Greed and Debt - The Corporate Side

I believe that greed and debt has a corporate side as well as a personal side. After all if a loan isn’t a good business transaction for the borrower, it probably isn’t a good transaction for the lender as well so why do such loans get made. Back in the early 1970’s went I began an 11 year banking career, there was a crisis around Real Estate Investment Trusts for REITs. The concept was that banks lent money to the REITs which, in turn, lent it out for real estate transactions.

The problem was that the REITS were lending the bank’s money to borrowers who the banks would not have lent to in the first place. So no one should have been surprised that as soon as the real estate market had problems that the REITS couldn’t collect from the borrowers and, therefore, the banks couldn’t collect from the REITS.

Banks, almost all of which are public companies in one way or another are always under pressure to show an increase in earnings. Banks earn money from loan interest so sometimes the only way to increase interest earnings is to increase loan volume and if there aren’t enough good borrowers then lenders go to the next level and so on. That’s greed in the corporate sense whether from market pressure or other reasons, the drive for profits leading lenders to do things that are not in anyone’s long term interest.

Something that is always forgotten in those situations is that one bad loan can offset the interest income on a large number of good loans. Interest after all is typically calculated at a rate of say, 10% of the principal. 10% on a $100,000 loan for a full year earns $10,000. As a result one $100,000 loan that is not repaid offsets the interest on ten good $100,000 loans or on one good $1 million loan.

Even without greed as a motivating factor some loans will not be collected, but typically those losses are limited. It is when greed, the desire for income overcoming the risks inherent in earning that income, is out of control that the bank or banks in question can get hurt in a big way. When such situations are widespread enough, then stockholders also get hurt.

The desire for financial success both corporate and personal is not a bad thing. It is a driving force in any free market economy and in the U.S. has created a higher standard of living for a greater percentage of the population than anywhere else in the world or in history. When greed sets in, however, at both levels, then tools like debt will most likely be used in destructive ways that can harm both individuals and corporations in some pretty serious ways.

How to prevent this or at least lessen the risk is not an easy thing to do. If it were, we wouldn’t have such crisis every so often. On the personal side leadership political and otherwise needs to emphasize sound economic values. One place this can come from is the church, since this is really a stewardship issue. On the corporate side adequate regulation is important. Something else that would be helpful would be less pressure to have earnings go up quarter after quarter, to recognize that sometimes lower levels of income aren’t as bad as major asset write offs. While I don’t have my hopes up, it would be nice if at least some progress could be made coming out of the current situation.