Ethics of the 2008 Financial Crisis: Paulson and TARP

Introduction: Ethics and Decision-Making in International Business

Decision-making is one of the fundamental keys to the survival of an organization, more so now that economic boundaries between countries are crumbling, business is becoming more complex, and the results of decisions often have global impact. Decisions are made constantly in business; they are part and parcel of being effective in one's job. Innovation and regular improvement are required to maintain and strengthen the ability to make rational decisions, and some psychologists even believe that the ability to make effective decisions is at the core of an individual's success or failure within their organization (Porter, 1998). Managers, in particular, realize that if their organizations are to survive in this dynamic and uncertain environment, they must make moral and ethical decisions concerning new business opportunities, products, customers, suppliers, markets, and technical developments. This clearly indicates that the most important managerial attribute is the ability to make the right decision within an ethical framework. The outcomes of those decisions serve as the benchmark for evaluating whether managers are successful (Drucker, 2001).

As the global economy becomes more of a reality, and as various developing countries increase the amount of business they conduct with developed countries, many cultural issues arise. Doing business is not the same worldwide, and as citizens of a global village, we must recognize that there are different cultural norms and behaviors that are acceptable in some countries, unacceptable in others, and even expected in still others. International companies face increasing pressure from stakeholders regarding social and ethical issues. Questions revolving around what the United States government calls "bribery" may indeed be part of doing business in some contexts, yet they force us to ask: "Is it moral, when trading in a foreign country, to participate in practices that would be considered immoral at home in order to survive?" Morality is typically the standard that a group holds about what is right and wrong — good and evil — permissible or unacceptable. As trade barriers fall around the globe, differences in morality are attracting greater domestic interest regarding such issues as human rights, political behavior, and environmental conservation (Deming, 2006).

Because ethics and morality are so closely linked within the rubric of international business, most countries believe they are part of the social "requirement" of both national and international commerce (Kolthoff, 2007). Before examining the ethics involved in the final stages of the Bush administration's management of the Treasury Department, it is appropriate to take a broad look at the surrounding events of the financial crisis. In October 2009, the New York Times presented an overview of the recent credit crisis and its impact on the United States:

Background: The 2008 Financial Crisis

"During the first nine months of 2008, federal officials sought to support an increasingly shaky banking system one crisis at a time. But since the collapse of Lehman Brothers in September sent shocks around the global financial system and brought down giants like the American Insurance Group and Washington Mutual, officials in both the Bush and Obama administrations have worked to create a more systemic rescue" (Chorafas, 2009).

President Bush's Treasury Secretary, Henry M. Paulson Jr., distributed $350 billion, primarily in the form of direct investments in financial companies. His successor under President Obama, Timothy Geithner, outlined a proposal intended to flood the financial system with as much as $2.5 trillion — $350 billion of that from the bailout fund and the rest from private investors and the Federal Reserve, making use of its ability to create money. The heart of the plan, outlined in detail on March 23, 2009, called for the creation of a new federal entity that would draw private investors into a partnership intended to eventually purchase as much as $1 trillion of the troubled assets weighing down the banking industry (Cho and Irwin, 2008).

But on June 3, the Federal Deposit Insurance Corporation (FDIC), which was to play a crucial role in the plan by guaranteeing loans to investors, announced that it was putting one part of the plan on hold indefinitely, as banks were refusing to sell their troubled assets at the prices they were likely to receive under the program. At the same time, some banks that had passed the Federal Reserve's "stress test" were raising funds independently to repay money they had received from the Treasury (Irwin, 2008).

Some observers called the banks' refusal to sell the so-called legacy assets — and their moves to repay the government — signs that the worst of the crisis had passed. Others countered that any signs of bank profitability rested more on accounting changes than on improved business conditions, and that hundreds of billions in new losses lay ahead. The other major component of the Geithner plan, aimed at troubled mortgage-backed securities, was still being prepared, officials said (Chorafas; Weale, 2008).

The first proposal for a sweeping bailout of financial institutions came at the height of the panic in mid-September 2008. Mr. Paulson, backed by Federal Reserve Chairman Ben Bernanke, asked Congress for $700 billion to purchase mortgage-backed securities whose value had dropped sharply or had become impossible to sell, in what he called the Troubled Asset Relief Program, or TARP. As originally outlined, the government would have bought up toxic mortgage-backed securities at a premium over their then-current deflated values. By paying "hold to maturity" prices, Mr. Paulson said, the government would provide troubled firms with a capital infusion, reducing doubts about their viability and thereby restoring investor confidence.

The plan in its original form was quickly rejected by both Democrats and Republicans in Congress and was criticized by many economists across the political spectrum. Congress insisted on adding provisions for oversight, limits on executive pay for participating companies, and an ownership stake for the government in return for its investments.

TARP: From Toxic Assets to Capital Injections

Even so, the plan proved strikingly unpopular with an outraged public, and on September 29 it failed in the House of Representatives, primarily due to a lack of Republican support. As markets continued to plunge, however, a slightly altered version won the support of the Senate on October 1, and of the House on October 3. President Bush quickly signed the bill ("TARP Plan," 2008; Schmidt, 2009).

Shortly afterward, Mr. Paulson reversed course and decided to use the $350 billion in the first round of funds allocated by Congress not to buy toxic assets but to inject cash directly into banks by purchasing shares — an approach many Congressional Democrats had advocated earlier. In an initial round of financing, nine of the largest banks were each given $25 billion. The Treasury also used the bailout to steer funds to stronger banks to facilitate purchases of weaker ones. To the dismay of many economists, no conditions were attached to the Treasury infusions, and many of the banks appeared to be using the funds to bolster their balance sheets rather than to extend new loans (Kessler, 2008).

On November 12, Mr. Paulson announced that he was abandoning the idea of asset purchases and said the bailout money would be used instead for a broader campaign to shore up the financial markets and help consumers seeking loans for cars, tuition, and other purposes. To the anger of many Democratic members, none of the first-round funds were used to prevent further increases in foreclosures. An oversight panel created by the original bailout bill delivered a round of pointed criticisms in its first report on December 10. The report stated that the Treasury had failed to create a system to track how bailout funds were being used or to require banks to deploy them to increase lending and unfreeze credit markets.

The last major portion of the first-round funds went to Detroit — $17.4 billion in emergency loans to keep General Motors and Chrysler afloat. President Bush had initially resisted Democratic efforts to use the financial bailout for that purpose, preferring to redirect loan guarantees intended to help factories transition to more fuel-efficient vehicles. After Senate Republicans blocked a bill that would have accomplished that, however, Mr. Bush agreed to use TARP funds while imposing tough conditions on the automakers, their creditors, and unions that mirrored much of what Senate Republicans had sought (Greider, 2008; Lenzer, 2009).

On January 12, 2009, the White House announced that President Bush, at President-elect Barack Obama's urging, would ask Congress to release the $350 billion remaining in the bailout fund. The decision to request the money before taking office reflected a calculation by Mr. Obama and his aides that it would be better to have both the incoming and outgoing presidents urging lawmakers to release the funds, given the high level of anger and frustration on Capitol Hill over how the Bush administration had managed the bailout program ("Obama, $350 billion," 2009).

In addition, Lawrence H. Summers, Mr. Obama's top economic adviser, wrote to Congressional leaders of both parties, promising a five-point plan ensuring the money would be used for lending or preventing further crises and not for "enriching shareholders and executives." To that end, the Treasury Department would limit executive compensation for institutions receiving "exceptional assistance" (Geithner and Summers, 2009).

Troubles continued in the financial sector — both Citigroup and the Bank of America needed second rounds of capital infusions and federal guarantees against losses totaling tens of billions more — while Federal Reserve Chairman Ben S. Bernanke warned that additional capital injections might be needed to further stabilize the financial system. On January 16, the Senate voted 52–42 to release the second round of funds (Gerth, 2009).