We know now the causes of the financial crisis – excessive risk taking by banks encouraged by an incentive structure that was short-term and asymmetric (rewarding high returns but not clawing back if things went wrong). This culture was exacerbated by an over-trusting regulatory regime, an insufficiently independent credit rating industry and institutional investors who didn’t exercise necessary oversight. Collectively, they failed to ask the tough questions that might have reined in the excesses of the bankers.
Fundamentally though, the problem was one of ethical erosion. The pursuit of individual wealth masquerading as the pursuit of shareholder value combined with a discord between what banks thought their purpose was and what the public thought they were getting. As Gordon Brown has put it, instead of being ‘stewards’ of people’s money banks became ‘speculators with people’s futures’. Those in the upper echelons of our financial sector had de-coupled themselves from the code of ethics – fairness, honesty, integrity, respect that we expect in any interaction with others.
In creating a new economy out of the rubble of the banking system there is an opportunity also to build a system that reflects our moral values and not just orthodox free-market principles.
Last week I attended an interesting seminar at the IPPR as part of their ‘Tomorrow’s Capitalism’ series. The speaker was David Pitt-Watson, senior adviser to Hermes Fund Managers and one time nearly-General Secretary of the Labour party. Pitt-Watson’s central premise is that all the agents in the system failed to exercise responsibility for the decisions they made and failed to take accountability for the outcomes of those decisions.
The conclusion was roughly that although there is nothing wrong with making money, this should be the outcome of selling goods and services that people actually need, with profits derived from that activity. Instead, the banks and the shadow banking sector (hedge funds and the like) were making money through betting, punting and manipulating the system providing little economic or social benefit, except to themselves. At heart the value system – what matters – had been lost. Bankers had forgotten that they were responsible for customers, and shareholders, money and that they would be held accountable for their actions.
Instead of asking what they can get away with – tax avoidance for example, or how they can make short term profits through betting on vulnerable companies, currencies and countries – the financial services sector should think instead how it can innovatively and creatively provide consumers with the products and services they want and need. This is a marked philosophical change and will not be happened on by chance.
The system sowed the seeds of its own destruction. Short-termism, betting on failure and failing to exercise restraint and responsibility has come home to haunt not just the whole financial system but the ‘real’ economy too. What is built in its place is up to us.
FSA Chairman Adair Turner’s proposals for a new regulatory regime challenges the traditional orthodoxy, including the privileged status of the non-banks (hedge funds et al). This is welcome. Tough new rules in the UK will be under-pinned by a broad set of principles set out by the G20 last week – including a more robust stance on pay and bonus structures, regulation of hedge funds, a crack-down on tax havens and an end to the race-to-the-bottom in rules and regulations. G20 action reflects that this is a global failure of corporate governance and culture.
The new regulatory framework must encourage simplicity and transparency. If we can understand the banking system again then there is a greater chance that trust can be re-built – essential for a fully functioning market system that relies on money for transactions, savings and borrowing. Regulation can put a limit to some excesses – capping bonuses and stopping the opaque, complex investment vehicles and excessive leverage which enabled traders to demand their huge rewards – which ultimately collapsed the crazy system erected.
But a system that relies on regulatory rules alone will never succeed. Credit rating agencies, pension funds, the media and all of us, as investors, savers and borrowers must ask tougher questions. And bankers must re-learn that when they go to work they can’t leave their moral values at home. Ultimately markets will not work without the values of trust, integrity and honesty being upheld. Banks can no longer expect us to trust them, that bond has to be re-established. Financial markets are not value free, so in this new economy financial markets will be built on a new premise – a premise that you won’t push the limits as far as you can; that self-interest does not automatically trump collective interest; and that the financial system is there to provide a service for customers not a blank cheque book for those in the board room.
It might sound ambitious to call for a change in the moral philosophy of bankers – if they had a greater collective conscience we wouldn’t have witnessed the greed and excess that led to the crisis. But anything less radical will fail to tackle the systemic nature of the problems. Moreover, unless banks are seen to change, and some basics like paying more tax and responsible pay would help – then trust will not return. A re-shaped financial system, with clear responsibilities, accountabilities and a system built on fairness, integrity and transparency is the only way to re-build our troubled economy.