Eye of the Needle

Author: Terrence Keeley ’81

In The Divine Comedy, Dante accompanies the Roman poet Virgil through purgatory and hell. Up until about a year ago, one could be forgiven for presuming only a smattering of bankers and financiers would be found in the inferno’s depths, somewhere between the second and fourth circles, where those overcome by lust and obsession with material goods are forever damned.

Now it’s apparent some Wall Street professionals deserve to be sentenced to far worse.

In Dante’s telling, the most horrific eighth and ninth circles of hell are reserved for those guilty of deliberate evil, like fraud and simony. If true, when death’s final curtain falls, a number of mortgage bankers and credit rating agents, collateralized debt obligation traders and all of Bernie Madoff’s accomplices may well be found among the most wicked evildoers — right next to Popes Boniface VIII and Nicholas III.

Finance is not the only profession with qualified candidates for the hellish fates Dante has immortalized. Not every financier deserves to ride Charon’s ferry past the ominous “Abandon hope, all ye who enter here” banner. Few financiers believe they have committed any act of fraud or deliberate evil. Given the calamity that has befallen the global financial and economic system, however, all members of the banking and investment management profession have some serious soul-searching to do.

“When you make money out of money, unmoored from morality and regulators,” Maureen Dowd of The New York Times recently wrote, “it must unhinge you.” Wayward financiers, along with certain rap singers and professional athletes, need to become re-hinged.

Like thousands of Domers, I have spent the bulk of my professional life — 25 years and counting — in the money business. Every industry has its ingrained mores and conventions. Banking has challenging, long hours, intense stress and debilitating politics. It must also be said that banking involves more than its fair share of financial reward relative to its level of social contribution.

As a man of conscience, I have been greatly pained by the economic and financial headlines of the past 18 months. I have wondered whether my life has been inadvertently given over to ignoble pursuit, if not outright evil. Are Notre Dame’s sons and daughters on Wall Street, myself among them, somehow culpable for the mess our country finds itself in? If so, what in heaven’s name should we do about it?

The reckoning

Our banking system has imploded because of an inordinate amount of bad assets and insufficient equity capital to absorb those losses. The prosecutor’s case on how malfeasance got us here goes something like this: Ubiquitous, predatory lending practices foisted hundreds of billions in mortgage debt upon unsuspecting borrowers with less than pristine credit history. These “subprime” mortgages were bundled up and repackaged by scheming Wall Street alchemists who, in an unholy alliance with rating agencies like Moody’s and Standard & Poor’s, knowingly passed them off to unsuspecting investors with the misleading sobriquet of Triple A.

Billions in profits were booked and huge compensation packages paid out before the music stopped, as everyone involved knew it ultimately must. To cover their mounting losses, banks stopped lending to creditworthy entities, like first-time homebuyers, municipalities and aspiring college students. This downward spiral became self-feeding. Greed built a house of cards. It collapsed. Now there’s no bottom in sight.

“I don’t think Alan Greenspan should burn in hell for promoting low-income home ownership,” a former (and now unemployed) collateralized-debt-obligation trader said, exasperated by charges of malfeasance against the former Federal Reserve chairman. “The idea that any of us knew that housing prices were about to crater or that mortgage-backed securities were ticking time bombs is ridiculous. Only hindsight is 20-20. What if housing prices kept going up? More and more poor people who bought their first home would have climbed out of poverty and realized the American dream! Would Greenspan be a candidate for canonization then?”

His points are fair — to a point. Prior to 2005-06, when lending standards and documentation deteriorated below acceptable levels, a subprime mortgage was the only hope that some 35 percent of Americans — and virtually all of her most needy — ever had of owning their own home. From 2000-04, more than 5.5 million subprime mortgages were awarded. Their default rates remained well within actuarial forecasts, and their fortunate recipients began to build up personal wealth for the first time.

As real estate prices had long been a one-way bet — rising for 16 years straight, even doubling in some markets during George W. Bush’s first term — one would have to have been a modern-day Scrooge not to promote mortgage finance to this class of aspiring Americans. Many politicians (mostly Republicans, it must be said) tried to rein in mortgage lending by capping out the portfolios of government-sponsored lenders Fannie Mae and Freddie Mac. These critics were beaten down by the powerful lobby that had formed around the mortgage-lending giants, however.

Things that sound too good to be true almost axiomatically are, and “too good” is how “teaser” adjustable-rate mortgages should have been classed from their inception. Mortgages requiring no or little credit documentation, many with low initial but then rising — hence “teaser” — rates, were granted at the astonishing rate of 50,000 per week at the market’s peak in 2005-06. These loans, often mischaracterized by lenders and misunderstood by borrowers, were likely to end up in default even if real estate prices continued to appreciate. Default rates on the 2005-06 vintage of subprime mortgages are now nearly three times higher than those made three years earlier — proof of their toxicity.

Mortgage lenders also heavily promoted home equity loans to a credit-hungry public as home prices rose. For too many, home ownership became a source for unnecessary spending rather than saving; cash was extracted from properties via second and third mortgages to finance immediate consumption. In 1990, Americans owed $2.5 trillion in mortgage debt; by 2006, $10 trillion. Total U.S. household debt — a figure that includes mortgages, credit card debt and auto loans — was less than 50 percent of our gross domestic product (GDP) in 1984; by 2007 it had doubled, to 100 percent of GDP.

In sum, our economy has been driven by a consuming debt addiction. As much of our so-called “wealth” was in fact borrowed, it has turned out to be ephemeral, increasing our vulnerability to credit market breakdowns.

A number of Federal Reserve officials and Wall Street analysts raised concerns about deteriorating loan standards and deceptive lending practices during this rush, but the Fed, which had all requisite regulatory and oversight powers, and the same Wall Street firms with prescient analysts ultimately turned a blind eye to their consequences. Times were too good. The first rule of central banking — to take away the punch bowl before the party gets out of hand — was ignored. Failure to act enabled a housing bubble to build and ultimately burst, bringing misery to the entire capital market.

The case against The Maestro, as Greenspan had come to be called, is particularly damning because of two fundamental principles that personify his era as Federal Reserve chairman. The first is that the Fed is powerless to identify and prevent asset bubbles; all it can reasonably be expected to do is clean up after the bubbles burst. On his direct watch, Greenspan had significant evidence to support this thesis, including the 1987 stock market crash and the bursting of the high-tech/NASDAQ bubble in 2001. Each resulted in relatively tame and short-lived recessions because of the aggressive monetary easing Greenspan pursued immediately following.

Unfortunately, the same medicine he prescribed to cure these crises contributed to a much more virulent and ultimately uncontainable housing bubble as mortgage finance ballooned. The burst housing bubble has engendered cascading systemic losses that few, including The Maestro, ever imagined.

The second discredited principle Greenspan adhered to was self-regulation in finance. According to this principle, the profit-maximization function — a balancing of costs and revenue to increase profit — is so strong that financial firms do not require extensive risk management oversight. Put succinctly, as banks want so badly to make money, the last thing they can be expected to do is assume risks that would destroy their business.

Events of the past 18 months have now discredited both of these precepts. A more pre-emptive and vigilant Fed coupled with stricter underwriting standards, more responsible securitization and genuine capital adequacy would have prevented the current crisis. Such rules for American and all major financial markets are a certainty for the future.

The banality of greed

Does systemic regulatory failure mean all the traders and banking leaders directly involved in the processing of mortgage debt, the attendant build-up of the housing bubble and consequent financial market collapse should be exonerated for their behavior? Are Greenspan’s lapses alone responsible for our sorry state of affairs?

In 1963, the German political theorist Hannah Arendt made a convincing case that the principal cause of the Holocaust lay not in the inherent evil of Nazi leaders like Hitler and Eichmann but rather in the tendency of ordinary people to conform to mass opinion, without fully reflecting upon the results of their action or inaction. A similar indifference — a banality of greed, let’s call it — has also been an essential precipitating cause of this crisis.

In recent boom years, profits generated by financial firms proved nothing short of astounding. In the mid-1980s, only some 11 percent of U.S. domestic corporate profits came from financial institutions. By the outset of the new millennium, however, this had nearly quadrupled to 41 percent, or $180 billion in 2004 alone.

It is not terribly surprising that tens of millions in cash, stock and options would be awarded to senior officers of such organizations in such good times — but the converse should also hold true, and that’s not been the case. In 2008, more than $18 billion in bonuses were paid on Wall Street when collective losses exceeded $80 billion. Few in the financial services industry stopped to consider whether their annual pay packages — which at their peak amounted to an astronomical 100,000 times more than that of the average teacher or federal air marshal — were a sign of excess and imbalance in the system. In retrospect, nothing could seem more obvious.

Self-regulation is a privilege, not a right. It is viable only as long as it serves the greater, common good. Too many Wall Street professionals assumed their pay packages from 2000-07 were some form of entitlement. Expecting or demanding lucrative employment contracts when one’s employer has lost money and/or received public assistance is an abrogation both of the collective responsibility that self-regulation requires and basic, common sense. It would be tolerated in no other industry. One cannot live by the sword and expect to expire on cushy, prenegotiated terms.

Capitalist economies depend upon the profit maximization credo, of course. Professor Roy C. Smith of New York University, in a reprisal of Michael Douglas’ Wall Street movie role, earlier this year wrote, “Greed is good. Wall Street bonuses are an important and useful part of the financial services industry, and taking them away could hamper the economic recovery.”

Church teachings

Surprisingly, those looking for categorical Church teachings to repudiate such practices will be frustrated. Centesimus Annus — the most recent and elaborate papal encyclical on economic and social teaching, written by Pope John Paul II on the 100th anniversary of Pope Leo XIII’s Rerum Novarum — states that the “Church acknowledges the legitimate role of profit as an indication that a business is functioning well.”

Centesimus Annus goes further in support of capitalism over socialism, stating “on the level of individual nations and of international relations, the free market is the most efficient instrument for utilizing resources and effectively responding to needs” and “there is certainly a legitimate sphere of autonomy in economic life which the State should not enter.” On multiple occasions, Centesimus Annus and Rerum Novarum reaffirm the Church’s commitment to individual private property rights.

The Church also teaches there are moral limits to profit maximization. “In fact,” John Paul II writes, “the purpose of a business firm is not simply to make a profit, but is to be found in its very existence as a community of persons who in various ways are endeavoring to satisfy their basic needs, and who form a particular group at the service of the whole of society. Profit is a regulator of the life of a business, but it is not the only one; other human and moral factors must also be considered which, in the long term, are at least equally important for the life of a business.”

John Paul II’s words presaged by exactly a decade those of our new president. Speaking recently at a news conference, President Barack Obama instructed that “we must not demonize every investor or entrepreneur who seeks to make a profit — yet we must also understand how, when we look beyond our short-term interests to the wider set of obligations we have to each other, we best succeed.”

A 2005 study by Moody’s Investors Services — CEO Compensation and Credit Risk — provides hard data our last pontiff may well have intuited. “Firms where CEO pay is substantially greater than expected based on firm size, past performance and other variables experience higher default rates and more frequent, large downgrades than do similarly rated companies,” the report concludes. Weak management oversight, unduly large risk-taking, and obsession with accounting results rather than the social and environmental impacts of their business are the three likely reasons why excessive executive compensation departs from acceptable norms, Moody’s asserts.

For Catholics and Christians generally, moreover, whatever good greed might proffer in creating the life we desire in this world or a more efficient economy in the aggregate, it almost certainly leads to problems in the hereafter. “Those whom fortune favors are warned that riches do not bring freedom from sorrow and are of no avail for eternal happiness, but rather are obstacles,” Leo XIII emphasized. “The rich should tremble at the threatening of Jesus Christ . . . [and] a most strict account must be given to the Supreme Judge for all we possess.”

My classmate, Monsignor Charles Brown ’81, now a senior oblate in the Vatican’s Congregation for the Doctrine of the Faith, put this same, final test — our highest calling — into similarly clear context when I queried him about competing economic paradigms and careers.

“The Catholic Church has definite views only about one civilization, which we confess at the end of the Creed each Sunday: the life of the world to come. There is such a world and such a life,” he told me. “Everything on this side of that civilization is flawed and imperfect. The Church’s only real job is to help us in the arduous struggle to be found worthy of eternal life and not be swept into eternal misery. By inference, whatever professional calling and economic or financial system that helps people best prepare for death and eternal life is okay for Catholics.”

A true mission

Part of the mission statement of Our Lady’s university is to inculcate “a sense of human solidarity and concern for the common good that will bear fruit as learning becomes service to justice.” As one of thousands of Notre Dame alumni working on Wall Street, events of the past year have brought me to wonder if I have not somehow badly failed this noble mission.

The excesses and virtual implosion of our banking and broader financial system have been well-documented, but the individual and collective failures of judgment that have been committed by regulators and financial professionals alike have not yet received sufficient, serious reflection.

Has there been malfeasance and neglect in the industry? Yes. Has it been limited to a few? No, it has been endemic, spanning mortgage originators and credit agencies to banks, hedge funds and insurance companies.

Do regulators bear a large share of the blame for letting imbalances build? Indeed, but our entire debt-based way of life is similarly to blame. Americans must save more and consume less, ideally while the rest of the world saves less and consumes more. Is Wall Street uniquely evil? No, but it is often hard to trace the chain of what many of us do — e.g., advising clients, optimizing portfolios, pitching for deals — to making the world a better place. Doctors and nurses attend ill patients. Priests and teachers counsel and cajole their followers to greater understanding and wisdom. Bartering for an extra quarter point on a multibillion dollar trade is a zero sum game; someone is merely going to end up several million dollars better off at the other’s expense.

On September 11, I lost four colleagues and many more dear friends in the worst terrorist attack ever on U.S. soil. For weeks, as ashes floated through the open windows of our Upper West Side apartment, I wondered what my role should be in seeking justice, repairing broken lives and helping others in need. I reached out to many who had suffered incalculable losses, but in time I realized that my greatest contribution lay in helping the financial markets return to order. New aircraft leases needed to be financed if people were to fly again. Municipal bond issues needed to be arranged and distributed to willing savers to fund hospitals, student dormitories and pensioners properly.

In short, credit had to be channeled from savers to industrial firms and public institutions actively engaged in building the future. A shrinking economy does no one any good, especially the least fortunate. My job was to be a cog in the financial wheel that got our economy going again.

Now is no different. We — the sons and daughters of Notre Dame on Wall Street — can be the change we need by understanding our callings are a privilege, not a right, and by accepting that a larger part of our reward and self-esteem must come from the intrinsic good we effect rather than our paychecks. In sum, a greater “sense for human solidarity and concern for the common good” can enable us to support our families, help our economy grow, allow our society to heal, coax our world to become more just — and maybe, just maybe, bring us to eternal life.

Terrence Keeley has worked on Wall Street since 1987. He was one of the University’s first Young Trustee and now serves on the advisory board of the Nanovic Institute for European Studies.