Can Ethical Restraint Be Part of the Solution to the Financial Crisis?
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As we look at the turmoil in the financial markets from an ethics perspective, we have to ask what problems we are trying to solve. Or more aptly, what problems can, and should, the more vigorous and appropriate application of ethics, address? I would argue that we need to apply ethics to our entitlement culture as a whole, in order to truly address the fundamental issues affecting our economy.
Fellow, Caux Round Table
Consider variations of this question. Do we want to re-inflate the stock market? Not necessarily. If the stock market’s higher valuations were predicated on inaccurate risk assessments and inflated values, then the market’s current valuation may correspond more accurately to the real intrinsic value of the economy.
Do we want to restore trust in the financial markets? First of all, we would have to unpack what this means. Whose trust? The trust of investors? Regulators? Customers? For investors, it may not be trust in financial markets that is at stake so much as trust in financial analysis and financial analysts. Investors always vote with their money. It is not trust that will cause investors to pour money into an asset class, it is its money-making potential. Stock market volumes have ebbed and flowed over the course of this entire crisis, but investors are not sitting on the sidelines due to lack of trust, it is due to a lack of visibility about what will make money in the future.
We would also have to differentiate between trust in individual companies and trust in the over-all sector, and trust of individual managers versus trust in the entities as a whole. Investors quite rightly, might not trust the snapshots that they receive about GE Capital, Citi, Bank of America, Wells Fargo, or JPMorganChase, not because they are not ethical, but because their operations are so far flung that no one, not even the management of these respective companies could possibly know everything that was happening within them with absolute certainty.
So is it the volatility and the swiftness that markets can rise and plummet that we want to rectify? Do we consider speculation to be evil? If it is, then how can investors re-allocate resources to take into account new opportunities? Do we want markets to be more liquid and deep or less? Do we equate reducing the speed of transactions and the depth of the capital pool with increased stability? Investors who suffered through the 1690s, the 1720s, the 1850s, the 1890s, 1907, 1929, etc. might beg to differ.
On the other hand, maybe we should be talking about restoring the trust of the financial sector in the general public. Some argue that comparatively speaking, companies have more capital, particularly with the federal government as backstop, but they don’t trust the ability of potential customers to pay back the money they have available to lend.
Perhaps what we really want to accomplish is something like the following:
- A commitment on the part of business managers not to “over promise and under deliver.”
- A commitment on the part of borrowers not to overextend themselves.
- A commitment on the part of analysts to “speak truth to power” and not get caught up in conflicts of interest
- An end to foolish speculation, but the preservation of wise speculation
- A reduction in financial complexity
- Restraint in seeking tax havens and lower regulatory transaction costs
This list not only is idealistic, it would be impossible to enact from a regulatory perspective. One person’s view of foolishness, is another’s wisdom. What one says is not always what another person hears.
Also, the problems associated with the financial system aren’t all due to inherent evil. People make mistakes. They sometimes act on incomplete information. They sometimes have to choose between two competing outcomes that have both costs and benefits. They sometimes have to act before they are completely ready.
But on the outside, regulators, investors, and consumers may not appreciate all of the challenges that financial operators face. All of us represent individual pushes and pulls on a gigantic system that we only see partially. We are all like blind people around an elephant.
So in this impossibly complex, multivariable system, we can’t just think about restoring trust, we have to think about mechanisms that help us to approximate the level of action we would want to have if we did have trust. We need trust substitutes in other words.
The private sector uses trust substitutes all of the time across many different industries. Think of warranties. Pay $199 extra, and even if your TV does break down within the next four years, we will fix it. Think about brands. Every time we buy something from Nabisco or General Mills or Johnson & Johnson, we expect that it will be good for us. Think about endorsements and third-party referrals.
Institutionalizing and upgrading all of these trust substitutes within the financial sector would have an ameliorative impact.
We also have to look at the level of complexity in which the financial sector is operating. It is very hard to trust other actors when there is a lack of understanding of policies, procedures, rules, regulations, guidelines, and so on. In fact, as Hernando de Soto wrote about in his book The Other Path, there seems to be a direct relationship between complexity and corruption. The more complex a situation is, the harder it is for the actors within the system NOT to break the rules.
Is it possible for us to move from a rules-based system to a principles-based system and reduce the complexity that we currently face? I leave this one to the experts.
However, perhaps our problem is not so much an issue of business ethics, as it is a problem of our general culture. We live in an era where all of us think we are entitled. We all want to jump to the head of the line, take the last piece, and get preferential treatment.
But guess what? As anyone knows who’s been stuck in a traffic jam, if everyone jumps the line, no one moves. A little patience enables everyone to get through although it might cost each individual a few seconds of time compared to what they might save if they jumped the line and everyone else stayed in place.
In short, we are suffering through a society-wide version of the thieves’ dilemma. As is well-known, the police often separate thieves from each other in order to get confessions. If both thieves trust each other, they remain silent and both escape. If one thief implicates the other and the other one doesn’t, the one that is trustworthy loses, and the one that sells out his partner wins. If neither one trusts the other, both lose. The implications for society are clear: if we don’t trust each other, we all lose.
So how do we apply ethics to the current crisis? We apply it to ourselves. We can borrow a page from Virgil that “we do our duty although the sky falls down.” We can begin to realize the truth of the Biblical story of Nehemiah, where the townspeople realized that each of them had to build their part of the stone wall in order to protect themselves from their enemies.
Even if we see others cheat, we have to stay in line. Even if others get benefits that we don’t get, we can’t just pick up our marbles and go home. Even if others complain, we have to pay our taxes. We have to internalize restraint and then lead by example. This doesn’t just apply to managers or to speculators or to profligate home buyers, but to all of us as constituents with a vested interest in the health of our society. We have to stop the erosion of trust personally, and we have to bring immense social pressure to bear against the entitlement mentality.
This concept of restraint may be foreign in a society where every demand is cultivated, but consider the alternative. When everyone jumps the line, what happens sooner or later? A traffic light gets set up, cops come, and the flow of traffic, which used to just be a problem during rush hour becomes institutionalized and rationed at all times of the day. The lack of internal restraint leads to perpetual external restraint enforced by political forces that aren’t fluid and dynamic and contextual.
The same thing will apply to access to capital, as market forces give way to political forces. Our markets will be structurally slower, less efficient, and less competitive as the regulators intrude more and more.
This is the process that we are currently living through and why ethical restraint is so vital for the future of our capital markets. Although they may be slightly inefficient, they are much more efficient than the alternative of regulatory power.
Fellow, Caux Round Table