Dear Reader

Clients have been asking us why we still own major banks in light of their tarnished reputation in the aftermath of the financial crisis. As emotionally satisfying as it might be to avoid the largest banks, we believe that they play an extremely important role in our economy. We would rather work for prudent bank and financial system regulation than avoid them completely.
Last September, as housing prices fell and the value of billions of dollars of mortgage-related securities plummeted, the U.S. was at the brink of worldwide financial disaster. This is not hyperbole. Consumers, manufacturers, company executives, bankers, stock traders, bond traders and pension funds were all paralyzed. Our financial system, previously bloated on an excess of credit, suddenly teetered on the precipice of no credit. The purpose of the financial rescues and bailouts was to prevent the implosion of the worldwide economic system, as an increasing number of small defaults on mortgages led to escalating losses on all types of bonds, stocks and financial instruments.
Much of the excessive expansion in mortgage credit happened in the “shadow” or unregulated banking system of mortgage brokers, but we have no doubt that many, if not most, of the major banks also contributed to the immoderate expansion of credit. After watching highly leveraged hedge funds reap outsize returns and fat fees, the major banks and investment banks greatly expanded their leverage, without considering the potential for systemic risk. Banks encouraged their employees and traders to take on additional risk with pay incentives that heavily rewarded successful bets and only lightly penalized unsuccessful ones. We agree that there is more than sufficient blame to go around. We don’t like having had to use public resources to save private companies in order to ward off worldwide financial collapse.
In an advanced financial economy, both big and small banks serve essential functions. When all is functioning well, banks gather smaller sums of money as deposits and use them to fund loans critical for business expansion and growth. Without loans and without credit, economic growth is severely constrained. We actively invest in small community development financial institutions (CDFIs) that direct credit to the most underserved communities, helping to build small businesses and neighborhoods. These small CDFIs cannot put together the scale of loans and credit necessary for bigger borrowers in the way that big banks can do.
We now see an amazing opportunity for advocacy. In the past, opportunities to influence public policy were limited, and we focused on advocacy at the company level. Over the years, shareholder advocacy helped pave the way for the Equator Principles, a set of voluntary standards adopted by major banks to ensure that environmental reviews precede the financing of large infrastructure projects. We’ve filed “say on pay” resolutions at major banks. At this point, Congress and the Obama Administration are drafting the regulations and creating the governing bodies to strengthen the oversight applied to the banking sector and to other financial institutions. As a start, the Troubled Asset Relief Program contained a restriction on executive pay, limiting it to $500,000 as long as a bank still has those funds outstanding. We have joined with the Social Investment Forum on a range of policy initiatives in financial regulation. Our goals are to increase transparency, safeguard the financial system, strengthen say on pay initiatives on executive compensation, mandate corporate disclosure on environmental, social and governance issues, and to reduce conflicts of interest. Now is the time and the opportunity to change the system; we choose to do it as involved and active investors.