The end of financial triumphalism

Bill Gross: we are all to blame

Bill Gross: we are all to blame

Time will tell what the lessons of the financial crisis really are. One way of exploring the lessons is to look at how people were apportioning the blame at the time. From lenders to investors to regulators, it seemed everyone had blood on their hands. As Bill Gross, chief investment officer at Pimco, the world’s biggest bond fund, put it, ‘we are all to blame. For the most part, you can throw in central bankers, Wall Street, investment bankers and you can throw investors into the pot as well as mortgage bankers and regulators who looked the other way.’19

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz: the idea that banks should self-regulate is absurd

Joseph Stiglitz, winner of the 2001 Nobel Prize for Economics, summarised the main debate around the financial industry and its social responsibility: ‘In both the UK and the US, about 40 per cent of corporate profits go to the finance industry. What is the social function of the industry that justifies that generous money? The industry exists for managing risk and allocating capital. Well, it clearly didn’t do either very well [. . .] The idea that banks should self-regulate, relying on their own risk management systems and rating agencies, is absurd. We lost sight of why regulation is needed. The trouble is that regulators are too close to the people they are regulating. There was a party going on and nobody wanted to be a party pooper.’20

It is true that clues of the crisis to come were abundantly available to regulators. As early as 1993, the Interfaith Center on Corporate Responsibility (ICCR), a faith-based investors’ association, warned of the risks to households, communities and investors associated with sub-prime lending.21 In 2000, a House of Representatives hearing addressed many of the issues that were blamed for the sub-prime market woes, in particular abuses by mortgage lenders.22 In December 2006, a report by the Center for Responsible Lending, a not-for-profit organisation based in North Carolina (USA), published a report showing that, despite low interest rates and a favourable economic environment, foreclosure rates in the sub-prime market were very high (almost 20%). The report held predatory lending practices such as adjustable rate mortgages, no- or low-doc loans and pre-payment penalties as culpable.23

There is also evidence that regulators knew about the loosening of lending standards. The Fed’s survey on bank lending practices revealed a deep fall in standards beginning in 2004 until the end of the housing boom in 2006.24 In addition, global institutions, such as the Bank of International Settlements, issued warnings of the risks associated to parts of the US housing market in 2004.25

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

Kenneth Rogoff: governments and central bankers fell prey to ‘financial triumphalism’

If the evidence was so clear, how could the regulators let the party go on? According to former International Monetary Fund (IMF) Chief Economist Kenneth Rogoff, governments and central bankers fell prey to ‘financial triumphalism’,26 the idea that light regulation and a self-correcting financial market are not only enough to maintain discipline but can help economies to grow faster. That the IMF did little to curb this process, and a lot to increase it through influencing financial liberalisation, raises a serious question mark over its legitimacy and proficiency in helping solve the problems now. It was the International Labour Organisation of the UN that has been warning in recent years of the excessive financialisation of the economy.27

Financial derivatives had became so complex that people trading in them did not really know how they worked, just that they were offered from reputable institutions and were receiving good credit ratings. The more complicated a product, the more ingenious, and the more profitable, or so it seemed. Some call this approach the greater fool theory, or pyramid selling: so long as someone else is willing to buy, then the prices can keep going up. Some talk about a collapse of trust, but that is misrepresenting what was involved in the market and emptying the term ‘trust’ of any meaning. Trust involves people. Most trades are done through a computer, often automatically. Finance professionals did not so much as trust, but they assumed—that complexity, ingenuity, a famous institution, and large market power, were all signifiers of financial value. With the onset of the credit crunch they now assume almost the opposite—hence inter-bank lending grinding to a halt.

Credit ratings agencies took some heat for an apparent lack of rigour in their valuation of complex derivatives. Developments in accounting, with the introduction of mark-to-market or ‘fair value’ approaches, facilitated a global-market group-think of ‘it is valuable because many of us think that many other people think it is valuable’. The credit ratings agencies are involved in a process that sociologists call ‘social construction’, i.e. where assumptions, beliefs and norms are constructed by people and organisations in society. The larger and more famous the ratings agencies, the more authoritative their ratings are and the greater impact on perceptions and thus of the market price of what they value. Thus within the current system there is an implicit value in play—that might is right. The socially constructed nature of financial markets was discussed at length by financier George Soros. Yet he did not articulate a value basis from which such processes could be more accurate and beneficial. Sociologists and stakeholder dialogue experts have different views on how a socially constructed concept of something’s nature or worth can be made legitimate and effective, with some advocating forms of ‘communicative action’ in the process as a way to achieve a participatory and intelligent view of phenomena. There is no such ‘communicative action’ in the valuing of assets in the financial markets.

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Niall Ferguson: a lack of political-historical understanding contributes to the problem

Perhaps the underlying reason for this situation is a lack of sociological and political-historical understanding within the financial services sector and its regulators. Finance services professionals, like most people, are naturally competent in objectivist or positivist approaches to understanding reality, and so, when they work in fields that are relativist in their nature, they are not at ease with exploring how we might wish to shape the ways in which we decide what the value of something is, and so just fall back on mob rule—where something is valued according to the sum of the views of the most powerful. If we are explicit about values, then we might seek a credit ratings system that allows new entrants, balances views, moderates the influence of strategic commercial self-interest and seeks to arrive at socially beneficial forms of valuation, such as using a five-capitals model of valuation.28 In this way the financial system might be able to learn something from the corporate responsibility community. A lack of political-historical understanding also contributed to the problem, according to Harvard historian Niall Ferguson. He said that most people in the industry and its regulators do not have memories stretching back before the 1980s, so they do not understand how financial systems have evolved over time and how they can collapse.29

This philosophical turn may seem to some readers to be miles away from matters of corporate citizenship. What are the implications of this financial crisis for corporate responsibility and responsible finance? A few immediately appear. First is the issue some dub ‘the political bottom line’.30 Intense lobbying by the financial industry helps explain how the financial crisis took shape. According to the non-profit advocacy organisation Common Cause, the mortgage lending industry spent nearly US$210 million between 1999 and 2006 in lobbying activities as well as political campaigns contributions to both Democratic and Republican politicians that helped persuade the US Congress to refrain from passing regulation that would restrict predatory lending practices.31 In addition, economist Robert Kuttner blamed the repealing of key protections put in place by the New Deal for contributing to the crisis.32 An example of this is the Gramm–Leach–Bliley Act (1999), which eliminated restrictions on affiliations between commercial banks and investment banks. Senator Phil Gramm, who led the charge to pass this bill, has close ties with the financial industry: he is a vice chairman at UBS Investment Bank and was paid by the Swiss bank to lobby Congress on mortgage-related legislation.33 The political affairs of corporations are a key element of social responsibility, implying transparency and consultation on the societal impact of the forms of regulatory change sought by investors.

A second implication for corporate responsibility, and responsible finance, is that much of the work being done in our area is fiddling around the edges, and not addressing fundamental economic issues. This has been discussed in these Lifeworth Annual Reviews since 2001, when the Enron collapse led Business Ethics editor Marjorie Kelly to question whether work on corporate responsibility risked being beside the point, and called for more focus on the fundamentals of corporate law and financing.34 In a new book by one of these authors, The Corporate Responsibility Movement,35 it is argued that corporate responsibility is evolving in a way that can address these deeper challenges. ‘The corporate responsibility movement is a loosely organised but sustained effort by individuals both inside and outside the private sector, who seek to use or change specific corporate practices, whole corporations, or entire systems of corporate activity, in accordance with their personal commitment to public goals and the expectations of wider society.’ The analysis suggests an interlocking framework is slowly emerging, which seeks to integrate economic and social principles, dubbed ‘capital democracy’ by the author. ‘Capital democracy describes an economic system that moves towards the creation, allocation and management of capital according to the interests of everyone directly affected by that process, in order to support the self-actualisation of all’.

Might the financial crisis spur professionals in the corporate responsibility and responsible finance fields to take up this deeper agenda? One process holding back an embrace of that agenda is the way that work in this field has been defined as a particular set of professional practices rather than an evolving field of societal expectation on business and finance. This delineation of a field of practice meant that, in August 2008, the United Nations Principles on Responsible Investment (UNPRI) could put out a press release reporting ‘Rapid growth in Responsible Investment despite credit crisis’.36 They were referring to new signatories, yet many of those same signatories were being lambasted at the same time for irresponsibly investing in ill-understood derivative markets. Until now the field of investor responsibility has been defined by the investors themselves. Therefore the focus has been on the social, environmental and governance (ESG) performance of the firms they invest in. But, with the financial crisis, they are beginning to have to look in the ESG mirror, as the public and civil society increasingly question the financial institutions themselves.

Nicolas Sarkozy: the idea that markets were always right was mad

Nicolas Sarkozy: the idea that markets were always right was mad

Perhaps the lasting impact on the corporate responsibility field will be that the more critical perspectives, such as those often reported in these pages, will receive greater attention from the shapers of the mainstream agenda on corporate responsibility. They will be able to quote people in high places. In Europe, for instance, some political leaders have called for an end to laissez-faire capitalism. In a political rally in French city Toulon, French President Nicolas Sarkozy said that ‘the idea of the all-powerful market that must not be constrained by any rules, by any political intervention, was mad. The idea that markets were always right was mad.’37

Trade unions have also reiterated their calls for more regulation. The Trade Union Advisory Committee (TUAC) to the Organisation for Economic Cooperation and Development (OECD) issued a statement in September 2008 spelling out what governments should demand in return for taxpayers’ money. According to TUAC, ‘international cooperation should go far beyond what is currently under consideration—i.e. reviewing prudential rules for banks and “encouraging” more transparency on the market place. It is the national and global regulatory architecture that needs to be restored so that financial markets return to their primary function: to ensure stable and cost-effective financing of the real economy.’38

UNI Finance Global Union also called for a fundamental overhaul of the financial industry based on tougher regulation, more transparency, long-term investment and sustainable growth.39 In June 2008, it released a statement with 13 key demands on the regulation of finance markets. These asked regulators to act on issues such as pay systems for executives, consumer protection, sales targets, and tax breaks for private equity.40

Given the caution with which governments were saying they would seek to influence banks and change the banking system, the unions have some work ahead. This is not surprising given how in recent decades monetary policy has been turned into a technical not political issue—symbolised by the establishment of independence for national banks. Yet the recent financial crisis has made publics around the world more aware of the political nature of their monetary systems. Most governments oversee a system whereby private banks print money, and loan it out as debt, thereby benefiting from the system of money creation in a way no one else in the economy does. In return for that privilege, we could expect that governments might influence the way they then loan out that money. But they don’t. Why is this monetary process beyond the political process? Why can’t the contracts governing how the private banks issue money incorporate restrictions on the way that money is used, to promote the objectives set through government? For instance, guidance could be given on the employment or carbon created by the activities funded by the loans. Perhaps corporate responsibility could be embedded in the money system?41 Rising awareness due to the financial crisis might lead to more discussion of policy innovations in monetary systems, yet governments do not seem ready to lead that process in 2008.

At a time of crisis it is natural to look for a quick fix. Yet, once the gold dust settles, it is clear that deeper questions must be asked, and discussed by a broader range of people than international financial institutions and the finance ministers of powerful nations. Any economic historian will tell you that ‘moral sentiments’ precede ‘the wealth of nations’. We should be considering what values we want to further through the design of financial systems. Being clearer about the values embedded within and furthered by the current financial system, and whether that’s suitable for this century, would be a good start. Steve Waddell, of the Global Finance Initiative (GFI), said, ‘although stability is clearly the major concern, there are also significant concerns about the social and environmental impacts of finance. Indeed, increasingly there are suggestions that stability cannot be realized without more categorically considering these broader impacts. There is no formal, open and inclusive public space to develop a global strategy to address these concerns.’42 Along with the Network for Sustainable Financial Markets,43 the GFI is one of a number of initiatives of progressive professionals thinking big on the future of finance.

» Beyond the Western financial crisis

(The references are available in the pdf download and hard copy versions of this annual review, available from Lifeworth’s bookstore.)

This section can be referenced as:

Bendell, J., and N. Alam, S. Lin, C. Ng, L. Rimando, C. Veuthey, B. Wettstein (2009) The Eastern Turn in Responsible Enterprise: A Yearly Review of Corporate Responsibility from Lifeworth, Lifeworth: Manila, Philippines. (Page numbers for this section are available in the pdf download and hardcopy.)


One Response to “The end of financial triumphalism”
  1. Ray says:

    Quote…..”Any economic historian will tell you that ‘moral sentiments’ precede ‘the wealth of nations’. We should be considering what values we want to further through the design of financial systems. Being clearer about the values embedded within and furthered by the current financial system, and whether that’s suitable for this century, would be a good start.”

    Exactly right and the factor that is most often neglected. Their is a proverb that says, “Righteousness exalts a nation” but most want to achieve it by power, self effort and self righteousness.

Share your views or news on this subject