THE LIFEWORTH REVIEW OF 2008

The end of financial triumphalism

May 10, 2009 by  
Filed under Third Quarter

Bill Gross: we are all to blame

Bill Gross: we are all to blame

Time will tell what the lessons of the financial crisis really are. One way of exploring the lessons is to look at how people were apportioning the blame at the time. From lenders to investors to regulators, it seemed everyone had blood on their hands. As Bill Gross, chief investment officer at Pimco, the world’s biggest bond fund, put it, ‘we are all to blame. For the most part, you can throw in central bankers, Wall Street, investment bankers and you can throw investors into the pot as well as mortgage bankers and regulators who looked the other way.’19

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz, winner of the 2001 Nobel Prize for Economics, summarised the main debate around the financial industry and its social responsibility: ‘In both the UK and the US, about 40 per cent of corporate profits go to the finance industry. What is the social function of the industry that justifies that generous money? The industry exists for managing risk and allocating capital. Well, it clearly didn’t do either very well [. . .] The idea that banks should self-regulate, relying on their own risk management systems and rating agencies, is absurd. We lost sight of why regulation is needed. The trouble is that regulators are too close to the people they are regulating. There was a party going on and nobody wanted to be a party pooper.’20

It is true that clues of the crisis to come were abundantly available to regulators. As early as 1993, the Interfaith Center on Corporate Responsibility (ICCR), a faith-based investors’ association, warned of the risks to households, communities and investors associated with sub-prime lending.21 In 2000, a House of Representatives hearing addressed many of the issues that were blamed for the sub-prime market woes, in particular abuses by mortgage lenders.22 In December 2006, a report by the Center for Responsible Lending, a not-for-profit organisation based in North Carolina (USA), published a report showing that, despite low interest rates and a favourable economic environment, foreclosure rates in the sub-prime market were very high (almost 20%). The report held predatory lending practices such as adjustable rate mortgages, no- or low-doc loans and pre-payment penalties as culpable.23

There is also evidence that regulators knew about the loosening of lending standards. The Fed’s survey on bank lending practices revealed a deep fall in standards beginning in 2004 until the end of the housing boom in 2006.24 In addition, global institutions, such as the Bank of International Settlements, issued warnings of the risks associated to parts of the US housing market in 2004.25

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

If the evidence was so clear, how could the regulators let the party go on? According to former International Monetary Fund (IMF) Chief Economist Kenneth Rogoff, governments and central bankers fell prey to ‘financial triumphalism’,26 the idea that light regulation and a self-correcting financial market are not only enough to maintain discipline but can help economies to grow faster. That the IMF did little to curb this process, and a lot to increase it through influencing financial liberalisation, raises a serious question mark over its legitimacy and proficiency in helping solve the problems now. It was the International Labour Organisation of the UN that has been warning in recent years of the excessive financialisation of the economy.27

Financial derivatives had became so complex that people trading in them did not really know how they worked, just that they were offered from reputable institutions and were receiving good credit ratings. The more complicated a product, the more ingenious, and the more profitable, or so it seemed. Some call this approach the greater fool theory, or pyramid selling: so long as someone else is willing to buy, then the prices can keep going up. Some talk about a collapse of trust, but that is misrepresenting what was involved in the market and emptying the term ‘trust’ of any meaning. Trust involves people. Most trades are done through a computer, often automatically. Finance professionals did not so much as trust, but they assumed—that complexity, ingenuity, a famous institution, and large market power, were all signifiers of financial value. With the onset of the credit crunch they now assume almost the opposite—hence inter-bank lending grinding to a halt.

Credit ratings agencies took some heat for an apparent lack of rigour in their valuation of complex derivatives. Developments in accounting, with the introduction of mark-to-market or ‘fair value’ approaches, facilitated a global-market group-think of ‘it is valuable because many of us think that many other people think it is valuable’. The credit ratings agencies are involved in a process that sociologists call ‘social construction’, i.e. where assumptions, beliefs and norms are constructed by people and organisations in society. The larger and more famous the ratings agencies, the more authoritative their ratings are and the greater impact on perceptions and thus of the market price of what they value. Thus within the current system there is an implicit value in play—that might is right. The socially constructed nature of financial markets was discussed at length by financier George Soros. Yet he did not articulate a value basis from which such processes could be more accurate and beneficial. Sociologists and stakeholder dialogue experts have different views on how a socially constructed concept of something’s nature or worth can be made legitimate and effective, with some advocating forms of ‘communicative action’ in the process as a way to achieve a participatory and intelligent view of phenomena. There is no such ‘communicative action’ in the valuing of assets in the financial markets.

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Perhaps the underlying reason for this situation is a lack of sociological and political-historical understanding within the financial services sector and its regulators. Finance services professionals, like most people, are naturally competent in objectivist or positivist approaches to understanding reality, and so, when they work in fields that are relativist in their nature, they are not at ease with exploring how we might wish to shape the ways in which we decide what the value of something is, and so just fall back on mob rule—where something is valued according to the sum of the views of the most powerful. If we are explicit about values, then we might seek a credit ratings system that allows new entrants, balances views, moderates the influence of strategic commercial self-interest and seeks to arrive at socially beneficial forms of valuation, such as using a five-capitals model of valuation.28 In this way the financial system might be able to learn something from the corporate responsibility community. A lack of political-historical understanding also contributed to the problem, according to Harvard historian Niall Ferguson. He said that most people in the industry and its regulators do not have memories stretching back before the 1980s, so they do not understand how financial systems have evolved over time and how they can collapse.29

This philosophical turn may seem to some readers to be miles away from matters of corporate citizenship. What are the implications of this financial crisis for corporate responsibility and responsible finance? A few immediately appear. First is the issue some dub ‘the political bottom line’.30 Intense lobbying by the financial industry helps explain how the financial crisis took shape. According to the non-profit advocacy organisation Common Cause, the mortgage lending industry spent nearly US$210 million between 1999 and 2006 in lobbying activities as well as political campaigns contributions to both Democratic and Republican politicians that helped persuade the US Congress to refrain from passing regulation that would restrict predatory lending practices.31 In addition, economist Robert Kuttner blamed the repealing of key protections put in place by the New Deal for contributing to the crisis.32 An example of this is the Gramm–Leach–Bliley Act (1999), which eliminated restrictions on affiliations between commercial banks and investment banks. Senator Phil Gramm, who led the charge to pass this bill, has close ties with the financial industry: he is a vice chairman at UBS Investment Bank and was paid by the Swiss bank to lobby Congress on mortgage-related legislation.33 The political affairs of corporations are a key element of social responsibility, implying transparency and consultation on the societal impact of the forms of regulatory change sought by investors.

A second implication for corporate responsibility, and responsible finance, is that much of the work being done in our area is fiddling around the edges, and not addressing fundamental economic issues. This has been discussed in these Lifeworth Annual Reviews since 2001, when the Enron collapse led Business Ethics editor Marjorie Kelly to question whether work on corporate responsibility risked being beside the point, and called for more focus on the fundamentals of corporate law and financing.34 In a new book by one of these authors, The Corporate Responsibility Movement,35 it is argued that corporate responsibility is evolving in a way that can address these deeper challenges. ‘The corporate responsibility movement is a loosely organised but sustained effort by individuals both inside and outside the private sector, who seek to use or change specific corporate practices, whole corporations, or entire systems of corporate activity, in accordance with their personal commitment to public goals and the expectations of wider society.’ The analysis suggests an interlocking framework is slowly emerging, which seeks to integrate economic and social principles, dubbed ‘capital democracy’ by the author. ‘Capital democracy describes an economic system that moves towards the creation, allocation and management of capital according to the interests of everyone directly affected by that process, in order to support the self-actualisation of all’.

Might the financial crisis spur professionals in the corporate responsibility and responsible finance fields to take up this deeper agenda? One process holding back an embrace of that agenda is the way that work in this field has been defined as a particular set of professional practices rather than an evolving field of societal expectation on business and finance. This delineation of a field of practice meant that, in August 2008, the United Nations Principles on Responsible Investment (UNPRI) could put out a press release reporting ‘Rapid growth in Responsible Investment despite credit crisis’.36 They were referring to new signatories, yet many of those same signatories were being lambasted at the same time for irresponsibly investing in ill-understood derivative markets. Until now the field of investor responsibility has been defined by the investors themselves. Therefore the focus has been on the social, environmental and governance (ESG) performance of the firms they invest in. But, with the financial crisis, they are beginning to have to look in the ESG mirror, as the public and civil society increasingly question the financial institutions themselves.

Nicolas Sarkozy: the idea that markets were always right was mad

Nicolas Sarkozy: the idea that markets were always right was mad

Perhaps the lasting impact on the corporate responsibility field will be that the more critical perspectives, such as those often reported in these pages, will receive greater attention from the shapers of the mainstream agenda on corporate responsibility. They will be able to quote people in high places. In Europe, for instance, some political leaders have called for an end to laissez-faire capitalism. In a political rally in French city Toulon, French President Nicolas Sarkozy said that ‘the idea of the all-powerful market that must not be constrained by any rules, by any political intervention, was mad. The idea that markets were always right was mad.’37

Trade unions have also reiterated their calls for more regulation. The Trade Union Advisory Committee (TUAC) to the Organisation for Economic Cooperation and Development (OECD) issued a statement in September 2008 spelling out what governments should demand in return for taxpayers’ money. According to TUAC, ‘international cooperation should go far beyond what is currently under consideration—i.e. reviewing prudential rules for banks and “encouraging” more transparency on the market place. It is the national and global regulatory architecture that needs to be restored so that financial markets return to their primary function: to ensure stable and cost-effective financing of the real economy.’38

UNI Finance Global Union also called for a fundamental overhaul of the financial industry based on tougher regulation, more transparency, long-term investment and sustainable growth.39 In June 2008, it released a statement with 13 key demands on the regulation of finance markets. These asked regulators to act on issues such as pay systems for executives, consumer protection, sales targets, and tax breaks for private equity.40

Given the caution with which governments were saying they would seek to influence banks and change the banking system, the unions have some work ahead. This is not surprising given how in recent decades monetary policy has been turned into a technical not political issue—symbolised by the establishment of independence for national banks. Yet the recent financial crisis has made publics around the world more aware of the political nature of their monetary systems. Most governments oversee a system whereby private banks print money, and loan it out as debt, thereby benefiting from the system of money creation in a way no one else in the economy does. In return for that privilege, we could expect that governments might influence the way they then loan out that money. But they don’t. Why is this monetary process beyond the political process? Why can’t the contracts governing how the private banks issue money incorporate restrictions on the way that money is used, to promote the objectives set through government? For instance, guidance could be given on the employment or carbon created by the activities funded by the loans. Perhaps corporate responsibility could be embedded in the money system?41 Rising awareness due to the financial crisis might lead to more discussion of policy innovations in monetary systems, yet governments do not seem ready to lead that process in 2008.

At a time of crisis it is natural to look for a quick fix. Yet, once the gold dust settles, it is clear that deeper questions must be asked, and discussed by a broader range of people than international financial institutions and the finance ministers of powerful nations. Any economic historian will tell you that ‘moral sentiments’ precede ‘the wealth of nations’. We should be considering what values we want to further through the design of financial systems. Being clearer about the values embedded within and furthered by the current financial system, and whether that’s suitable for this century, would be a good start. Steve Waddell, of the Global Finance Initiative (GFI), said, ‘although stability is clearly the major concern, there are also significant concerns about the social and environmental impacts of finance. Indeed, increasingly there are suggestions that stability cannot be realized without more categorically considering these broader impacts. There is no formal, open and inclusive public space to develop a global strategy to address these concerns.’42 Along with the Network for Sustainable Financial Markets,43 the GFI is one of a number of initiatives of progressive professionals thinking big on the future of finance.

» Beyond the Western financial crisis

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)

Drinking problem

May 8, 2009 by  
Filed under First Quarter

Ken Livingstone, former London Mayor: behind the ‘London on Tap’ initiative

Ken Livingstone, former London Mayor: behind the ‘London on Tap’ initiative

In February 2008, London Mayor Ken Livingstone launched London On Tap, a campaign encouraging consumers to ask for tap water in restaurants and pubs for environmental reasons. Jenny Jones, Green Party member for the London Assembly, called the bottled water market ‘one of the biggest con jobs of the last two decades’, adding that ‘Selling water in bottles and burning massive quantities of fossil fuels for its transportation does not make economic or environmental sense.’31

San Francisco Mayor Gavin Newsom passed an outright ban on the purchase of bottled water by city departments in July 2007; New York City officials heavily promoted tap water over bottled that same summer; and officials in Minneapolis, Salt Lake City, Chicago, Rome, Florence and Paris have taken similar actions. On top of being 500 times more expensive,32 bottled water comes with a heavy carbon footprint: from the oil used to make the plastic bottles most water comes in, to the carbon emitted during transportation and refrigeration, to the millions of bottles that end up in landfills. And the market is booming: the world spends $100 billion on bottled water every year; in the United States its sales are second only to carbonated soft drinks.33 The Worldwatch Institute has previously calculated that this is a similar amount to that required to ensure the whole world has potable tap water.

More than 25% of bottled water is treated tap water, including Pepsi’s Aquafina and Coca-Cola’s Dasani. In many parts of the developed world there is no particular health value in drinking bottled water rather than water from the tap. In fact, laws governing the testing of bottled water are much less stringent than those covering tap water: New York City tap water was analysed some 346,000 times in 2006.34 Given this fact, much of the advertising that claims bottled water is beneficial to health could be challenged.

Principally, though, the corporate responsibility problem lies with the bottles. According to the Earth Policy Institute, more than 17 million barrels of oil are needed every year to produce the 29 billion plastic water bottles used in the United States alone. Less than a quarter of these are recycled; the bottles that end up in landfills take four centuries to biodegrade.35 Add to this the emissions generated through pumping, processing, refrigeration and transportation, since 25% of bottled water is imported relative to where it is consumed, and its environmental impact per litre is estimated to be up to 300 times that of tap water.36

Kim Jeffery, president and CEO of Nestlé Waters North America, does not like the comparison with tap water. He argues that consumers don’t choose between bottled and tap water but between bottled water and other bottled drinks, which are sugar-loaded or otherwise unhealthy. In addition, he highlights that water is one of hundreds of beverages to come in plastic bottles. According to Jeffery, water bottles constitute less than 1% of municipal solid waste in landfills.

All of this raises the question: is it legitimate to target bottled water producers? Is similar attention being paid to really big water users, such as agriculture, or old and inefficient infrastructure? Part of the bottled water focus is due to the fact that large corporations are easy, cohesive advocacy targets. But of all drinks sold in plastic bottles, water is the easiest to replace instantly—in most industrial countries—it is quasi-ubiquitous, safe and cheap, and in this regard makes for an excellent advocacy target, since the public can act instantaneously.

Those pushing for extended producer responsibility would demand that companies take responsibility for their containers’ life-cycle. But producers have shunned deposit programmes and emphasised community recycling, for which they are not responsible and incur no costs. There are, however, signs of change: in September 2007, Coca-Cola announced its intent to build the world’s largest recycling plant in order to recycle and re-use the entirety of its plastic packaging in the United States.37 Unfortunately, there was no specified time-frame. Nestlé and Coca-Cola are reducing the plastic in certain bottle sizes by 20–30% to diminish plastic waste and the energy spent in making the bottles. Nestlé produces its own bottles on-site, so they don’t have to be shipped to the plants, which would add to emissions. An option that seems greatly ignored could be a shift towards materials that are more easily biodegradable, such as hemp- and natural fibre-based pseudo-plastics, which are made without resins and break down much more quickly than petrochemical-based plastics. Finally, producers could offer a re-usable bottle, or join in on the trend of directly encouraging re-use by selling water at a discount to those who bring their own container. Regarding emissions, the problem applies more widely than this industry; legislation and political pressure could encourage the use of modes of transport with lighter footprints.

Congressman Ed Markey: calling for deposit law

Congressman Ed Markey: calling for deposit law

Legislators could offer consumers a real incentive for bottle return, e.g. a deposit law charging a small sum for each bottle on purchase, which is refunded on return. In the US, states that have deposit laws and community recycling have much better rates of return than the national rate, but they are in a stark minority. Again, there are signs of change: Massachusetts Congressman Ed Markey has called for what amounts to a nationwide deposit law on single-use beverage containers, though his programme is still to be fleshed out, as it currently lacks crucial specifics such as management and sources of funding. A final way to target bottled water consumption is to look at it practically: people also buy bottled water because having a portable form of hydration is practical, since it’s not given that there will be a clean source of water wherever one is. In Bath, where council bottled water costs were running into the thousands of pounds annually and a ban on bottled water in all council offices was recently passed, activists have additionally called for the rehabilitation of public water fountains.

As with most environmental dilemmas, the problem is structural: it has to do with how we live and consume in daily and seemingly inconsequential ways. Campaigns such as London On Tap, which seek to raise awareness about our societal disconnect with the environmental and commercial systems we function in, are only a first step to jolt consumers towards simpler, cheaper and more environmentally friendly modes of consumption.

This is not to say that this is not a matter of corporate responsibility. Nestlé articulates its new approach to corporate strategy is one of creating ‘shared value’ for its shareholders and society. Its 2007 annual corporate responsibility report highlights a range of commercial initiatives that are generating revenues while addressing social problems.38 Such initiatives are laudable, but any reader of its report could justifiably ask whether this ‘shared value’ approach is really central to the Nestlé core business. It is difficult to see which social or environmental problem is being addressed, which social value being created, by the sale of bottled water in industrialised countries, rather than adding to existing problems of pollution and waste. The arguments offered by their CEO do not resonate with a ‘shared value’ approach. Given that many of the examples offered by companies of how they can address social challenges through business are in practice making less of a rate of return than that expected from the business as a whole, are not scalable, and are dependent on government or NGO subsidy through partnership, we may question whether they really embody a new strategy. Perhaps they could be more appropriately understood as an advanced form of an established strategy: effective public relations through corporate philanthropy.

» Glassed: women and CSR

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines.
(Page numbers for this section are available in the pdf download and hardcopy.)