Recognizing and resolving ethical dilemmas in business

Business Ethics

Recognizing and Resolving Ethical Dilemmas

The foundation of the American financial system is home ownership. Spending on the construction of a home, furnishing it, maintaining and reselling it is the most valuable asset the majority of Americans have in their investment portfolios, in addition to being an essential catalyst of the American economy. The meteoric rise of subprime mortgages based on lower interest rates and loan programs that were based on adjustable financing, negative amortization, and other financial transactions that were designed to ensnare consumers into more debt than they could afford (Verschoor, 2007). From an ethical standpoint the debate of who is primarily responsible for the subprime mortgage crisis continues, yet there is no clear answer. From a purely financial perspective the bundling of known high-risk loans into loan investment packages or bonds, then resold to investors globally is the primary culprit (Rutberg, 2008). The ethics of packaging up known flawed loans was foreseen as early as 2006, yet nothing was done until 2007, when state governments began requiring lenders to get background criminal checks (Churchill, 2007). Yet others argue it was the continual reduction of interest rates by the U.S. Department of Treasury which led banks to become opportunistic and seek out predatory lending offerings that capitalized on low-income, borderline credit-worthy customers who would not be able to scale their incomes to keep up with the average increase of $1,600 per month in mortgage payments (Schwendimann, 2007).

Analyzing How Banks and Mortgage Companies Lost Their Ethical Judgment

From a culture of financial stewardship and transparency to one of predatory lending practices and an absence of ethical leadership, the financial services industry in particular, and banks and subprime lends specifically have abandoned their culture basis of the past (Bond, 2007). In doing so, the predatory nature of creating loans that escalate far beyond the applicant's income afford them had become commonplace in the last five years (Schwendimann, 2007). In attempting to answer how an industry culture so engrained with risk aversion and accountability (Bond, 2007) could become so opportunistic and predatory, one needs to look not at the metrics but at the management teams, the leaders, of these banks and subprime mortgage lenders. What is remarkable is the extent to which an industry so engrained with metrics of performance that included auditable standards that sought out the quantification of risk to the loan level could descend into such a contrary ethical mindset than it had been within for decades previously (Khasawneh, 2008).

The paradox of how the leadership of financial institutions transformed from being focused on accountability, the nurturing and growing of public trust to one concentrated on predatory lending practices is a prime example of how critical the ethics of leaders are in the context of exceptionally opportunistic and exceptionally contracting economic times. Apparently the lessons learned from Enron, MCI, Tyco and others that stretched the ethical band of tolerance, so to speak, of the American people which promptly led to it "snapping" back into place with the Sarbanes-Oxley Act (Riotto, 2008). Leadership of the financial services industry played a pivotal role in creating predatory lending programs that in turn opened up many opportunities for corruption, graft and fraud. One of many examples is the one of an Indian family in California buying and selling a home three times over, each time getting more in loans from Wells Fargo, defrauding the bank for hundreds of thousands of dollars. Multiply this by many other examples and financial chaos ensues, all attributable to the catalyst of a failure on the part of company and industry leaders and managers to enforce ethics throughout their organizations

Ethics of Financial Services Leaders and CEOs: The Catalyst of the Chaos

There have been many studies specifically about the role of leadership and its impact on ethical standards within financial services organizations including many analyses by Schwendimann (2007), Khasawneh (2008) and Rutberg (2008) that illustrate the finding that ethics of leaders are the most potent attribute that subordinates use in forming their own judgments of the ethics of the organizations they work in. Lessons learned from a multi-industry study of 7500 managers from a range of private and public organizations nationwide (Kouzes & Posner, 1990) found that 87% of those surveyed selected honesty as a characteristic of superior leaders, and integrity was selected as the most important leadership characteristic, even above competence. This is noteworthy in an industry such as financial services and the banking and subprime industry supporting it, as engineering and technical competence is critical for overall career growth. Both the stature and credibility of a leader appear to be enhanced when employees perceive that the leader is ethical (Urbany, Reynolds, Phillips, 2008). Integrity is not only expected, it is essential to effective leadership and must be demonstrated in order to enlist others in a common cause and to maintain others' commitment to action (Kouzes & Posner, 1990). Kouzes & Posner (1990) also found that the ethics of the leaders in any organization directly impact the discernment and ethical limits or boundaries as perceived by subordinates as well. Subordinates judge leader integrity by the behaviors in which the leader engages in highly service-driven and technical industries in particular because the nature of their business is to make commitments and keep them to customers and clients. As a result a lack of promised follow through, cover-ups, inconsistency between word and deed are all indicators of a lack of integrity (Kouzes & Posner, 1990). Unethical leader behavior creates confusion in subordinates over corporate values, creating stress that in turn leads to conflict, indecision, and rivalry and the adoption of predatory lending practices in the mortgage industry for example (Verschoor, 2007). The energy required to cope with incompatible values takes its toll on both personal effectiveness and organizational productivity within the banking and broader financial service industries as a result (Kouzes & Posner, 1990).

In addition to having an impact on leadership, business ethics is a factor in job satisfaction, turnover, and employee theft. Vitell and Davis (1990) found that all dimensions of job satisfaction (promotion, co-worker, supervisor, and work itself) were negatively correlated with perceptions of unethical behavior within one's company. Greenberg (1990) found that both employee turnover and employee theft increased when temporary employee salary reductions were perceived as being unjust. Yet paradoxically the cultural shift was so significant in banks and subprime mortgage lenders that the practice of by-passing traditional measures of accountability, transparency and auditability of results (Khasawneh, 2008).

In framing the discussion of service businesses in general and banks and subprime mortgage lenders specifically it's critical to first review the concepts of utilitarianism as defined by John Stewart Mill. Mill's Utilitarianism (Mill, 1861) instructed decision makers to select a course of action most likely to minimize harm while maximizing good. John Stuart Mill, similar to Kant, viewed ethics from a duty perspective. Mill, however, saw virtue in action in accordance to duty, not simply for the sake of it (Solomon, 2000). To Mill, problem solving was a matter of assessing the "utility" of an individual decision, such that it provided the greatest amount of happiness for the greatest number of people. Mill's Utilitarianism (Mill, 1861) instructed decision makers to select a course of action most likely to minimize harm while maximizing good.

To select an alternative course, according to Mill, was an unethical action. Jeremy Bentham offered a quantifiable method of determining the utility of an action. His "happiness calculus" measured the amount of pleasure and pain that resulted from an action by its degree of goodness or badness, or sommum bonum (Solomon, 2000). Sommum bonum was the ultimate good, a single principle toward which all actions should be aimed. Shaw (2004) elaborated upon Bentham's happiness calculus and cautioned against individual good actions that might cause bad consequences if performed by many. For this reason, Hutchison argued, certain laws exist that prohibit actions in general. From these foundational elements the calculating of ethics and their implications have forced the development of legislation to bring enforce the greater good, which is the essence of the ethical dilemma banks and subprime mortgage lender face in delivering exceptional service while at the same time having to manage costs. The ethical lapse towards being predatory began as a rewarded behavior by management for exceptional sales growth yet quickly degenerated into the basis of aggressive subprime lending practices with no regard for the applicant or the future state of their financial condition (Verschoor, 2007). The bottom line is that corporate responsibility still gets played with in a fast and loose manner with in financial services companies, and even legislation is just now having an effect.

Ultimately corporate responsibility and ethics reform needs to focus on the contributory effect of banks, both good and bad, to the economy. Left unchecked for example, the lack of ethics standards in the financial services industry could have crippled the entire U.S. economy even more so than they have today. Ethics have bottom line implications and are quite quantifiable as can be seen by the many bailouts the government has to now provide to save our economy.

The Bank CEO's Role in Defining Ethical Integrity

Based on a thorough review of existing literature of the role of ethics in the banking industry, the role of the CEO as the ethical leader of their organization is next discussion. Based on the concepts presented in the paper to this point as the foundation, these key points provide insights into how CEOs and senior management actively shape the ethical standards of the organizations they manage on behalf of shareholders.

Risk Management Is a CEOs' Ethical Responsibility combination of forces -- changing regulatory expectations that open companies up to intense levels of examination, heightened stakeholder sensitivity to and scrutiny of corporate behavior, and the severity of punishment by financial markets for corporate missteps -- push reputation and ethics management onto the CEOs' and senior managements' agenda. The paradox CEOs face is when to risk the reputation and brand of the company and engage in risky decisions for the sake of incremental gain or to realize greater cost savings. There are few positions in any industry that have such a direct interrelationship between ethics and brand performance, and also the long-term stability of their clients' financial conditions and the broader condition of the general economy (Rutberg, 2008)

CEOs in Banks and Subprime Mortgage Lenders Share No Common Definition of Risk

Startling from the research is the finding that there is no single definition of safety risk in any of the ethical analyses completed of the financial services industry, yet there is an abundance of research on Corporate Social Responsibility (CSR) initiatives and programs. In conjunction with the lack of definition for subprime borrower risk, there is no consensus on a definition for reputation and broader ethics risk, but industry participants agree that it is broader than legal, compliance, and regulatory risk that arise from a lack of congruence between ethics standards each company espouses in their CSR initiatives. A common meaning of reputation risk would improve companies' ability to identify, assess, and mitigate risks that can potentially generate negative stakeholder reaction. This lack of ethical standard definition on the part of banks and specifically subprime mortgage lenders translates into why Option One Mortgage could lend to many customers who could not verify their income (Churchill, 2007) while Countrywide Home Loans often lied to existing customers and told them a home equity credit line had been approved and they just had to sign for it (Cassling, 2008). In a few cases Countrywide representative signed up homeowners for these equity lines and then sent them the paperwork saying it was a perk of their existing loan package, which not surprisingly led to many lawsuits today (Cassling, 2008). There are many more examples of this type of behavior yet it is all tied back to the ethical lapse of CEOs and senior management which redefined the culture of these companies to adopt a more unethical stance on illegal transactions.

The Future of Banking and Mortgage Lending Includes Compliance Management Officers

As has been the case with publicly-held corporations that are held to the standards of the Sarbanes-Oxley Act, a comparable set of regulations will eventually be needed to ensure the ethical violations so pervasive in the subprime mortgage industry are not repeated. The baseline metrics of performance for this industry need to also be re-evaluated (Verschoor, 2007) with the Chief Compliance Officer being at the same level as the CEO, reporting to the Board of Directors on all matters pertaining to auditing, reporting and management of the business. Any company governed by the Sarbanes-Oxley Act has since 2002 been engaging in the same approach to regulating and enforcing ethics throughout their organizations.

The role of Compliance and Ethics Officers in the banking and financial services industry will also be noteworthy for the growing authority to evaluate each process in their companies, from loan origination and client screening to the actual packaging of loans for resale as investment programs for institutional investors. Further, their role is to sensitize the business to key reputation risks and instill and create escalation processes that reduce the effort required of loan origination, branch sales and services development managers to recognize and report threats and build accountability into each process. This continues to be critical for the development of ethical guidelines that give banks and subprime mortgage lenders the means to stay in compliance to an increasingly high level of government regulations across nearly sixty different nations looking to increase banking accountability, auditability and transparency (Schwendimann, 2007).