Finance Accounting Investing Business New Moral Imperative Mortgages

Finance, Accounting & Investing & Business’ New Moral Imperative

Mortgages, Risk & Financial Institutions • In a free-market, efficient producers serve customers with good prices outperform competitors & succeed. - Through competition, the general public reaps the benefits of lower prices and better goods & services. - The role of government is to keep competition fair. • Traditional mortgage model was slowly replaced as lenders no longer sought profit from long-term loans. - Instead, banks reaped profits from origination fees or from commissions on making loans. - Banks then sold mortgages to others who bundled, divided them, & sold them to still other investors. • The profit was in commissions: no value was added, but others made $ by reselling the paper in various ways.

Homebuyers • Those who lied about their income are guilty of lying or falsification of some sort. • With booming housing market, buying more house than you could afford did not seem reckless. Lenders 1/2 • Some people blame the lenders (banks & brokers), who received fees for writing mortgages. – Critics charge them & others with greed & acting unethically. • Had the lenders simply lent money to home buyers & assumed the risk of failure to keep up payments, the mortgage crisis likely would not have arisen. 3

Lenders 2/2 • Commercial banks sold mortgages (often subprime) – Investment banks bought, bundled the loans, & issued securities based on the collateral they provided. – The bundles were divided into various sorts of securities & sold to investors of all kinds. • Investment banks developed new financial instruments that became so complex that no one knew what they represented & no one knew what they were worth. – These banks became interested mainly in the commissions from selling financial instruments they invented, & gave little thought to the value of the underlying mortgages. • No one was sure what MBSs were worth or whether they could rely on CDSs, and the lack of knowledge led to a lack of trust and a worldwide financial crisis.

Insurers • AIG structured instruments in ways that no one knew what was subprime &, what the collateral or risk was, & what the risk was. - AIG was morally deficient in providing essentially insurance when it did not have the assets to make good on the instruments sold. Raters • Bond-rating agencies are Standard & Poors, Moodys, Fitch. • Ratings range from AAA to C. – Higher ratings = more secure principle & interest payments. • All 3 agencies gave AIGs paper AAA ratings. • The rating agencies certainly did not perform their function well until it was too late. 5

Government Policy • Lack of regulation by governments, both in the U. S. worldwide, contributed to the financial crisis. • The government bears responsibility for its failure to keep the market fair. • The government failed to sufficiently regulate and oversee the financial giants. • It allowed AIG to issue what amounted to insurance without making sure that it had assets to cover its commitments. • Credit default swaps were over-the-counter two-party contracts, and so not subject to regulation. 6

Moral Lessons from the Mortgage Crisis • Risk should be borne by those likely to benefit. – Those who assume risk in expectation of returns should bear negative as well as positive consequences of their actions. • To increase transparency & make transactions clear to all those directly affected by the it is a matter of justice. – Those who buy securities should know what they are buying and the level of risk involved. • Since moral injunctions aren’t effective in face of big incentives to act unethically or recklessly, we need market-generated controls &/or governmental controls. • When government steps in to remedy situations that risk the economy, its remedies should be carefully constructed to be fair to all.

Corp. Takeovers & Restructuring • The trend of corp. mergers & takeovers developed in the 80 s has been called the restructuring of business. • The trend continued into the 1990 s, when it was joined with the downsizing of many firms. • The many takeovers of one firm by another often brought significant changes in the firms taken over • Takeover threats frequently forced changes in many firms. other companies. • Topics pertinent to an evaluation of restructuring are: corporate takeovers, LBOs, and downsizing. 8

Corporate Takeovers • Ethical debate about corp. takeovers often focuses on the utility & consequences of such takeovers. • Another set of debates focuses not on efficiency or consequences, but freedom versus fairness or justice. – The benefit of this is it allows us to make well-founded ethical decisions now, rather than waiting for anticipated or predicted consequences, like junk bond failures or the onset of a recession. 9

Leveraged Buyouts • Taking private a publicly owned firm by buying its stock. – The $ comes from what have become known as junk bonds. – These are bonds issued against the assets of the company. – Called junk bonds since they are below investment grade. • From an ethical point of view, management LBOs raise a serious issue of possible conflict of interest. • Governments role here is not clear & is being debated. 10

Downsizing • As the 90 s began, restructuring via downsizing joined restructuring by mergers / takeovers rampant in the 80 s. • Downsizing involved making do with fewer workers, both at the managerial and lower levels. – Workers may not have a right to lifelong employment with a firm, but they have a right to be treated with respect, & firms have the obligation to do as little harm as possible in firing folks who have done good work & would normally be kept on. 11

Ethics & Restructuring 1/2 • Restructuring is defended in terms of efficiency, but it is not yet clear whether this has been the result. – Critics claim that no new products have resulted, along with no increased productivity and no new jobs. – The process has also tended to undermine corporate loyalty & increase the level of fear about job security. • Institutional stockholders have fed takeovers. – Fund managers are obliged to vote for a takeover that pays a premium, even if not in the best long-term corp. interest. 12

Ethics & Restructuring 2/2 • Both the utilitarian & deontological approaches can be used to evaluate restructuring financial practices. • Central to the market is competition, and central to acceptable competition is fairness. • In addition to fairness, the market should operate to the benefit of society in general. • If the root of the problems in the finance industry has been correctly identified as greed, – The solution is not to try to change people so they are not greedy or motivate them to control greed, but to establish structures to eliminate temptations to which many succumb. 13

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Accounting • Accounting is the process by which any business keeps track of its financial activities by recording its credits and debits and balancing its accounts. • Management is ultimately responsible for the financial statements, & choosing among the various accounting methods for reporting assets, liabilities & income. 15

Ethical Issues for Accountants • Accountants face a great many pressures from clients who want them to do what is illegal: - Underreporting taxable / over-reporting financial income. - Falsifying accounts, and engaging in outright fraud. • Accountants are governed by FOUR (not 3) codes: - Generally Accepted Accounting Principles (GAAP), Generally Accepted Auditing Standards (GAAS), and Code of Professional Ethics (COPE). THE LAW! • For many practicing accountants, obeying the rules are the guide to ethical behavior (for the law, its insufficient). • For some critics, it is not the individual accountants honesty that is the problem. - They attack the rules & the system itself as ethically deficient.

The Accounting Rules • One major issue is the apparent conflict of interest that is built into the accounting system. • A 2 nd complaint stems from the idea that accounting firms simply certify that the accounts are correctly presented & are in accord with the generally accepted accounting & auditing standards. YES THEY VERIFY. • As a result of widespread scandals, the general public lost confidence it had in accounting firms & corp. s in general, though only a small % engaged in wrongs. • The Sarbanes-Oxley Act was an attempt to help restore public confidence and trust. 17

Ethical Investing 1/2 • Moral responsibility involves a causal connection: – to an action or result that is morally evaluated, – and moral responsibility is properly ascribed and assumed only if the action in question was done knowingly and freely, – and if there were no excusing conditions. • Shareholders cannot be held morally responsible for what a firm does since they are distant from control: – This does not relieve shareholders of all moral responsibility. – No one is ethically allowed to invest in an unethical corp. • To evaluate a firms ethical practice one must consider – The company’s policies. / The company’s record. – Whether a firm is to be held responsible for anything that its employees do, or whether it is to be held unethical only if the action done by a corp. official is part of company policy.

Ethical Investing 2/2 • Critiques include: – Demands are too stringent & so are impossible to follow. – If some individuals & institutional investors do not invest in unethical firms, other less scrupulous investors will. – Ethical investing demands too much because it looks only at specific policies and fails to consider the broader picture. • Many claim there is no evidence that ethical investing applies pressure on firms to change policies. Yet: 1. Even if firms do not change, that is no reason for others to engage in unethical practices by providing them with funding. 2. Strong protests against firms operating in S. Africa during apartheid had some effect since many of them withdrew. 3. Ethical investing should be seen as one part of an overall strategy to apply pressure on companies to operate ethically.

Case Analysis CASE ANALYSIS 20

The Changing Business Mandate • The original mandate to business has changed, as times and conditions have changed. • The new moral mandate to business can be found not only in efforts like consumerism, environmentalism, & conservationism, but in outcries over bribery, windfall profits, & excessive exec. compensation, & new laws. • What is clear in the new mandate is that business must now consider the views of the worker, consumer, & the general public as well as the shareholder in making decisions. The good of all must be considered. 21

Quality of Work Life • Quality of work life is a reflection of the affluence & level of tech. development present in a society, which has become concerned with the general quality of life. • Quality of Work Life involves the following: – – Conditions of Labor The Organization of Worker Relations Worker Attitude 22

The Role of Government • From a moral point of view, no government has the right to demand, through law, that which is immoral. – A prime requisite for a moral government is that it act justly. • A tendency for law to move in the direction of greater free enterprise is no more or less moral than the tendency for it to move in the direction of socialism. • Issues that deserve careful scrutiny are: – Complaints about inefficient government regulation; – About regulators being partial to the industries they regulate; – About people moving back and forth between the regulating agencies and the industries regulated, and; – About overregulation. 23

Corp. Democracy & the New Entrepreneur • One reaction to the death of corp. paternalism has been the rise of individual entrepreneurs. • Once lifelong employment could no longer be taken for granted & once corp. loyalty had eroded workers came to see they were responsible for their own futures. 24

Building a Good Society 1/2 • A society without justice, at least without justice in its basic institutions, cannot be a good society. • A good society must also have a sufficient amount of wealth, distributed in such a way that all its people have their basic needs satisfied & enough in addition for them to enjoy some of the goods of life. – Beyond this, there is no single morally preferable mix of other goods in a good society. 25

Building a Good Society 2/2 • There are three stages in the process of overcoming the Myth of Amoral Business. 1. To see it as a myth. 2. Raise the moral consciousness of those engaged in any aspect of business (workers, investors, management, consumers) or those affected by what happens in business. 3. Change the structures that have been built under the guise of being value neutral. • Processes of business are all value laden. • The need for moral heroes in business is an indication of immoral structures in business. 26

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