We live in a world that is networked in ways we cannot see,
fully comprehend, or at times even imagine. The idea that brokers on Wall
Street dealing in credit default swaps could have an impact on my retirement
seemed unlikely not too long ago. I hadn’t even heard of credit default swaps.
I didn’t own any. Still don’t. I don’t even particularly like hearing about
them. But as it turns out the Wall Street brokers really exist, the impact on
my retirement certainly is real—though whether credit default swaps actually
exist as things with actual value is a question worth debating.
In any case, some huge investment banks—“too big to be
allowed to fail”—have lost money, while some have made money, very large
amounts of money during the crisis. One firm that has had a profitable time is
Goldman Sachs. They recently built a new headquarters, a massive new skyscraper
to house the brokers, lawyers, secretaries, and managers and that make up the
firm.
Most large investment banks love the limelight, and calling
attention to their flashy, expensive headquarters is just part of the process
of projecting a successful image. Paul Goldberger picks up the story in “Shadow
Building,” which you can read here (The New Yorker, May 17, 2010; p. 114-115):
Goldman Sachs, one of
the largest and most profitable financial firms in the world, has a different
view of things. Several thousand Goldman employees have just moved into a sleek
steel-and-glass headquarters in lower Manhattan that is emphatically not called
One Goldman Sachs Plaza. At 200 West Street, as the building is known, the name
of the firm appears nowhere on the exterior, or in the lobby, or even on the
uniforms of the security personnel or the badges given to visitors. Forty-three
stories tall and two city blocks long, the Goldman building appears to have
been designed in the hope of rendering the company invisible.
These days, it would
be understandable if Goldman Sachs wanted to disappear: being the object of a
suit by the Securities and Exchange Commission and, reportedly, of a criminal
investigation by federal prosecutors is hardly conducive to the desire for a
high profile. But this building, designed by Henry Cobb, of the firm Pei Cobb
Freed & Partners, was planned long before the financial crisis, and before
accusations were made that Goldman had bet against its own clients in the
subprime-mortgage market. The design speaks less to Goldman's current problems
than to the firm’s long-standing obsession with being both extremely powerful
and utterly inconspicuous.
Today, the idea that
Goldman Sachs could operate with a low profile seems bizarre, even delusional.
But for a long time it did. Its previous home, at 85 Broad Street, was a
precast concrete tower, from 1983, one of the most forgettable tall buildings
in New York. Having outgrown those premises, Goldman hired Cesar Pelli to build
a glass tower in Jersey City, facing the Hudson River—finished in 2004, it’s
the tallest and most elegant skyscraper in New Jersey—and laid plans for a new
headquarters on the New York side, too. It fixed on a plot in Battery Park
City, one block northwest of Ground Zero, which had been a parking lot for
years. At the time, there was not a lot of development going on in lower
Manhattan, and Goldman’s plans appear to have sent city and state officials
into giddy ecstasy. They quickly agreed to give the company a hundred and
fifteen million dollars in tax breaks and cash grants to build the new tower.
More singular still, state and local governments decided to give the firm
another big subsidy by letting it use $1.65 billion in tax-exempt Liberty
Bonds, intended to stimulate economic development after 9/11, to cover part of
the building’s $2.1-billion cost. Last month, Goldman announced that it had
made a profit of nearly three and a half billion dollars in the first quarter
of this year—enough to have paid for the entire building, in cash, in a couple
of months, without any help from taxpayers.
On March 20, 2009, David Miller (author of God at Work, director of the Faith & Work Initiative at Princeton University, Senior Fellow of Trinity Forum, and professor of business ethics) was interviewed on Religion & Ethics Newsweekly (a PBS program). Though brief, Miller identifies some key issues that must be addressed if the world of business and finance is to serve any morality higher than an addiction to greed.
Q: President Obama has been talking this week, this past week about precisely that—some kind of change in the corporate culture, the business culture. What would that look like?
Dr. Miller: Well, it’s such an important issue—how can we have a culture, a corporate culture that accents character, that accents the common good and not just earnings per share or a penny more per share per quarter? That’s a new culture. Is it possible that companies can make a decent profit—create wealth, create jobs, provide goods and services for society and maybe even be a moral community to develop its people? I think it can, but it will take leadership that’s committed to a new vision.
You can listen to the interview with Dr Miller here. I recommend it to you.
James Surowiecki, a writer at The New Yorker who covers economics, business, and finance, says that credit-card debt is part of the problem which has added up to the world’s present financial crisis. And though it could seem that the answer is an easy one—simply have everyone pay off their balance—things in our globalized, interconnected world are never as simple as we would like. In his fascinating piece, “House of Cards,” Surowiecki provides insight into how the credit-card business works:
For decades, they’ve been deluging Americans with come-ons (in 2007, 5.2 billion offers for new cards were sent out), so much so that, as of 2006, there were nearly 1.5 billion charge cards in circulation. And these cards did not go unused: between 2000 and 2006, even as Americans’ real income was essentially stagnant and their savings rate negligible, credit-card borrowing rose by about thirty per cent. Our willingness to spend beyond our means served the credit-card companies well: their profits jumped forty-five per cent between 2003 and 2008…
But credit-card companies have created a strange business, in which there’s a fine line between good and bad customers. Their best customers aren’t those who dutifully payoff their balance every month; instead, they’re the ones who charge a lot and pay only a little every month, carrying a sizable balance and racking up interest charges and late fees. These are the “revolvers,” and the credit-card business feeds on them. Credit-card companies don’t necessarily want revolvers to payoff their debts; if they did, there’d be no interest or fees to collect. They want their loans to be, in the words of a banking regulator, “a perpetual earning asset.” And they’ve thought a lot about how to keep those interest payments coming. For instance, they used to keep minimum payments relatively high. But, over time, companies started lowering minimum payments, sometimes to just two per cent of the balance. The lower the minimum payment the less people pay off each month and the longer they stay on the hook.
The catch is that while revolvers are the companies’ best customers, they’re also more likely to default, which would make them the worst. That’s why credit-card companies have had to rein in their lending and shed accounts. Since that risks shrinking profits, they’re also trying to get as much as they can out of their existing customers, by doing things like sharply increasing their interest rates. This increase is partly a response to the greater risk of default, but it also takes advantage of the recession. Many cardholders don’t have enough money to pay off their balance in full, so when interest rates rise they aren’t able to just close their account and get a different card. Effectively, they’re captive customers. And since credit-card companies, unlike most lenders, are allowed to change the terms of their loans at any time, people who borrowed a big chunk of money at, say, nine per cent may now be paying seventeen per cent on the loan.
These tactics are not going to improve the credit-card industry’s dismal reputation. They’re also not going to help an economy in recession, since reduced credit lines take away an important cushion for consumer spending, and higher interest rates and increased fees are likely to drive more people to default. But the odd thing is that while less access to revolving credit is a bad thing for us in the short run, having people rely less on credit cards is a good thing in the long run. The easy availability of credit cards encouraged people to live beyond their means—studies suggest that people really do spend more when they can pay with a credit card, and that big credit lines further encourage extravagance. And the high price of credit-card debt meant that billions of dollars in interest and late fees went to credit-card companies instead of to more productive uses. Smaller credit lines and less borrowing make sense. But in the short run they’re going to throw a lot of sand into the economy’s gears.
Source: “House of Cards” (The Financial Page) by James Surowiecki in The New Yorker (March 16, 2009) p. 45.
The Root of the Problem
September 26, 2008
Hank Paulson, secretary of the Treasury, argued last weekend that the new bailout plan he was proposing would finally go to the root of the problem. That problem, he said, is the “illiquid mortgage assets that have lost value as the housing correction has proceeded.” He wants Congress to approve a $700 billion package that would give him, on behalf of the federal government, almost unlimited authority to buy up the bad (“toxic”) assets so banks can feel confident to lend again.
But why have so many mortgage assets lost their value and become illiquid? The primary reason is that banks and investment companies irresponsibly encouraged people to take out mortgages not adequately backed by the value of the homes they were buying. Perhaps, then, that is the deeper root of the problem.
Well, not quite. Why were these sub-prime mortgages offered and accepted so irresponsibly? Because both the financial institutions and the homebuyers were betting--gambling--that home values would continue to rise and thus “produce” in the future the asset security that did not exist at the time of purchase. That, in turn, would give the financiers more time to try to make more money by means of more leveraging of more money.
Martin Wolf explains that the “aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007” (Financial Times, 8/24/08).
Yet, why were so many families and financial institutions taking on and trying to leverage so much debt? What was the root of that dangerous gamble? In part, government itself was encouraging individuals and companies to buy (or borrow) now and pay later. Government-sponsored mortgage companies Fannie Mae and Freddie Mac led the way or backed up those who were leading the way in this direction. Homebuyers trusted the banks. The banks trusted Fannie and Freddie as well as the investment companies that leveraged the mortgages. Investors trusted the market and those who rated the investments. And this circle of trust depended finally on trust in the government, whose laws and policies backed up or overlooked all this debt-mounting leveraging.
Now, however, the circle of trust has been broken--all around. As a consequence, Paulson’s narrow focus on the “liquidity problem” doesn’t begin to go to the root of the problem. Over the past few months, and particularly the last two weeks, Paulson and Federal Reserve Chairman Ben Bernanke have tried one expensive fix after another that has failed to overcome the liquidity crisis. And they, along with President Bush, now want us (and investors, and Congress) to put our trust in their last-minute bailout plan that requires additional massive public indebtedness? Why should any of us now assume that this program will work?
Clearly, the root of the problem is a lack of trust, including lack of trust in government. For after all, Congress as well as the executive branch has been complicit in the entire system that is now collapsing around us. It is a little late, then, for them to cry “emergency,” abrogate the so-called principles of free-market capitalism that the president says he still believes in, and ask the country to trust them now. This is simply the next--and an even bigger--gamble, made in the hope that prosperity can somehow be recovered without requiring any fundamental change in our habits, desires, and mind-set.
But it won’t work. Trust will not be restored until real responsibility and genuine accountability are reestablished at every point around the circle.
-- James W. Skillen, President
The Capital Commentary may be photocopied or retransmitted in its entirety but not otherwise reprinted or transmitted without permission. Commentaries do not necessarily represent an official position of the Center’s but are intended to help advance discussion.
Copyright Center for Public Justice 2008.
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James Skillen is a keen observer of the political sphere of life, committed to seeing it through the clarifying lens of the gospel. This brief essay arrived via email as part of The Center for Public Justice’s thoughtful Capital Commentary series. I recommend the work of the Center to you, and would encourage you to sign up to receive the Capital Commentary emails.
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If you are like me, what is happening in the financial markets is difficult to comprehend. So, when thoughtful scholars who have expertise in such matters write about it in a way that sheds some light, I am grateful.
Like this post, "Distinctions of This Financial Crisis," (September 21, 2008) by Robert Bruner (Dean, Darden School of Business at the University of Virginia) on his blog, which you can read here.