Local Official Involvement in Shadow Banking
An interesting question arises from <a href="http://www.miamiherald.com/2011/04/10/v-fullstory/2159921/robaina-at-ce…; target="”_blank”">a
big
investigative article in yesterday's Miami <i>Herald</i></a>: is it
unethical for a mayor and his wife to be part of a shadow banking
network in their city?<br>
<br>
The city is <a href="http://en.wikipedia.org/wiki/Hialeah,_Fl" target="”_blank”">Hialeah</a>, the second largest in Miami-Dade County. The
shadow banking network arose during the boom years, when individuals
who could not get loans but wanted to buy properties talked to their
friends, who introduced them to their friends, to get high-interest,
short-term loans.<br>
<br>
Assuming that the loans were legal, would it be unethical for a mayor or other local government official to make them? Or, better, under what circumstances would such loans constitute
unethical conduct?<br>
<br>
It does not appear that the mayor was using his position to benefit
himself or others. If anything, the issue is more the other way around. Was he
benefitting politically from his loans?<br>
<br>
According to the article, some of the mayor's
borrowers and their family members gave thousands of dollars to the
mayor’s campaigns and to a political action committee that supported
him. Assuming the contributions were legal, there are three issues
here.<br>
<br>
One, could these contributions actually have been interest
payments, that is, was the mayor effectively using his shadow banking
to help fund his campaigns? One response to this question would be,
since the mayor could have used his own money anyway, the only
difference would be making it look like he had more supporters
than he really did (and saving him from paying taxes on the profit).<br>
<br>
Two, is there an appearance of preferential treatment in the way the
mayor combined his business and his political career? </span>The
reporters talked to Kenneth Thomas, an independent Miami bank industry
expert, who said that shadow banking systems are not unusual, but that
he had never heard of a politician lending money to his constituents.
“Usually, political figures won’t want to do anything that could raise
questions about a conflict of interest. This is why bankers should
stick to banking, and politicians should stick to politics. Whenever
you mix banking and politics, you have that potential problem.”<span class="bold"><br>
<br>
<b>Disclosure of a Spouse's Finances</b><br>
Three, did the mayor disclose his loans? It turns out that he only
disclosed one out of six loans he made. </span>The ones he did not
disclose totaled about $1.1 million. He did not disclose them because
they were made through companies controlled by his wife. Under state
ethics rules, he didn’t need to disclose those because the companies
were registered to his wife, not to him.<br>
<br>
If you didn't think "protecting" spouses from disclosing their finances
is a problem, you hopefully will now. Through January, the mayor took
the position that the loans had nothing to do with him; they were his
wife's business. Then the story changed. He said that he packaged the
loans with his wife, that the money came from an inheritance from his
father and money he'd made in condo conversions.<br>
<br>
<b>Outcome Bias</b><br>
And then, in March, came the clincher: “My wife and I did this
from our savings. We were victims in this whole thing.”<br>
<br>
It's true, the mayor was a victim of a Ponzi scheme. The schemer was
convicted last year. The mayor is owed $750,000 on loans to the Ponzi
schemer, as well as more than $300,000 on three other loans.<br>
<br>
But had the boom lasted, the mayor might have made hundreds of
thousands of dollars. The fact that he was one of the losers makes no
difference to whether it was right for a mayor to make such loans and
whether it was right for him not to disclose them. By calling himself a
victim, he is trying to appeal to what Max H. Bazerman and Ann
E. Tenbrunsel, the authors of the new book <a href="http://www.amazon.com/Blind-Spots-Whats-Right-about/dp/0691147507" target="”_blank”">Blind
Spots:
Why
We
Fail
to
Do
What's
Right
and
What
to Do about It</a>, call "outcome bias." Outcome bias is "the
tendency we have to take results into
account, in a manner that is not logically justified. … People
too often judge the ethicality of actions based on whether harm
follows, rather than on the ethicality of the choice itself."<br>
<br>
<b>Doing Business with Shadowy Characters</b><br>
One problem with participating in such a shadow system is that some
shadowy characters can be involved, like the Ponzi schemer. That puts
an official in the middle of state and FBI investigations, not to
mention civil suits and investigative articles such as the <i>Herald</i>'s.
This is not a good way to gain the public's trust.<br>
<br>
Officials considering getting involved in even completely legal
shadow endeavors should think more than twice. But if they
feel they have every right to go ahead and make some money on the side,
or help out their friends, they should make it clear to everyone
involved that everything that happens will be made public from the
start. Disclosure will make the more shadowy characters think twice about
doing business with a government official. They will realize, "Hey,
this guy is on the same side as the police, even the FBI. I don't want
him around." If you keep things secret, you're effectively saying you're not on the side of the law.<br>
<br>
In short, you've got to choose. Be a public servant and do everything
by the book, or be prepared to have your government career end abruptly
when the news comes out, even if you broke no law.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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