Tuesday, September 8, 2009

Credit Rating Agencies and the Abandonment of Excellence

As the ramifications of the 2008 financial panic continue to illustrate the extent of the damage inflicted upon the global economy, it is indeed reassuring to see that Wall Street has not lost its sense of humour. The hilarity stems from the fact that desperate, yet imaginative, lawyers on behalf of the major credit rating agencies (CRA) presented arguments that investors can’t sue the firms over deceptive ratings of private-placement notes because those opinions are protected by free-speech rights. A U.S. District Judge in New York rejected the arguments, forcing them and Morgan Stanley, which was also sued, to respond to fraud charges in a class-action by investors claiming the raters hid the risks of securities linked to subprime mortgages. Anyone familiar with the workings of Wall Street knows that—like lunches—nothing is ‘free’. If the judge had accepted the defense argument, an entirely knew cottage industry could have sprung to life—perhaps it would be coined as “Slippery Slope Defense Attorneys.” Financial Advisors that enticed clients to invest in ‘unsuitable investments’—the catch all phrase for contraventions of fiduciary duties—could claim that the opinion was just the FA exercising his right to free speech. The CPA firm, after signing off on the financial statements of a bogus company, could clamber into court with their attorney claiming that rendering their opinion was simply a matter of applying their first amendment rights. Perhaps the once venerable Arthur Andersen would still exist if this bizarre legal strategy had been accepted by the courts.

Blaming the credit rating agencies for the demise of the commercial mortgage-backed securities (CMBS) market and the ensuing destruction that occurred in global financial markets is pointless since there is ample culpability to be apportioned throughout the social order. However, the individuals who contributed to the alleged transgressions of the CRAs exemplify the individual’s role in creating the moral morass that has permeated Western culture.

Many of the executives of the CRAs have the designation CFA after their name. Attaining the esteemed designation of Chartered Financial Analyst is acknowledgment that an individual has the utmost level of knowledge in the securities industry. To become a CFA, an individual must not only demonstrate superior knowledge of advanced investment strategies and financial acumen, but he must also exhibit acute awareness of the ethical dimensions affecting the investment industry. An important goal of CFA Institute is to ensure that the organization and its members develop, promote, and follow the highest ethical standards in the investment industry. The CFA Institute Code of Ethics and Standards of Professional Conduct is a set of principles that define the professional conduct that the CFA Institute expects from its members. Rules and standards of practice are admirable initiatives and should be vigorously promoted, but perhaps Plato best expressed the reality of regulation in society: “Good people do not need laws to tell them to act responsibly, while bad people will find a way around the laws.”

To become a CFA one has to be adept in what Aristotle would call techne (technical knowledge or skill of a craft) and areté (virtue or excellence as defined as a mean between two extremes of excess and defect in regard to an action determined by rational principles.) It would appear that some executives of the CRAs did not only demonstrate a lack of techne—whether by intent or by ineptitude—but at the same time totally disregarded the concept of areté—whether induced by malicious intent or imposed necessity.

For the credit ratings agencies, techne or effectiveness, manifests itself as a drive towards maximized profitability accomplished via ruthless competitiveness. Wall Street, which has become exclusively directed by consequentialist principles, has found a substitute ethical base in the concept of effectiveness. In commerce today the ‘ethic of effectiveness’ concerns itself with ‘getting the job done’ and is often achieved in a Darwinian or Hobbesian manner. Profit maximization has become the exclusive factor in management decisions. The concept of ‘good’ has become solely based on effective achievement of a defined external goal without consideration being given to the virtue of excellence—areté.

From an Aristotelian perspective, individuals and corporations have a telos or end. For individuals this means achieving a good life partially through rewarding, fulfilling work and contribution to the polis.(community). The ‘good’ for a corporation consists in contributing to making the good life possible for the community’s members through the generation of wealth, creation of employment and provision of services. Our life narrative is what connects the individual to the community. How we conduct our lives, honing our intellectual virtues whilst habituating our moral virtues, will determine our life’s narrative. An individual’s narrative is a crucial factor in sustaining the traditions of the community since our individuality is both socially constituted and socially situated. We are all members of several communities, whether it is situated in an individual company, neighborhood or town, as part of a social institution or in society as a whole. Our self-interest is for the most part identical to the larger interests of the group and when an individual’s actions reflect an imbalance between effectiveness and excellence the community as a whole inevitably suffers. If the intellectual virtue of techne is not balanced with the moral virtue of areté, skill will become corrupted and the individual will ultimately succumb to the vices of excess and/or deficiency.

It is ironic that the CRAs were ostensibly promoting a service that was critical in providing information to allow the investment community to construct balanced portfolios of CMBS, while the individuals responsible in providing this information neglected to find a balance of intellectual and moral virtue in their professional lives. These imbalances—both in the resultant CMBS portfolios and in the character of CRA executives—were significantly instrumental in triggering the largest loss of wealth the global community has ever experienced—an event that will reoccur with increasing devastation until the concept of areté is habituated in the actions of individuals in financial community.

1 comment:

  1. Well written Pete. Love the Plato quote as it has a resounding truth to it all these centuries later.