An interview with me conducted by Usman Hayat of the CFA Institute was published on 24 March 2015 on the CFA Institute blog, and can be seen here.
If there is one issue on the minds of the general public, the media, and policy makers alike when it comes to financial services, it most likely is ethics.
That’s why I was surprised to find that there have only been a few books published since the financial crisis that directly address ethics and finance. Of these, one prominent title is John Hendry’s Ethics and Finance: An Introduction, which was released by Cambridge University Press in 2013. Although it is intended as a textbook, at about 300 pages long, it is a relatively easy read, similar to more mass-market finance books in its accessibility. I found that it covers most of the key issues on the topic, with lots of recent examples to help make it clear and engaging.
Reading this book stirred some provocative questions in my mind, and to find the answers, I turned to its author. Professor Hendry, a fellow of Girton College, University of Cambridge, offered some compelling insights.
CFA Institute: With all the bad press concerning financial services, readers are left wondering if there is something about the sector in general that makes professionals more prone to ethical lapses than would be the case if they were working in another field, say in health services. Having worked extensively on business ethics, what’s your view on this?
John Hendry: The first thing to say is that, despite the efforts of CFA Institute, financial services is not a profession in the traditional sense of the term. Setting that aside for the moment, the answer has to be yes, the financial services sector is especially vulnerable to ethical lapses. There is no doubt that ethical problems are more common in this sector than in almost any other. And we have no reason to think that the sector attracts people who are especially unethical. So it must be something to do with the sector itself.
Why, then, are financial services so vulnerable to ethical lapses? I think there are two main factors. One is the nature of money. There is a complex story to be told here, but in simple terms, because money has no intrinsic value, and at the same time has a uniquely high exchange value, it has all sorts of de-moralizing effects. For example, whenever a debt, or a service rendered, or a product is exchanged for a purely monetary value, the qualities, values, and personal obligations associated with what is exchanged are all lost and replaced by a pure monetary quantity, anonymous and value free. And because morals are always associated with values and with personal obligations or commitments, they are lost too. As behavioral economists have shown, monetary incentives crowd out ethical motivations.
Another example: Because money can be transferred freely across borders and across cultures, it is not tied, as goods and services are, to the context of a community. And since moral values are essentially community values — indeed, they are what hold communities together — money eludes them. Of course, all businesses involve money, but most businesses are built around other things — physical products, personal services — which are themselves rooted in people and their communities. The human costs of unsafe working conditions, poisonous emissions, addictive or toxic products, psychologically damaging media, or exposure to Internet grooming cannot be ignored, even by those making a profit from them. The impacts of financial services are much less direct and much harder to trace.
The second factor is the culture of a sector shaped by an established and largely unquestioned dogma, rooted in the assumptions of economic theory: that unrestrained financial self-seeking by financial agents will, through the magic of markets, maximize the well-being of society at large. As I explain in the book, this argument just doesn’t work, but it is deeply embedded and it leads to the view that moral qualms are out of place. Even George Soros, a man deeply concerned with ethics and deeply critical of economic orthodoxy, insists that financiers have to act, as financiers, out of pure self-interest, and leave their morals at home. Now Soros has also argued for much more extensive regulation to impose ethical standards, but on this he is a lonely voice. For the sector as a whole, minimalist regulation is part of the formula by which self-interest is supposed to work.
Can we come back to that question about financial services as a profession. Why do you say that it isn’t, or isn’t yet, a profession?
If we look at the traditional professions — medicine, law, engineering, or even accountancy — they have a number of key characteristics. The first is a very high and uniform required standard of scientific and technical knowledge, without which people cannot practice. The second is a substantial period of apprenticeship or on-the-job training, again compulsory, through which professionals acquire supervised practical experience and understanding of the broader context in which their knowledge is employed. The third is a set of enforceable ethical standards that include a clear commitment to both the public interest and the welfare of the client and make every professional personally responsible for the actions of their team. If you have dealings with a professional firm, then no matter how junior or incompetent the person with whom you are dealing, there is a fully qualified named individual taking full responsibility for everything they do, or don’t do.
None of the professions is free from ethical lapses. Accountancy in particular has had its problems, partly because, like finance, it is concerned mainly with money, and partly because the major accountancy firms have moved outside the profession for much of their business. But there is still a very marked difference between the cultures of accountancy and financial services, and this is at least partly a matter of professionalism. I can only applaud the efforts of CFA Institute to professionalize financial services, but in terms of the characteristics I have listed, there is an awfully long way to go.
In the third chapter of your book, you write “The central issues in the ethics of finance, and the issues in which there is a broad public interest, are all to do with the . . . impact on other people.” A key issue, as you discuss later, is the impact on society at large, especially through rising economic inequality. Is finance a cause of rising inequality? And if yes, should such a broad issue be a day-to-day ethical concern for individuals working in financial services?
The relationship between financial services and global inequality is highly contentious, but if we look at the growth of inequality within developed economies such as Britain and the United States, there can be little doubt that the proliferation of financial services is a major cause. It is not the only cause: technological change and changes in taxation have probably had a greater effect. But it is a major one.
There are two aspects to this. First, a large and increasing proportion of all income generated has gone into the sector and the households of its principals and employees. The rich who are getting richer are doing so, to a large extent, on the back of financial services. Second, because financial services are essentially non-productive (they redistribute wealth rather than create it), these gains have come at the expense of the productive economy on which lower income households depend. So the poor who are getting poorer are also doing so, to some extent, on the back of financial services. Now, to say that financial services are themselves non-productive is not to say they are not valuable. The core purpose of the sector is, after all, to redistribute resources to the firms most able to use them productively. But in the last 30 years it has far outgrown that purpose, so that it now acts far more to extract resources from the productive economy than to allocate them within it.
Should this be a day-to-day concern for people working in financial services? No, I don’t think so. To the the extent that there is a day-to-day problem it is with the overselling of products that will lose clients money, but you don’t need to think about inequality for that to be a problem. And the main problems are structural ones. Despite all the rhetoric in favor of free, efficient markets, the markets in financial services are extraordinarily inefficient. Were they not so, both fee levels and pay levels would be much, much lower. When you build a career, as an individual, you make choices around the financial and non-financial rewards of different jobs and their value to the community. But once you’ve made your choice you do the job to the best of your ability. And if a firm offers to pay you more than you would actually be willing to do the job for, which is the case for many people in the sector, well good luck to you!
In your view, where does the best hope for ethics in finance lie? For instance, does it lie in making individuals more aware of ethical considerations, or in tightening regulation, or in fundamentally restructuring financial services along the lines proposed in limited purpose banking, reducing reliance on both ethics and regulation?
I suspect that in the longer term financial services will be restructured, if not along the lines suggested in limited purpose banking, then in some similar way. From Wikipedia to Uber taxis, we are already seeing the extraordinary power of the Internet to maintain self-correcting systems, and while these pose ethical challenges of their own (and will do so especially in the context of finance), they will surely impact on financial services. But I think the best chance of their doing so is through market forces, and given the inefficiencies of the financial services markets, this won’t happen quickly. Meanwhile, I am skeptical of attempts to impose change on the sector. Just look at the way the very modest provisions of Dodd-Frank are being diluted in implementation, and at how in Britain the politicians’ determination to change things never seems to result in anything.
I think the best hope for a more ethical financial sector — or, as I would put it, for a sector in which people behave much as they would in any other context, a sector that no longer claims amoral exceptionalism — probably lies with increasing professionalization, along the lines I suggested earlier. Both firms and individuals have an interest in this — like anybody who gets rich, they then want to get respectable — and if just one large firm were to take a stand and impose genuinely high professional standards (and not just a professional rhetoric) on its entire workforce, others would feel compelled to follow.
What practical measures would you advise to individuals and firms in financial services to do a better job at ethics for a better future of finance?
Before giving any advice I would ask two simple questions. Should people behave ethically? And are you and those who work for you people? If the answers are “yes” (and it’s hard to see how they could not be), then my advice would be as follows: For individuals, find a way of thinking regularly about the ethical implications of what you’re doing. It needn’t take long, but it does entail stepping aside from the pressures of performing and getting yourself into a different, calmer mindset, so a trigger of some kind is helpful — I find a cup of tea and a garden work for me. The point is that we all know what is and isn’t ethical. That’s not the problem. The problem is awareness.
For firms, I would go back again to professionalization, but with a warning not to confuse it with codes of conduct or compliance. Codes of conduct in the professions are a way of writing down the ethical standards to which professionals are committed, not a way of imposing those standards on the uncommitted. The commitment has to come first.