Who Will Guard the Guardians? "Darth Rater" Part I.

I've been doing a lot of reading on our economy's financial institutions in preparation for a public forum sponsored by our undergraduate majors' club on the financial markets meltdown. I've been prepping to speak on the ethics involved, and I've obviously been working from my previous two posts.

In my second post, I mentioned that there many actions in this whole crisis that admitted of significant self-justification, the "good intentions" of the road-paving variety. I also mentioned there would possibly be some things discovered that, to reuse my favorite metaphor, could only be described as coming from the Death Star. I've been doing some reading on a highly technical and little known part of the crisis that is so disgusting that I'm calling it "Darth Rater". This is the saga of the companies (primarily S&P and Moody's) who provided ratings for the toxic waste securities. In case you didn't guess, the outrage is that these securities at least initially received very favorable ratings from the two companies.*

These "ratings" probably haven't received the notice they deserved. At one level they're not that complicated: These two organizations rate debt securities in a way that is not all that much different than two of my favorite non-profit organizations: Consumers' Union (at least their non-political arm, the magazine "Consumer Reports") and "Wall-Watchers" which rates Christian charitable agencies. Beyond these two examples, our society is full of ratings of everything from movies to software to football players for fantasy leagues. Often we treat these ratings game as a kind of parlor entertainment, with the fun of pitting our own opinions against those of the pros, and with very small long term consequences. I mean, I always check Consumer Reports, but what is the actual long term cost, if they are wrong, of getting the second best buy on a washing machine? However, the cases of S&P and Moody's have serious differences, as follows:

1 ) My reliance on Consumer Reports is a private transaction. However, the ratings of the financial instruments has been incorporated into the structure of public regulation. For example, according to Bloomberg and the Wall Street Journal, regulation on bank reserves, insurance companies and so-forth is sometimes keyed to the ranking of the securities by the two agencies. Consider the following: I can read Consumer Reports and choose to heed or ignore their ratings of new cars.... that's a purely private transaction. But if I were appointed as a trustee of the investments of a church, and the by-laws required that I only invest in securiteis of a specific quality as rated by S&P or Moody's, then I am not free to ignore that requirement. If I am a banker, and government regulations make a similar requirement, then the decision to rely on the ratings becomes explicitly a matter of public policy.

2 ) Requirements about trustees and bankers that I mentioned above are another example of my "... Good Intentions" thread. We want church trustees and banks to make wise decisions. But when put that expectation in terms of structured regulations, there is a huge incentive for CYA activity of relying solely on the outside raters and not on one's own independent investigations. But, according to the Wall Street Journal, these professional opinions may be less informed than what an informed layperson could "read in a newspaper." Playing if safe by relying on Moody's or S&P rather than on one's own judgment is another example of Moral Hazard.

3 ) Private reliance on raters is subject to market discipline. My wife and I once invited friends over for dinner and a DVD which a movie reviewer had labeled something like "a light-hearterd comedy". The movie turned out to be full of graphic sexual references and cannibalism. That was the last time I paid any attention to that reviewer. If Consumer Reports or movie reviewers persistently make bad recommendations, presumably they will suffer in the market place for opinions. But governments, specifically the federal government, have enshrined Moody's and S&P as a part of a tight, government sponsored oligopoly so that they are not subject to as much market discipline. If you want your securities rated, you have very little choice but to play ball with Moody's and S&P.

4 ) Consumer Reports and Wall Watchers get their money from the consumers of the rated good and organizations, in the form of donations and (for Consumer Reports) subscriptions and sales. Consumer Reports will not carry advertising. Obviously, issues of popularity factor into their decisions as to which goods and organizations to rate. There are some obscure appliances or tiny non-profits that simply can not be handled. However, securities issuers are put in a position (because of the regulatory requirements mentioned above) that their products must be rated. Therefore, it is the securities issuers who pay for the rating services. Or, to say the same thing another way, the ratings companies make their money from the issuers of the securities they are rating. I can imagine that you can see where this is going.... To Be Continued.

* See especially a two-part September series in Bloomberg and an article in the Wall Street Journal.

... With Good Intentions II

In my last post, I focused on the ability of individuals to engage in massive self-deception about the morality of their personal actions. I used Judas as an example, and argued that it was plausible to believe that the root of Judas’ betrayal was not that he turned into some 1^st century Darth Vader, but rather that he substituted his personal moral agenda for that of God. In today’s post, I would like to expand that discussion to societal level decisions and look at the current financial crisis.

I am not enthralled with the positions of either of the two major Presidential candidates on this topic. One of them appears completely clueless. The other has a better handle about the causes and potential remedies for the problem, but --- to stretch the Star Wars analogy to its breaking point --- insists upon casting his analysis as some kind of war between the Good Side versus Bad Side, with the implication that all of our present problems are the result of evil people doing evil things. I will let you, the reader, debate which candidate is which, but the one I wish to challenge today is the one who would like us to believe that these problems were entirely cooked up on the Death Star (there I go again).

There is a likelihood that, by the time that the definitive history of this episode is written, instances of actual fraud will be found. There was undoubtedly a culture of mutual reinforcement between what is now the late, lamented Wall Street and the corridors of power in Washington. (Let us not forget that the Old Testament is particular hard on any unholy alliance of injustice from the combination of wealth and political power). However, what I wish to emphasize today is how many people with good intentions were at work in developing this situation over a total of about 30 years. If the story of Judas is how an individual can disconnect between good intentions and actual outcomes, how much worse can this be in a complicated collective process?

At a minimum, the following good intentions help to contribute to disastrous results:

1 ) It is a good thing to want lower income families to be able to live in dignity in a house that they own and in which they can take pride of ownership.

2 ) It is a good thing to shape public policies that might control fraudulent behavior.

3 ) It is a good thing to want to keep the economy out of a recession.

Yet from each of these good intentions came a piece of the witches’ brew that became part of the current financial mess. Let me elaborate:

1 ( home ownership). Loans to buy houses are called mortgages, and banks have traditionally been very cautious about them. “Prime” home mortgages require significant down payments and credit analysis. In the 1970s during the Carter administration, federal regulators began watching banks to insure that they followed equal processes in considering mortgages from low income areas. By the 1990s, the Clinton administration and various community activism groups had shifted the regulatory emphasis to equal outcomes, which could only be accomplished by banks writing mortgages with much smaller down payments and looser credit requirements. To protect themselves from the concentrated risk of these loans, banks sought to re-sell the mortgages in a larger national market. The two “government sponsored” corporations, Fannie Mae and Freddie Mac, were more than willing to act as major players in the resulting massive securitization, with implicit government guarantees, of what we now call the sub-prime mortgage market. I suspect that if you were a politician between 1997 and 2006, and you waived warnings flags about the securitizations of mortgages to people with low down payments and risky credit, you would have been called an opponent of “affordable housing” and “community redevelopment.”

2 (keeping the economy out of a recession). In 2000, part of the U.S. stock market was tanking from the bursting of the “dot com” stock bubble. By late 2000 or early 2001, the U.S. economy had entered a (mild) recession. However, the terrorist attacks of 2001 sent a secondary shock through the U.S. economy, and the recovery from the recession seemed to be stalling. The response of the Federal Reserve System was to engage an aggressive expansionary monetary policy, possibly taking a cue from the lessons of the previous recession. The resulting low interest rates improved the climate for investing. Unfortunately, so many investors seemed stunned by the previous stock bubble that it seemed that just about everyone on the street decided to invest in what they thought was a “safe” asset --- housing. The result was a massive nationwide bubble in housing prices. The problem with this was that if John Doe, paying on a subprime mortgage (see above) lost his job, he could still get out of his house intact because of the hot housing market. Thus the housing bubble was masking the inherent riskiness of securities based upon subprime mortgages. This cut the legs out from any attempt by politicians to reign in the growing “toxic sludge” of securitized subprime mortgages being abetted by Uncle Sam’s own Frankenfirms, Fannie Mae and Freddie Mac.

3 (accounting regulatory reforms) Following the corporate scandals of the 1990s, federal regulators adopted new accounting standards that required certain types of firms to report their assets at market value, not at what the firms believed that the assets would actually return.

So how did this perfect storm of good intentions get us to where we are today? Well, when the Fed finally began to unwind their easy credit conditions, interest rates went up. This began to burst the housing price bubble. As housing price quit rising at their unsustainable levels, the next John Doe who lost his job was not able to get out from under his mortgage. More and more subprime mortgages went into default, which exacerbated the housing price slowdown, which led to more John Does having problems. All of this meant that suddenly sub-prime mortgage backed securities were not performing as advertised, and the prices of these assets began to fall. But as the prices of these securities began to fall, the new federal regulations on market pricing kicked in, and this threatened the balance sheets of many firms (including Fannie and Freddie). In order to raise cash, firms began trying to dump their toxic sludge mortgage securities, meaning that the prices began to fall faster, causing more firms to have balance sheet problems, and so forth. Companies that sold what was in essence “insurance” against such fluctuations got slammed, and their survival was threatened (AIG being the big example). When enough assets, now not just securitized sub prime mortgages but also insurance contracts, corporate debt, and equity, start crashing together, nobody can sell anything because no buyer can come up with enough liquid assets to make a purchase. This is the liquidity crisis panic that has hit the U.S. financial system.

There are plenty of lessons in humility to go around here. I suspect that a lot of people with economics training were mistaken in their analysis of six years or so of data on subprime mortgage securities. Federal accounting regulators didn’t see the broader effects of their new accounting standards. No adult in the United States should be excused from understanding that bad things can happen if you are paying 60 percent of your income in housing costs and your adjustable rate mortgage payment goes up or you lose your job. But, purely in terms of community “good intentions” gone awry, there is probably no better example than those who set the U.S. on a government-sponsored and enforced program of encouraging home mortgages for people with little down payment and shaky credit, all in the name of “community redevelopment” or “affordable housing” or “helping the poor.” This episode should be required reading for every Christian who reflexively argues that “that government” can, without cost or risk, fix every social problem that comes our way.

....Paved With Good Intentions I

A couple of seeming completely unrelated topics this week lead me to comment upon the idea of “good intentions.” It’s important to recall that the Fall of Adam and Eve was not that they ate of the fruit of the “tree of sin”. Genesis (NIV) version clearly states the fruit was “the knowledge of goodness and evil.” I think that this is an important distinction, because it means that humans, as morally sentimental beings (as Adam Smith might say) get into a lot of trouble because we do think that we know the difference between goodness and evil, and I believe that it is, paradoxically, our reliance on our own good intentions that form a basic part of our sinfulness. I want to discuss this in two parts. This part will look at individual good intentions; Part II, to follow in a couple of days, will look a community of good intentions, and how group “good intentions” were an integral part of the dramatic troubles in our financial system, through the so-called “subprime mortgage” market meltdown.

The point I wish to make today is not proven Biblically. I think it is consistent with the Biblical text, but it depends on my own interpretations. What I wish to argue is that Judas did not become evil in the sense of waking up one day and saying, “Gee, I’d really like to sell Jesus to the authorities so that I can have 30 pieces of silver and buy that vacation house on the Mediterranean that I’ve always wanted.” Instead, I believe that Judas’ sin was in pursuing his own agenda of goodness and evil. I’ve had this idea for a long time, and I was interested that a recent episode of the “Naked Archaeologist” told pretty much the same story.*

Judas was one of the Twelve, called by Jesus, and participating with as part of his inner circle. There is a debate whether the name “Iscariot” refers to a place or perhaps to an association with radical anti-Roman sects. So put yourself into Judas’ shoes. Jesus makes his triumphal entry into Jerusalem. Soon, he fires up the population with the “cleansing of the temple.” If you were interested in Jesus as a temporal, political Messiah who was going to led a real-time uprising against the Romans and the upper-class collaborators, wouldn’t this be the time to strike? Instead, “they went out of the city” (Mark 11:19), returning to Jerusalem only for Jesus to engage in less political but more spiritual teachings and debates in the temple area. For example, in Mark it is in one of these teachings that Jesus issues his “Render to Caesar…” reply, which is hardly the way to get the populace stirred up for the revolution. Can’t you just imagine Judas saying to himself: “Jesus had the city in the palm of his hand, and he’s missing a golden opportunity?” After all, this would be about the zillionth time that one of the disciples misunderstood the nature of Jesus’ ministry and calling. How natural, how much sense it might have made to Judas to say, “If Jesus isn’t willing to bring things to a head, I’ll give him some help. If I send the guards to arrest him, then he’ll have no choice but to launch the revolution.” Of course, Judas was completely mistaken about Jesus task on earth. On a more mundane level, the “Naked Archaeologist” pointed out that by betraying Jesus to the religious authorities, Judas would have had every expectation that being held by the religious council would be the extent of Jesus’ troubles --- a jailed Jesus being the perfect spark for starting a revolt. Instead the religious leaders double-crossed Judas by handing Jesus over to Pilate on sedition charges, leading to His torture and crucifixion. Thus, the motive for Judas’ suicide is obvious.

I’m interested in this not just as a theological puzzle, but rather as part of a broader picture of our own moral sentiments. As mentioned above, I believe that when we substitute our own models of right and wrong for those of God it is in our misguided “good intentions” that we are capable of doing incalculable wrong.

* And if you want a retro source of a similar narrative, read the text of the songs in “Jesus Christ, Superstar”.

Blood Cries Out from the Ground

Since 1973 when the Supreme Court decided that restricting abortions violated the Constitutional right of Americans to privacy (under the Due Process clause of the fourteenth amendment) an estimated 50 million abortions have been carried out in the United States. To place the number of abortions in perspective, they outnumber the populations of New York, Los Angeles, Chicago, Houston, Philadelphia, Phoenix, San Antonio, San Diego, Dallas, San Jose, Detroit, Indianapolis, San Francisco, Seattle, Boston, Denver, Portland, Las Vegas, New Orleans, Oklahoma City, Cleveland, Minneapolis, Omaha, Kansas City, Atlanta, Nashville, Washington DC, Milwaukee, Baltimore, Memphis, and Austin combined. Even when these populations are summed the total number of abortions is still greater by an unknown amount because not all abortions are reported and recorded.

Moreover, an estimated 97% of these 50 million abortions were reportedly obtained for the purposes of birth control, ie without the circumstances of rape, incest, or birth complications that are often repudiated as reasons for the allowance of abortion. Note also that 97% may be upward biased as there are likely significant amounts of women that obtain an abortion that do not admit to their rape. To continue the pregnancy that was built upon such a heinous act many would consider virtuous. Those particular circumstances are ones that I do not choose to expound on in this blog post. But, I would like to talk about the abortions obtained from those using abortion as birth control using the story of Cain and Abel.

The story of Cain and Abel takes place in Genesis Chapter 4. Cain is a farmer and Abel is shepherd. Both Cain and Abel produced to the Lord an offering from their occupation. Cain presented the Lord with some of his crops while Abel presented God with “the best of the firstborn lambs from his flock”. God rejected the offer Cain made but accepted the offer Abel made. Cain became jealous and later murdered Abel. When the Lord asked Cain about Abel he acted as though he was ignorant to his whereabouts. But, God told Cain that he could hear Abel’s blood cry from the ground.

The reason I convey this story is to make the point that we often commit egregious acts of violence or wrong for petty reasons, because something inconveniences our lives. Often these violent acts such as abortion are justified by an explanation that the mother would have been unable to give the child the very best care. While I cannot measure the sincerity of such a claim it appears to be a partial explanation that misses the greater scope and importance of life. Life is precious. This is not a concept easily understood. How can you convince someone that their child’s life is sacred when they do not recognize their own life as being sacred? Jesus died for every person on this earth. John 3:16 did not read, “God so loved the people in the American Suburbs that he gave his only begotten son . . .”. Instead the scripture reads, “God so love the world”.

Convenience though is king. In economics we say that “profits direct business” and many times these businesses are in the business of making our lives easier and more convenient. This is not inherently a bad thing. Increased convenience also gives us the opportunity to invest our time in other endeavors that have the possibility of increasing productivity or the quality of our relationships and community with other people as well as God (Though our free time may not often be used in this way). Instead I believe that all of this convenience has had the unintended consequence of creating a culture that does not want to -or- does not understand the concept of being inconvenienced. In that way our love of convenience may create a mindset that abhors anything that blocks our path to selfish maximization of our own happiness and goals. What is more, we do not even realize how petty these goals really are!

Do You Want the Paper Pill or the Electricity Pill?

One of my pet-peeves, as any reader of this blog and many of my students will know, is what I call “bumper-sticker environmentalism”. By this I refer to the tendency for individuals to prescribe overly simplistic personal choices as public markers for being environmentally politically correct: “Drive a hybrid and heal the planet.” One of the reasons I don’t like these catchphrases is that they tend to be self-referential in a “look how noble I am” type of way. And then there’s the larger theological question as to whether the idea that the Heavens and the Earth need our “healing” isn’t putting human beings substantially above our pay-grade. But a third reason I am skeptical is because these “bumper-stickers” resort to such incredible simplifications that they ignore environmental or social costs on other dimensions. These are the so called “unintended consequences” of good intentions….an increase in the incidence of malaria after DDT is banned to saved endangered species; the presence of trace amounts of mercury in energy-saving light bulbs; the fact that looking at the retail consumption “carbon footprint” of a product may be very different than the lifecycle carbon footprint, taking into account the production, transportation and distribution of the good before it reaches the retail market and also all relevant disposal issues.

On a recent vacation, I had the opportunity to visit several public buildings such as museums, restaurants, theaters, and churches. What struck me (and maybe I have just been missing this recently) is how many of the Men’s Rooms now have both paper towel dispensers and electric hand dryers. I can recall a time when many companies put up placards saying that, in order to save the forests of the world, they were eliminating paper towel dispensers and switching to electric hand dryers. Of course, electric hand dryers run on, well, electricity, which is produced largely (in the United States) by fossil fuels with carbon emissions. So, one might expect a switch to paper alone. But I regularly saw both.... a "let's satisfy everyone type of approach."

Fair enough, but I had this weird picture of someone wedded to bumper sticker environmental slogans washing his hands at a theater with just a couple of minutes left in the intermission….the lights are blinking, and soon he will be shut-out of the second act. He’s standing there, paralyzed with indecision, trying to figure out what is better for healing the planet.

“I if I use the paper towels, then in some small way I contribute to deforestation (this is true even if these particular towels are re-cycled, because any shift in demand is going to affect the whole market). But if I use the dryer, then I’m using electricity which adds an incremental amount of use of fossil fuels, unless of course this electricity is produced by a nuclear base-load power plant or wind-power. But there’s the same general problem as with the towels; any increase in demand is going to pass through the entire grid, so even if in Manhattan they have a contract for wind power (not generated, of course, by windmills that would harm the vistas of people living on Cape Cod or Martha’s Vineyard, but windmills that are somewhere out in flyover country where nobody cares about the vistas, except that windmills do have an unfortunate side-effect of buzz-sawing birds ) the net effect could still be an increase in load from a gas-turbine generation facility”….. Tick Tock Tick Tock, time is running out. What will you choose? Do you want the paper pill or the electricity pill?

Adam Smith is often completely misunderstood to assert that individuals are naturally greedy or uncaring towards one another. Actually, what he’s saying in the Wealth of Nations is that because of the information-decentralized and highly interconnected world of the market, it’s virtually impossible to try to squeeze virtue through society by imposing some social benefit lens on our daily market transactions. Although he wasn’t talking about “green” consumers, I think his point pretty well applies to the example I’ve given above. From reading through the Theory of Moral Sentiments, I don’t have any doubt that Smith thought that virtuous men and women might want to consider their own preferences about final consumption and whether, for example, a 24,000 square foot mansion or gold-leaf covered ice cream are marks of prudence. But I think he would have been skeptical of our current moral fascinations about paper or plastic, organic or attractive, this fair-trade organization versus the other fair-trade organization, trees or electricity, hybrid versus plug-in. And, as a final thought, as Doug often has pointed out to me and is implicit in Adam Smith, if you purchase prudently in the market, don’t you have more resources at the end of the month that you could directly contribute to solving some of society’s problems?

All in the Family: A Frayed Part of the Safety Net

Every year I have my undergraduate "Principles" class try to find someone who lived through the Great Depression and interview them. (I don't know how much longer this will be easy, so the alternative is for them to go to a Depression-Era book, movie, or play and discuss the lives depicted there). When I read the reports, I'm getting both a look at what the people who lived through the Great Depression remember and what of that made an impact on my students.

Maybe this has been the case in years before, but I was really struck this year by how many times the report that families moved in together (parents with adult children and grandchildren, sibling with siblings, and so forth) was mentioned. As I said, this probably meant that it happened a lot, that it was remembered, and that it was striking to my students. I know that my mother and her sister were "farmed out" (as she put it) with her aunts and uncles in another state for many summers during the Depression. My father's Dad spent some time working for his brother. My Great Grandmother and Great Grandfather moved in with my great aunt Bernice.

When I was discussing another long-lost part of the social safety net to my students (religious homes for unwed mothers) one of my students told me essentially that it was impossible to think of America ever going back to such a system. It just couldn't happen. I wonder if the same thing is true of the extended family? Social Security, Medicare, and Medicaid have not had merely economic consequences; they have had enormous social consequences, for good or ill, as well.

Dead Authors can be Heroes

My new hero is Soren Kierkegaard. He is a tremendous writer that does not pull punches and he wrote in an environment not dissimilar to the environment of the church today,

1. Intellectualism – Direct mental assent to Christ without the involvement of the heart. (Recall the first time that you accepted Jesus, was it a direct mental assent? Or, did your heart convict you of the need for a savior and then knowledge about Him was desired? Many churches today are stuck in the mode of discussing their brokenness and the intellectual ideas surrounding that without their heart saying “Yes” to the healing power of Jesus.)
2. Formalism – Those in the aisle practiced a kind of silent atheism, unbelieving believers. (Those who attend church out of habit or for the purpose of taking something away from the church. For example, that the church would provide them with a social platform or a good moral foundation for their children. Lost in the formalism is the radical love for the person of Jesus Christ. Finally in formalism we almost never ask what we can contribute to the church because habit does not actively consider the needs of other members of the church)
3. Pharisaism – Hypocritical Clergy serve themselves rather than the flock they promised to tend and keep. (Leaders with alternative motivations that benefit them and not necessarily the Kingdom are as prevalent today as they were then. Hunger for power and wealth derails many well meaning men and women in leadership)

Those dominated Kierkegaard’s contemporary church and we can hear it in the tone that Kierkegaard writes. I actually found the book Provocations on Jason Upton’s recommended reading page for following Jesus. It is a survey of his writings and is an excellent alternative to his normally dense and difficult essays. Likely, many of my upcoming posts will contain seeds from his thoughts and so here I will leave you with three of my favorite Kierkegaard quotes thus far (the first twenty pages or so),

“The path of an honest fighter is a difficult one. And when the fighter grows cool in the evening of his life this is still no excuse to retire into games and amusement. Whoever remains faithful to his decision will realize that his whole life is a struggle. Such a person does not proudly fall into the temptation of telling others of what he has done with his life. Nor will he talk about the “great decisions” he has made. He knows full well that at decisive moments you have to renew your resolve again and again and that this alone makes good the decision and the decision good.”

“He who says, “No,” becomes almost afraid of himself. But, he who says “Yes, I will,” is all too pleased with himself. The world is quite inclined- even eager- to make promises, for a promise appears very fine at the moment- it inspires! Yet, this is the very reason the eternal is suspicious of promises.”

“The greatest danger of Christianity is, I contend, not heresies, heterodoxies, not atheists, not profane secularism – no, but the kind of orthodoxy which is cordial drivel, mediocrity served up sweet.”