O’Meara Ferguson Responds to the Global Financial Crisis

(October 2008) In response to the economic crisis, Patrick O’Meara, President and Founder of O’Meara, Ferguson, Whelan, and Conway, Inc., gave his response to several questions that many people are asking – specifically, Mr. O’Meara discusses the potential impact of this crisis on our Church finances and fundraising.

Additional O’Meara Ferguson Response Information

The scholarly answers to these questions will be contained in many books which will be written in the months and years following this current crisis. My answers are partial at best, I hope but they are helpful indicators of the fundamental issues at stake. With that caveat, and for the sake of brevity, I will be painting with broad brush strokes.

I’d like to start with a favorite quote from JP Morgan. Morgan was providing congressional testimony on the nature of banking. His interlocutor was Congressman Untermyer, a populist, who strongly disliked Mr. Morgan:

Untermyer: Is not commercial credit based primarily on money or property?

Morgan: No sir: the first thing is character.

Untermyer: Before money or property?

Morgan: Before Money or Property or anything else. Money cannot buy it…because a man I do not trust could not get money from me on all the bonds in Christendom.

What we have now is truly a global crisis of confidence (as opposed to strictly a liquidity crunch), confidence in the character of the people running the banks, the investment firms, and the government’s response to the crisis. Banks are not lending to one another because they do not trust the others’ assets, valuation or numbers. The devil they do know (their own portfolios) is better than the one they do not know. The lack of short term liquidity is bleeding the life out of our body politic. Every entity everywhere needs short term liquidity for normally managing an enterprise. How they access it varies. Those with excess capital cannot sit on cash without having inflation erode its value. They must invest. There is enormous money on the sidelines now that must, and will, get invested. The question is when and where. The pessimism that exists now is truly global. The process of getting into this crisis took some time and the solution will also take some time. The primary reason it will take time is that there is not one person or group of persons who can restore this confidence. Moreover, there is a high degree of interconnectedness amongst banks and financial institutions and this too is having a magnifying effect. Governments collectively can add stability, but we need investors (be it 401k savers or Diocesan CFOs or Corporate Treasurers) to begin to believe there is more opportunity than risk out there. It will take some time to un-ring this bell.

Let’s take a short look at how we got here. Lots of people in Congress and in the White House are pointing fingers at each other to assign blame on one party or the other. Fortunately there is enough blame for both parties. Unfortunately there is very little responsibility being taken. What we have here is a failure on the part of regulators to enforce oversight as well as a failure on the part of legislators who opened the door and over time allowed this crisis to develop. From the private sector, there was a lapse in the fiduciary role of boards and other corporate governance as well as a misalignment of incentives and fraud that exacerbated regulatory oversight. We also have a mortgage crisis that ignited the problem and was magnified dramatically by the failure of those who were supposed to be responsible stewards of other people’s money.

The Glass-Steagall act of 1933 separated the Commercial banking businesses from the Investment Banking businesses. The rationale behind that act is that the Investment Banking businesses which generated much higher returns took much greater risk and as such should not endanger deposits but only the capital of investors who were willing to take such risks. This was a very sensible decision.

In 1999 after much lobbying by large Commercial banks this legislation was repealed by the Graham-Leach-Bliley Bill. The rationale given was that executive leadership and risk management is much better now than it was early in the previous century. The Commercial banks’ view at the time was that they had lots of good capital producing far fewer returns than funds invested in large Investment Banks (like Bear Stearns, my former employer, and Lehman Brothers) with an inadequate discussion of differentiation of investors versus depositors. So Congress being a trusting lot took depositors’ money and put it at risk.

This is not the only place where our legislators put our money at risk. Freddie and Fannie are to some large degree public trusts and the management team at these institutions again saw all this capital that could be leveraged up to produce much greater return with very little discussion of risk on the other side of the balance sheet. Risk management is a larger responsibility and a more complicated question when the U.S. government (the tax payer) is the guarantor. The shareholders, if they are dissatisfied, are not able to move their deposits or investments; instead they must rely on regulators and the U.S. Congress. When some regulators tried to push back on this leverage, and the accounting of it, these Government Sponsored Entities’ management was defended vociferously by both parties in the name of greater home ownership in America. This is clearly a wonderful goal, but the manner in which it was promoted was reckless – looking only at the benefits so that risk was absent from the discussion.

This very neatly brings us to executive compensation. The management of large institutions instead of acting as stewards of the public trust placed in them acted in their own self interest which was irresponsible, and most likely criminally negligent in some instances. Their bonuses have to be measured as fractions of billions of dollars (and large fractions at that). This returns us to a need to be able to trust. We are all for capitalism, but there must be a genuine relationship between long term value creation and compensation. Not compensation based on short term realities that put investors, depositors, and the tax payer, at serious risk! The longer measuring stick builds this measure of trust. I used to have a speech that I gave in 2001-2002 entitled, Truth as the Basis of Free Market Economy. I gave it several times, it was well received, but I was told it was not really relevant here in the US, but was needed more in Russia, and other countries that do not have a strong rule of law. Apparently we need it everywhere.

For the sake of brevity I will say that recent accounting changes (Mark-to-Market, Basile II Capital requirement) magnified all these problems dramatically through their underlying assumptions and their unintended consequences. These changes were being driven by academics who argued from an ideology that attempted to differentiate risk levels and the associated valuation of certain assets or capital allocation. . These “efficient market theorists” suggested that the price of an object is always accurate because the market is always efficient. While the market is efficient over a 5-10 year time, assets are mispriced occasionally. This is why Warren Buffet can buy low and sell high. The theorists view him as a statistical aberration, arguing that with so many investors someone has to be right all the time. Similar to the concept that if you put enough monkeys in the room with typewriters one will eventually type out War and Peace. While an interesting notion, that fact that this drove how we were forcing companies to account for their assets is scary.

With all these sellers and no buyers, people had to mark down assets and a downward spiral was established. If a few investment banks had gone under and as a result their investors lost their money, it would have been a shame, but these investors were aware of the ante at the poker game. Unfortunately the American public found out it had been “in the game” for years completely unaware of that fact – or of the risks being taken in our name! It what a situation classically know on Wall Street as the traders bet; heads I win, tails, you lose. This is what truly began to shake the confidence of the American people-so that banks, fearing exposure of other banks to the risky securities business, stopped lending to each other. If they were just in the deposit and lending business – and not in the equivalent of a high risk poker game, they would clearly lend to each other.

So this is where we find ourselves. The solution will come with restored confidence in the banks’ fundamental businesses. The British Government’s plan is a good one and a similar plan in the US would be helpful to restore confidence in inter-bank lending. Once this happens the markets will return to normal over time. Those with significant cash and investment positions will find significant values in times like these. So the next question is what does this mean to us, as the Church.

In any downward economic turn, the axiom for investors is: “Go long and invest in religion and alcohol.” As good Catholics, we would recommend both. But, seriously, what does all this mean from a stewardship and development standpoint?

Large donations will require more cultivation over a longer period, more relationships from which we will expect to receive large donations. This is so because those donations are going to be less from excess cash flow or appreciated investments and, more from the core capital of the donor. This truly means “sacrificial giving.”

We as a Church will continue to rely on large numbers of smaller donations. Our ability to manage, and grow, these smaller donations will require us to have better base line data on the small donor. Using stewardship-based offertory enhancement programs and capital campaigns is a clear part of this.

Exceptional Catholic organizations that have clear mission statements, a compelling Case for Support, strong communications with their constituents, multiple levels and means of involvement for their donors and stakeholders, and are clearly seen as making a difference in the communities they serve, will do well. Others will need to change.

The primary way that we can be assured of our success is by making sure that we remain faithful to our primary purpose: advancing the mission of the Church. This is vitally important. Christ came that we might have life and life to the full and that we would have peace which surpasses all understanding. Having peace in these troubled times truly surpasses understanding. Placing our hope in someone other than the next person who will occupy the White House, or lead the Federal Reserve Board, is especially important and appropriate today. That is not to say we shouldn’t work hard at making sure the right persons occupy these positions, but we need to make sure we remind ourselves, neither one is our Savior.