In Business, Integrity Still Matters

Monday, 03 Mar 2008 12:13 PM

By Christopher Ruddy

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Word last month that the FBI was opening up a criminal probe into the subprime mortgage mess should come as no surprise. Greed usually sprouts corruption.

One of the reasons America has been the safe haven for the world and has been its economic leader (though we have just 5 percent of the world population, we generate about 25 percent of global GDP) is that world investors have, for a long, long time, trusted America.

The subprime crisis is undermining that worldview. Investors liked the United States not simply because of our free enterprise system, but because of the values reflected in our financial and legal systems: trust, honesty, integrity.

I remember as a child, maybe 8 years old, accompanying my dad to the bank on pay day — always a big deal for me. Every time Dad cashed his check, the teller would quickly count out a bankroll of bills.

Invariably, my dad would step to the side and count every single bill to make sure that the count was accurate. I remember one occasion when the teller miscounted and gave Dad an extra $20 bill. When my father discovered the error, he moved to return the money — which left his son perplexed. No doubt my imagination went wild with what $20 could buy me!

My dad poked me in the chest and said, “Never take anything that isn’t yours. God will take care of you.”

It was an important lesson for a young child, just one of many Mom and Dad taught me.

American values such as these showed that people here agree to behave in certain ways even when the impersonal facts of the case make getting away with something easy (my dad did not know the teller, she did not know him, and the bank would have made up for the $20 error at the end of the day). Still, my dad intuitively saw a much bigger picture of how his actions in a small way might affect the larger world.

Looking back at this childhood incident, I can see how American values have frayed. No, we are not a banana republic, as some pessimists suggest. The rule of law and values still prevail. But they are under attack by a “whatever-it-takes” culture that emphasizes material success over spiritual values.

At the heart of the subprime banking crisis, I think we will see how core American values have been discarded.

So far, financial institutions have written off more than $100 billion in subprime debt. Low interest mortgages (ARMS) only began resetting en masse in January 2007. We have three more years for massive ARM resets. We could easily see $500 billion to $1 trillion in losses when the dust settles.

There is increasing evidence that mortgage lenders systematically encouraged applicants to lie on their applications about income and credit worthiness. Even low interest mortgages were supposed to be approved on the basis that the borrower could still repay the loan when it reset at a higher monthly payment.

Apparently, many borrowers got loans they should never have. Why would banks and lenders encourage loan applicants to lie?

To understand this, one has to understand how the banking business has fundamentally changed. Decades ago, your local bank wanted to underwrite your mortgage as the basis of its relationship with you as a customer. You paid your mortgage to Main Street Bank and also kept your checking and other accounts with them.

But in recent years, banks got away from holding mortgages long term. As soon as they sold you a mortgage, they would bundle it with others, “securitize” it in a bond-like instrument called a CDO (collateralized debt obligations ) and then sell these CDOs to global investors who wanted the income the underlying mortgages seemingly provided.

But as many mortgage holders have stopped paying their mortgages and foreclosed on their homes, the CDO holders have realized they were sold junk. Big and small CDO investors, including many foreigners, are left holding the bag.

Now creditors are exacting revenge. They are demanding a huge premium from borrowers across the board. Even credit card holders are feeling it as rates are skyrocketing to 30 percent.

This credit squeeze is spilling over and affecting consumers and businesses, helping to push the economy into a recession.

All of this because someone lied on their mortgage application thinking they could beat the “teller.” My dad could have told them otherwise.

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