The Root Cause of America's Financial Problems...and a Good Solution

It all started with the people who wanted to buy something they couldn't afford. Rather than save up until they could, they applied for a loan: for example, for a new car, a home, real estate investment, new furniture, jewelry, vacation, etc.

In earlier times, if their income suggested they would be unlikely to afford to pay back the loan, lenders would turn them down and the person would have been forced to save some money or increase their income before trying again to get a loan.

But in recent years, lenders had a lot of money to lend and had methods--often deceptive methods--of making a profit even if the loan went unpaid, so lenders offered to lend money to unqualified borrowers.

And those borrowers accepted the loans, many knowing they were unlikely to afford to pay it all back but could later walk away from their car or credit card debt, or sell their real estate at a profit if the market went up or walk away from their mortgage if the market went down. And so now, for example, a record number of U.S. homes are in foreclosure. The number of repossessed cars has increased 10% last year and expected to rise an additional 7-10% this year.

In short, the root cause of the problem is borrowers' and lenders' poor ethics.

If poor ethics is the core cause of America's financial mess, then, even if the taxpayer ended up repaid, is the wisest solution to bail out the miscreants with $700 billion ($6,200 from every household in the U.S.) of your and my money? Especially a bailout that even its advocates are unsure how helpful it will be to us on Main Street or even to Wall Street?

(Update: The $700 billion has now been additionally larded with $150 billion in pork. Even in crisis, politicians will be politicians.)

Is the solution yet more government intervention, thereby shackling the invisible wise hand of the free market? Remember the government's track record. Here are a few examples in the financial arena:

• Fannie Mae and Freddie Mac, massive government-sponsored enterprises, now in financial disarray and under conservatorship. Fannie's stock price has crashed from 70 a year ago to 1.5 today. Freddie's has plummeted from 62 to 1.7.
• The Community Reinvestment Act, which encourages lending to underqualified borrowers in the name of "social justice" and thus helped cause America's current financial disaster.
• The Sarbanes-Oxley Act, which mandated that U.S. companies submit mountains of paperwork that cost companies and in turn consumers $1.4 trillion(!) without clear evidence of SOX providing even a small fraction of that amount in societal benefit. You can't legislate integrity; unethical people will always find a way to be dishonest.

Yes, a modest increase in regulation is probably prudent, for example:

• Requiring buyers of CDOs, CMOs,and CDSs to meet margin requirements, just as stock buyers are.
• Preventing conflicts of interest between credit rating agencies and issuers of CDOs, CMOs, and CDSs.
  
• Ensuring that the companies that write insurance on those securities keep enough capital on hand to make good on the policies they issue.
  

But in my judgment, a taxpayer-paid bailout and a major increase in government regulation are not the answers to America's financial crisis.

If we are to get to the root cause of our financial crisis and of many other structural problems in the U.S. economy, a far wiser solution is to make the citizenry more ethical.

Of course, that's no easy task. After all, every business major must take an ethics course and that has hardly solved the problem. But I'd certainly rather see the nation invest $700 billion on improving people's ethics than to bail out the bad guys and then try to police everyone from being unethical again. That's not much more likely to succeed than Prohibition was to eliminate drinking.

How would I invest $700 billion to improve Americans' ethics?

1. Parenting education in the public and private high schools, colleges, adult schools, churches, etc., including how to--from Day One--ensure that your child treats ethics as the highest priority.

2. A critical-incident-based ethics curriculum from preschool through college. Many educators will claim that the school day is already overpacked but I believe the time would be better spent on ethics than, for example, on P.E., history, art, and yes, even the currently sacrosanct multicultural education.

3. A public education campaign, much like that used to reduce cigarette smoking, to emphasize the primacy of ethics to the life well-led and an America worth living in.

4. Periodic ethics training in the workplace. Just as annual sexual harassment workshops are required, annual ethics workshops should be. This training should focus on ethical stress points in that particular workplace: for example, whether a salesperson should voluntarily disclose a product’s weaknesses to potential customers.

5. 1-800-ETHICAL. Just as participants in Alcoholics Anonymous can call for counsel and support when tempted to take a drink, a government-paid-for hotline should be available for people, especially in the workplace, tempted to do something unethical.

6. Reinventing our system of electing leaders. Currently, it is rife with opportunity for dishonesty. We get the message that ethics is not primary in America when we see that our leaders get elected by accepting cash from special-interest donors, money that is used to air deceptive commercials and to hire spinmeisters.

7. Enforce our laws. For example, if we allow 13,000,000 people to illegally step ahead of the legal immigration line, and if we bail out unethical lenders and packagers instead of punishing them, we are taught, by example, that ethics is not primary in the U.S.

Of course, forgoing the bailout will mean a serious decline in our economy, but that decline is likely to be shorter and the eventual recovery more enduring than one that would follow a bailout.

As corporate America, government, indeed all of us should have done in the past, we need to eschew short-term profit for long-term, sturdy growth.

Your thoughts?