What to do about finance

In Uncategorized by John Hendry

In late July 2014 the think tank Res Publica issued a report with the title “Virtuous banking”, urging UK policy makers to reconfigure the banking sector so as to serve its proper moral purpose, with virtue at its heart. The authors made ten policy recommendations, but the one that caught the media’s attention was that all bankers should be required to swear an oath, committing themselves to put their customers’ interests above all other considerations. Online comments flowed thick and fast and the dominant response can only be described as one of hilarity. On what planet or in what cloud cuckoo land did these authors live? Did they honestly believe that bankers would ever swear such an oath, or if they did that it would make any difference at all to their behaviour?

Most of those posting online comments probably hadn’t read the report, but had they done so it wouldn’t have changed their responses. The other recommendations, which ranged from defining an overarching purpose for banking to increasing mutualisation, alongside standard issue suggestions such as codes of conduct, improved corporate governance and indices of customer satisfaction, were less comical, but no more likely to be effective. They were the kinds of recommendation you get from policy academics, who have all sorts of ideas about how things might work in theory but a rather limited grasp of how they work in practice.

And yet, as the authors of the report note, the kinds of changes the politicians have come up with, and the changes that have been implemented since the financial crisis, are not themselves likely to have much effect. The sector as a whole may now be more robust, but its tendency to extract resources from the productive economy (rather than, as one might hope, putting them to productive use) is unhindered. So too is its ability to ensure that when the income cake becomes smaller (thanks in large part to its own actions) its own slice remains undiminished, so everybody else has to go hungry. Capping bankers’ bonuses sounds good on the hustings, but it is never going to happen – and if it did the firms would just find other ways to pay the wages they do.

Something surely must be done. Not only the banks but the financial sector generally clearly does a lot of (mostly unintentional) harm and could very easily do a lot more. So what kind of thing might make a practical difference?

From an intellectual perspective, the core problem with the financial sector is an established and largely unquestioned dogma to the effect that unrestrained self-seeking on the part of those engaged in it will, through the magic of markets, be to everyone’s benefit in the long run. Formally speaking the argument underlying this is a rule utilitarian one. The twin rules of morally uninhibited – or amoral – financial self-seeking on the part of financial agents and minimalist regulation on the part of governments will maximise the utility, or wellbeing, of society at large. This argument doesn’t hold water. The rules may conceivably maximise wealth, and it is always tempting, especially for economists, to conflate wealth, which can be easily measured, with utility, which can’t. But at the end of the day the bankers’ wealth is not the ordinary person’s wellbeing, and no amount of arguing about trickle-down effects can make it so. All that has happened in the 35 years in which the dogma has ruled is that a small segment of society – the 1% – has got richer and richer, while everybody else has trodden water at best. And that small sector of society corresponds pretty well to the people who have drawn their incomes from finance and banking.

All of this is fairly obvious to non-economists, and with economists themselves turning their attention to questions of inequality and its relationship with subjective measures of wellbeing the dogma will eventually become untenable. But taken-for-granted assumptions can be remarkably persistent, especially when it suits those in power to maintain them, and before we can even begin to have a productive debate about the purpose and values of banking, we need to openly challenge the idea that the amoral pursuit of self-interest is somehow a good thing.

The authors of “Virtuous banking” take it for granted that bankers should, like anyone else in society, behave ethically. And so they should: people should, in general, behave ethically, and bankers are people. In other sectors of the economy, where amoral self-interest is manifest in physical damage to workers, communities, customers or the environment, there is nowadays a broad consensus (captured, for example, in the UN Global Compact) that self-interest should – as Adam Smith always assumed – be subject to moral constraints. But in banking and finance, where the effects are less direct, homo economicus still reigns, not only as a model of how people do behave, but as a model of how they should behave, or at least of how it’s OK to behave. And because self-interest generally has become socially much more legitimate than it once was, we tend to just accept this, even when we know full well, if we really think about it, that it’s not right. Where it’s not divorced from economic reality, and so irrelevant to the real world, moral thinking has become clouded by economic dogma. Both tendencies need to be challenged.

If we look at the direct harm done by the banking and finance sector, we find two quite different phenomena. At one end of the spectrum, behind all the problems arising from dodgy derivatives, artificial valuations, IPOs, LIBOR manipulation, excess trading and the like, are traders and bank executives whose education, training, and financial experience have given them no cause to think beyond their own self-interest. The emphasis throughout has been on technical expertise and its application to making money, self-interest assumed. They have no intention of being immoral, but no conception of what it would be to be moral. The concept has never been relevant.

At the other end of the spectrum, behind all the mis-selling of personal pension plans, payment protection insurance and complex and inappropriate add-ons to small business loans, we find independent financial advisors and the sales staff of commercial banks who really do want to serve their clients well and who fully understand, in ordinary everyday terms, what it means to be moral, but who don’t understand the products they are selling. Under-educated and under-trained (many are not even graduates), they’ve been told the products’ benefits, and incentivised to sell them, but have no conception of how things might go wrong, or what the consequences might be.

The two phenomena are very different, but both reflect a striking lack of professional standards. Indeed it is presumably a recognition of this that drove the authors of “Virtuous banking” to propose an oath akin to the doctors’ Hippocratic oath, though their version reads more like something out of Gilbert and Sullivan. Nowadays all sorts of occupations claim some kind of professional status, including banking, but if we look at the established professions, like law, accountancy and engineering, we find a number of characteristics that are clearly lacking in the financial sector. There is, for a start, a strong and clear ethical commitment, both to the welfare of the client and to well-defined standards of honesty and integrity. Understanding this commitment, moreover, is built into the educational process that qualifies people to practice. There is also an institutional commitment to knowledge and competence. If you have dealings with an accountant or lawyer, then no matter how junior or how ignorant the person with whom you are dealing there is behind them a fully qualified, named individual taking full and explicit responsibility for everything that they say, and everything that they omit to say. Being a professional means taking on a personal accountability for the actions of your team.

The world of banking and financial services has much in common with these older professions. In particular, there is an asymmetry of knowledge and expertise (and, in the case of advisory services, experience) that places the client in the hands of the expert’s judgement and makes caveat venditor more appropriate than caveat emptor. Ironically enough, the reasons it did not become professionalised, historically, had much to do with its perceived immorality: it is only in very recent times that lending money or selling shares became at all respectable. Nowadays, however, the sector is too large and too central to everyday life to be marginalised as it once was. Professional standards are needed, and the only way to achieve these is from the ground up, building the requisite values into the education, training and qualification status of practitioners.

This will take time, and it will need careful planning. The obvious model is accountancy, but financial experts have always looked down on accountants, and engineering might be a better starting point. There will be a temptation, no doubt, to try to get things both ways – to acquire professional status while keeping the privilege of legitimated self-interest – and this will have to be resisted. But unlike some of the other remedies suggested there is a clear positive trade-off for the sector which should make the process attractive. There is also now a large community of senior bankers who have made their fortunes and whose own interests lie in the respectability and esteem that would come with “giving something back” through the educational system.

Openly challenging the social and political consensus underlying financial exceptionalism, and constructing from the ground up a structure of professional education and training: these are modest proposals, but they aim at the core of the problem not its effects. They are also things that, while they can be kicked off here in Britain, are in no way peculiar or restricted to Britain, and when we are dealing with a global industry that is important. The prospect of global regulations for the sector is probably a chimera, but global values and global professional standards are not. We already have them in human rights, the major professions and even in business ethics, and there is no reason why we should not also have them in banking and finance, if we can only set about it in the right way.