Dropped in to the Institute of Economic Affairs (IEA) to hear a talk by Dr Elaine Sternberg (she is the author of “Just Business: Business Ethics in Action”, a research fellow of the Centre for Business and Professional Ethics at Leeds University and IEA’s corporate governance guru; not many philosophers have also been entrepeneurs and investment bankers).
The ethics of business are founded on norms of “ordinary decency”. The objective is to maximise long-term owners’ value (LTOV),subject to ordinary decency. To achieve the business objective, trust should be maintained. Performance related pay is acceptable if it meets criterion of LTOV. Finance deserves special attention not because of any special moral requirements but because it is pervasive. Theft and deceit are not intrinsic to finance. Folly is more of a problem than fraud.
Did banks contribute to the global financial crisis (GFC)? Were they especially greedy and even if they were, was this wrong? Unethical conduct is not defined by whether or not it is greedy – a relatively “clean” motive which is usually self-correcting. In any case, the moral status of an action is independent of motives. Was there an ethical problem with the financial instruments involved – CDOs, MBSs, derivatives and the like? Not if they had been used in a way to maximise LTOV. What about complexity? That is a problem common to many ethical questions.
Conduct of financial institutions in springing the money trap was unethical because it was NOT directed at LTOV. Making loans to people who clearly could not repay is unethical. Yet the conditions under which they worked provided strong incentives to misconduct.
Not only was there strong official encouragement for extending mortgages to low-income households, the entire environment was calculated to promote unethical conduct; this includes deposit insurance, mortgage insurance, state guarantees for financial institutions, tax relief for interest, and lax monetary policies.
Financial institutions can be blamed for giving in to skewed incentives. Many engaged in predatory lending and other violations of ordinary decency. Users of services lied about their financial status. But unethical behaviour could not have reached the levels it did without government regulations.
The official response to the crisis has been to make it even more difficult for institutions to behave ethically. Bad banks and bad bankers have been bailed out. Prudent lenders have been penalised. The profligate have been rewarded. Now governments and central banks are encouraging further imprudent risk-taking. Quantitative easing is immoral.
In sum, finance does not demand higher ethical standards than other businesses but is especially vulnerable to government actions that distort incentives.
I agree with much of this, and the issues go to the heart of what the UK parliamentary commission into UK banking standards and culture should be looking at. But as soon as one says this, one realises how far removed we are from creating the conditions for ethical conduct. Removing the incentives to unethical conduct created by regulation, bailouts, erratic monetary policies, QE, deposit insurance , state guarantees is not politically feasible, and is unlikely to feature in the Commission’s recommendations. But one can ask the Commission at least to acknowledge the challenges involved.
My main disagreement with Elaine is on the question of whether banking itself does require especially high ethical standards. I think it does, because of the nature of the business. Depositors cannot know what banks do with their money; they are behind a veil of ignorance. they do not know how much leverage is involved. Opacity and leverage means that there is a specially high premium on maintaining trust at all times. That is why they have to put the clients’ interests first at all times – not just follow norms of ordinary decency.
We will not get out of The Money Trap unless either (a) bankers everywhere understand this and apply old-fashioned standards to their conduct or (b) banks as we know them are abolished.
The Parliamentary Commission on banking standards has published my written evidence. Please click here
Did unethical conduct cause the crisis?
RP's Diary
Dropped in to the Institute of Economic Affairs (IEA) to hear a talk by Dr Elaine Sternberg (she is the author of “Just Business: Business Ethics in Action”, a research fellow of the Centre for Business and Professional Ethics at Leeds University and IEA’s corporate governance guru; not many philosophers have also been entrepeneurs and investment bankers).
The ethics of business are founded on norms of “ordinary decency”. The objective is to maximise long-term owners’ value (LTOV),subject to ordinary decency. To achieve the business objective, trust should be maintained. Performance related pay is acceptable if it meets criterion of LTOV. Finance deserves special attention not because of any special moral requirements but because it is pervasive. Theft and deceit are not intrinsic to finance. Folly is more of a problem than fraud.
Did banks contribute to the global financial crisis (GFC)? Were they especially greedy and even if they were, was this wrong? Unethical conduct is not defined by whether or not it is greedy – a relatively “clean” motive which is usually self-correcting. In any case, the moral status of an action is independent of motives. Was there an ethical problem with the financial instruments involved – CDOs, MBSs, derivatives and the like? Not if they had been used in a way to maximise LTOV. What about complexity? That is a problem common to many ethical questions.
Conduct of financial institutions in springing the money trap was unethical because it was NOT directed at LTOV. Making loans to people who clearly could not repay is unethical. Yet the conditions under which they worked provided strong incentives to misconduct.
Not only was there strong official encouragement for extending mortgages to low-income households, the entire environment was calculated to promote unethical conduct; this includes deposit insurance, mortgage insurance, state guarantees for financial institutions, tax relief for interest, and lax monetary policies.
Financial institutions can be blamed for giving in to skewed incentives. Many engaged in predatory lending and other violations of ordinary decency. Users of services lied about their financial status. But unethical behaviour could not have reached the levels it did without government regulations.
The official response to the crisis has been to make it even more difficult for institutions to behave ethically. Bad banks and bad bankers have been bailed out. Prudent lenders have been penalised. The profligate have been rewarded. Now governments and central banks are encouraging further imprudent risk-taking. Quantitative easing is immoral.
In sum, finance does not demand higher ethical standards than other businesses but is especially vulnerable to government actions that distort incentives.
I agree with much of this, and the issues go to the heart of what the UK parliamentary commission into UK banking standards and culture should be looking at. But as soon as one says this, one realises how far removed we are from creating the conditions for ethical conduct. Removing the incentives to unethical conduct created by regulation, bailouts, erratic monetary policies, QE, deposit insurance , state guarantees is not politically feasible, and is unlikely to feature in the Commission’s recommendations. But one can ask the Commission at least to acknowledge the challenges involved.
My main disagreement with Elaine is on the question of whether banking itself does require especially high ethical standards. I think it does, because of the nature of the business. Depositors cannot know what banks do with their money; they are behind a veil of ignorance. they do not know how much leverage is involved. Opacity and leverage means that there is a specially high premium on maintaining trust at all times. That is why they have to put the clients’ interests first at all times – not just follow norms of ordinary decency.
We will not get out of The Money Trap unless either (a) bankers everywhere understand this and apply old-fashioned standards to their conduct or (b) banks as we know them are abolished.
The Parliamentary Commission on banking standards has published my written evidence. Please click here
Written on September 16, 2012 at 8:44 am, by robert
Categories: Banking, Homepage, News and Comment, RP's Diary | Tags: bad banking, banking, central banking, central banks, Elaine Sternberg, ethics, finance, financial conduct, financial crisis, financial ethics, GFC, global financial system, The Money Trap