Jon,
Interesting arguments. I am not an expert in this area, but I think that all investment firms, social or otherwise will have to change how they do business.
One of the major difficulties with the type of advanced financial tools and innovative ways of packaging investments and securities is it makes the process less transparent. One of the major difficulties with these new financial tools is clearly identifying the risks of any organization. What were the causes of this crisis? Management Research News (Vol. 31, No.1, 2008) recently published an article by Lewis D. Johnson and Edwin Neave (both are Finance Professors at Queen's University in Canada) titled "The Subprime Mortgage Market: Familiar Lessons in a New Context". Who provide a good primer and provide various potential explanations on why this crisis occurred. They do not blame predatory practices, but the systems in place, such as new technology to actually decrease the transaction costs to make mortgage processing easier, greed, etc. Here is how they summarize their findings: "We find that a combination of need, greed, perverse incentives, inadequate risk controls, lax regulation and lax oversight caused a bubble in the subprime mortgage market which has inevitably burst. The principles of transaction cost economics provide a template for analysis and corrective action."
In their conclusions they say it won't be worse than about a $150 Billion concern due to the real assets that exist (houses). Even though the government has been throwing around the $700 Billion, much of this will be in purchasing the bad securities in the bailout. Eventually, (fingers crossed) much of it will come back and the government may actually make money.
Now how does this relate to SRI? I think they will have to look at risks. Part of responsible investment should explicitly include financial risks into the equation. Any investor that doesn't do this is negligent or criminal. But, I don't think that SRI need to change the other factors, every fund has some factors that they would consider. Clearly, they are setting constraints on their investments, as do most funds. When any constraints are set, it is highly likely (almost always be) that optimization will be less. You are limiting how much you wish to maximize. Are they being negligent, no, they are making their criteria clear to their investors. Is there a market for SRI? You bet. Will it continue to exist after this crisis? I believe so. Will they change their ways? Maybe if they consider the true risks of their investments. The question of whether there is greater or less risk in Socially Responsible Investments is an interesting question. I am not sure if the literature has discussed this issue. If the risks are higher and they are not giving the returns that are expected of them then people should not invest in them. But, some would argue that it is less risky to be doing good, so getting less return may not be a bad thing.
If you do not have access to the Management Research News article, I can send you a draft version.
Good luck with your report/study.
-Joe S.
-----Original Message-----
From: Social Issues in Management Listserv [mailto:
SIM@AOMLISTS.PACE.EDU] On Behalf Of Jon Entine
Sent: Friday, September 26, 2008 11:21 AM
To:
SIM@AOMLISTS.PACE.EDU
Subject: [SIM] Help on article for Ethical Corporation on the financial crisis thought the lens of CSR/SRI
From Jon Entine:
I'm working on an article on the financial crisis through the prism of the
CSR/socially responsible investing communities for the British based
international magazine Ethical Corporation, with a short deadline.
Does anyone have any thoughts on how this may impact the SRI world? Are the
problems that we are seeing something that could or should have been
identified by CSR/social investor advocates?
I'd be eager to incorporate people's ideas (and cite them) and also
interview some of you if you believe you have some interesting perspectives.
Could some of the 'values' of articulated by CSR advocates and SRI social
screening researchers actually be drafted to help us through this crisis?
Is this a "non-ideological crisis"? If CSR/SRI principles are supposedly
able to identify RISK (which is one of its central components), why is
almost every one of the companies in the center of this storm on most
recommended lists of SRI researchers? Does this indicate a fundamental
failure of the research focus of CSR/SRI advocates? Does the crisis
highlight the fundamental (and I mean fundamental) inadequacies of social
investing as a screening mechanism and ethical evaluating tool?
I'm LEANING towards the belief that this crisis has highlighted the
fundamental failure/inadequacies of the social investing screening model,
but would love to have comments to the contrary.
A number of things come to mind. I've been struck by how SRI funds have
dramatically underperformed the average funds during this year long crisis,
with that underperformance accelerating as this crisis has deepened. In part
its because the SRI community has long overweighted financials,
believing that they were intrinsically more "ethical" (e.g.: playing with
money is more ethical than generating natural resources) than almost any
other asset category. The overweighting has ranged in some funds as much as
50 percent higher than comparable benchmarks. Almost every financial firm in
crisis was on most SRI approved and/or recommended lists.
For example:
The Sierra Club SRI stock fund, through the end of August, trailed the S&P
by 6.65 percent over one year, 5.27 percent over 3, and 3.48 percent over 5.
That disparity has even widened considerably just over the past month, as
financials, which it overweights, continues to underperform.
I've always believed that the major SRI research services often focused on
trendy and relatively irrelevant side social issues (e.g.: board diversity)
and ignored serious issues (make up of pension funds; for financials, what
loans were being given and to whom, and how were they structured). A case
might be made that this crisis actually marks the end of social investing as
we've come to know it. Finally, social investing might begin focusing on the
serious "social values" of companies, such as secure job creation,
responsible business practices based on genuine transparency, etc., instead
of on litmus social tests that have appeal in placid times but ultimately
reflect only 'top of the pyramid' issues. Maybe social investing will
finally mature into a useful tool--or will it retain in its outdated litmus
test/negative screen/superficial social screen construct?
Or this is this an unfair characterization?
In other words, what are the negative and positive implications for social
investing as this financial crisis unfolds. Will social investors rebel when
they realize they are getting hit far harder in this turndown than average
investors??
One other issue I want to look at is whether the SRI community has the
economic/financial sophistication to weather this storm. I was struck and
disheartened by the bizarre letter drafted by the Social Investment Forum
and directed to Congress expressing its views on the bailout negotiations.
It deals with none of the real issues, including its members focus on often
superficial social factors to the relative exclusion of the financial impact
of a firm--which social investors had gotten away with until the tech/com
stock crash of 2000/2001 and now the financial crash of 2008.
Again, the letter is just weird, focusing on relatively minor matters during
this crisis. Consonant with many "liberal" critiques of the crisis, it
elevates as the number one stated concern the "predatory lending practices"
that it insinuates are behind the current problems. No one who wrote this
could possibly be familiar with the lending data. Going back to the early
1990s, there was huge pressure by liberals in Congress and backed
consistently by social investors to lower lending standards precisely
because there emerged a general belief that home ownership should be opened
to those who otherwise were shut out of the prime lending market--hence the
birth of subprime loans, in which people could take out loans with almost no
money down, and with little if any documentation (liars loans). Is
homeownership really right for those in such precarious situations? Those
who advocated it, for ideological reasons, promoted the line (actually
embraced by many people of varying ideological stripes) that home ownership
was almost a right, even for the financially marginal of society.
Consequently, a substantial number of people were lured into owning homes
that could afford them only so along as home prices were rising, which is
not a divine right. When home prices flattened and started to decline, those
with no equity in their homes have been forced into foreclosure. It's a
social disaster, and said, and definitely needs to be addressed, but
understanding why this happened is also essential if we are to set up
mechanisms to prevent future problems. To suggest that so-called "predatory
lending" (it used to be called helping the less affluent get loans until
some people, the SIF, looked for a bogeyman) are responsible for this crisis
is just silly--it makes SIFers feel good, but its intellectually dishonest,
and turns serious issues into ideological ones--and will hurt the displaced
and distressed homeowners as a result.
Are there examples of predatory lending within this crisis? Of course. But
every analysis out there -- and there are many, and obviously the SIF didn't
read them, nor cite evidence to the contrary -- suggests that "predatory
lending," while a tiny issue, is insignificant as a prime or significant
cause in this crisis.
This raises again my concern: is the Social investment community capable of
focusing on real issues rather than litmus test minor issues that ring true
to its base? It comes across to me just as bankrupt as crazy right wing
Republicans railing against liberal Democrats. Its disingenuous. I expect it
from Ralph Nader, et al. I really had hoped, especially in a time of crisis,
that social investors would finally get serious about economics.
Even in this crisis, there are very serious issues, which Congress is being
forced to address, about how the "little guy" will be treated as it rushes
to bail out the oligarchs. But to frame this in ideological terms, and hang
in it on "predatory lending," is just financially ignorant.
So...can SRI grow up, or is it doomed to intellectual infantilism?
Please attack (gracefully, I hope) at will!! I'm looking for a genuine
dialogue, and discussions by phone with those of you who may agree or (even
more interesting) violently disagree with my perspective!!
Regards,
Jon Entine
Writing for Ethical Corporation
http://www.jonentine.com
http://www.abrahamschildren.net
P. (513) 527-4385
C: (513) 319-8388
FAX: (801) 527-4384
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