government bailout. But Professor Susan Chaplinsky, who moderated the panel discussion, noted that the current climate is far worse. Today there’s a lack of transparency in financial institutions’ over-the-counter investments (unregulated, privately-negotiated contracts), compounded by illiquidity, exotic balance sheets and growing reliance on short-term financing. Overnight lending has soared in the last decade, she observed. This raises the cost of short-term capital – further weakening troubled institutions – or prompts lenders to close their vaults and deny additional credit.
Still, these are ancillary factors adding fuel to the fire, not the underlying cause. The discussion came full-circle with the observation by Professor Ed Freeman, an expert on business ethics, that the real problem is theoretical and has more to do with the way some executives approach their careers in business:
“We have a broken idea about what business is,” he said. “Ignoring ethics and responsibility is what drove this crisis. First and foremost, we have to learn to become leaders of people to create value. Finance without responsibility is like saying ‘I can do whatever I want.’ But we must go out and create value in a sustainable way. If we don’t address the theoretical problem – guess what? We’re going to have this again. We have to put ethics at the center of business education.”
The panel discussion was the first in what is expected to be an ongoing dialog within the Darden community about the role of ethics, leadership and personal responsibility as the financial crisis continues to unfold. All Darden alumni have been invited to join the discussion.
Founded in 1955, the University of Virginia’s Darden Graduate School of Business improves society by developing principled leaders for the world of practical affairs.