The financial crisis may have begun with a lion’s roar, but it seems to have concluded with something akin to a lamb’s bleat.
In late August, the SEC announced a settlement with former Fannie Mae CEO and President Daniel Mudd, who was accused of misleading investors about the organization’s exposure to risky mortgages, marking the conclusion of one of the last legal battles over the 2008 financial crash. Under the terms of the deal, Fannie will pay $100,000 to the Treasury Department. Mudd, meanwhile, does not have to pay anything out of pocket, he did not admit any guilt, and he is free to serve as an executive at another public company.
Then there’s Wells Fargo. In mid-September, the bank was served with subpoenas from three separate U.S. Attorney’s offices. For years, the bank had been opening false accounts and credit cards to meet sales quotas and charging customers fees for services they didn’t request. More than 5,000 Wells Fargo employees were fired in the wake of the discovery. Congress held hearings. Senator Elizabeth Warren demanded that Wells Fargo CEO John Stumpf resign, which he eventually did, forfeiting $41 million in unvested equity in the process. But so far, no other Wells Fargo executives have been punished for fostering a culture of deceit at one of the nation’s largest financial institutions. In fact, following Stumpf’s resignation, the current roster of executives simply moved up, with Wells Fargo President Timothy Sloan moving into Stumpf’s old post.
Such leniency for bank leaders offers fodder for those who argue that financial executives have largely escaped from the financial crisis and subsequent scandals without much consequence. But the responsibility for the failures of our financial institutions doesn’t rest with a single individual. These are problems of organizational culture and behavior. This is why Sloan’s ascension to CEO at Wells Fargo has left many, including Sarah Bloom Raskin, the deputy secretary of the United States Treasury, skeptical that meaningful change is on the horizon.
Since the financial crisis, Congress has attempted to rein in the financial industry. But even major reform efforts like Dodd-Frank have not fully addressed the many problems that led to the Great Recession. Robert Litan, an author and fellow at the Council on Foreign Relations, argued in a recently published article for Foreign Affairs that while Dodd-Frank has made some positive inroads by raising financial institutions’ capital requirements and increasing oversight of derivatives trading, its “problem is that these factors, although they contributed to the Great Recession, did not lie at the heart of the financial panic.” The crisis, Litan wrote, was a classic run on short-term debt by frightened investors who “lost all faith in the values banks [had] assigned to their assets, and many mistrust[ed] banks that claim[ed] to have enough capital.” In other words, a shortage of trust generated a widespread panic that froze the flow of capital and threatened the stability of financial institutions.
But how do you build a financial system that encourages such trust? It begins when bank executives and employees change their behavior and the way they make decisions. How do you judge the moral virtue of a bank manager’s decisions? Edward Kane, a professor of economics and finance at Boston College, proposed a simple system in a May 2016 paper published by the Institute for New Economic Thinking.
“In banking,” he writes, “professional standards of conduct derive less from fundamental moral principles (i.e. individual ethics) than from the pragmatic character of slowly evolving norms of banking and regulatory cultures.” Bank managers at the world’s biggest firms, he says, often consider three practical questions when they make decisions:
- What is profitable for our firm to do?
- What will regulators let us get away with?
- How can we defend and expand profit-making opportunities?
Kane argues those are not the right questions to ask because they simply focus on what’s permissible. To gain trust, Kane says, bank leaders need to replace the verbs “is,” “will,” and “can” with “should.” Read that way, the questions are as follows:
- What should our firm do?
- What should regulators let us get away with?
- How should we defend and expand profit-making opportunities?
Using 18th century German philosopher Immanuel Kant as a philosophical guide, Kane says that what bank executives should consider is the welfare of the people who work for them and the customers they serve as the ultimate goal and not as a means to a profitable end.
Organizing financial institutions this way, however, may require banks to change how they think about and describe their respective missions. Under Kane’s model, a bank wouldn’t provide a loan for the fees its brokers would collect, the interest the firm might earn, or the financial products it could cross-sell to clients. Instead, it would need to focus on how the funds might help a family buy a new home or an entrepreneur start a small business.
Despite recent headlines, some firms are already putting these values at the center of their activities and developing financial models that provide returns while promoting the greater good. One such company is Encourage Capital, an asset management firm dedicated to addressing environmental and ecological problems.
Encourage Capital was born in 2014, during a bike ride over the Brooklyn Bridge between Adam Wolfensohn, head of impact investing private equity firm Wolfensohn Fund, and Jason Scott, who ran EKO Management Partners, an investment management and advisory firm that focused on environmental protection. The two men decided to combine the financial expertise of the Wolfensohn Fund with the environmental advisory services offered by EKO and form a single enterprise they launched in March the following year.
“Our thought was a lot of impact investing was being driven from an asset management view and felt that wasn’t the way to achieve impact,” Ricardo Bayon, a partner at Encourage Capital and co-founder of EKO, said, implying that most impact investors are concerned first with their returns and then with social change. “Our way was to start from the other end and ask, ‘What is the issue you are trying to solve?’”
Among the issues that concerned Encourage was the alarming rate of collapse among wild caught fisheries in Brazil, Chile, and the Philippines. Over a billion people in the world rely on seafood as their primary source of protein, and an additional 4.3 billion depend on seafood to supply at least 15% of the animal protein in their diet. Economists estimate that over the next three decades, as the world population grows and more countries enter the developed economic world, seafood consumption will rise by 70%. The collapse of fisheries—driven mostly by overfishing but also due to the effects of climate change, habitat destruction, and pollution—poses a threat to global food security, marine ecosystems, and the livelihoods of fishers.
Encourage worked for nearly two years in collaboration with Bloomberg Philanthropies, The Rockefeller Foundation, and several NGOs to analyze the affected fisheries and develop a way private finance could help. The collaboration resulted in a 424-page public report that laid out several strategies to help the fisheries—including restoring fish stocks, upgrading supply chain infrastructure, and increasing the income of fishers—that would also deliver returns to investors.
“We actually believe that there is no trade off for doing the right thing,” Bayon said, “but there is potential for an uptick.”
Encourage proposed six different investment plans. It ultimately settled on one similar to what it calls the “Mariscos Strategy,” a $7 million total investment over a five-year term in the shellfish and crustacean markets in Chile. An initial investment of $1 million will go toward instituting limits on the number of fish that can be caught during a given period of time and another $3.5 million will go toward paying fishers who follow the guidelines a 25% premium for their catch. Those fishers will serve as suppliers for a seafood sourcing network in which the fishers will be given a 20% equity share. The remaining $2.5 million will go toward supply chain improvements for the network, including addressing the way fishers source raw materials, increasing manufacturing capacity, and expanding the distribution reach for artisanal Chilean seafood.
To date, Encourage has secured anchor funds from a family office and has begun looking at initial investment opportunities to launch the program. The firm estimates that the project could generate up to an 11.1% return to investors through a sale of the seafood network. And Encourage says it is confident that the model will protect—and potentially increase—the fish stock to meet growing seafood demands while also providing a repeatable and sustainable model for similar fisheries along the Chilean coast.
“The problem they are in is a vicious cycle,” Bayon said. Overfishing depletes supplies and fish then become harder and more costly to catch. The fishers’ only solution is to fish more to make up for the increased costs, which further reduces the fish supply. “If you can break that cycle and allow them to fish more sustainably, they can figure out what they need to do to recover that fishery.”
Changing the way financial institutions operate is no easy or simple task. And in many cases, it requires collaboration between government institutions, philanthropies, and members of the private sector. But it’s worth the effort. After all, full recovery from the pains of the financial crisis will come not only in the form of a rising stock market or stellar quarterly results, but also when institutions change the way they think about the people they serve.