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The Unresilient Society: When Integrity Leaves the Marketplace

Seven years after the onset of the Global Financial Crisis, we are still picking up the pieces of the worst economic disaster in modern history. At the same time, confidence that similar problems won’t derail us again in a few years remains at an all-time low, with good reason. Well, society’s resilience is a lot like an individual’s resilience – until you stop lying to yourself about the causes and face reality the way it is, you can’t fix anything…

Integrity in Business

Would it surprise you to learn that Wall Street had risk management officers who actually did their jobs and saw the crisis coming? Of course, in the heady sugar rush of unlimited profits from derivative financial products and improperly financed mortgages, those risk management officers were not just the minority voice, they were actively deprived of access to senior management, pressured and threatened into keeping their mouths shut. The results we know all too well.

And those managers who shut their doors and plugged their ears continued to make obscene amounts of money even at the height of the crisis (or found themselves nice golden parachutes) irrespective of the vast misery they had collectively created. Of course, they didn’t see it that way. They were merely cogs in the financial machine, professional gamblers who bet and lost. It happens.

One of the more interesting takes on the American financial sector came from the then-president of China’s sovereign wealth fund (which was heavily invested in the United States), Gao Xiqing. In an interview with The Atlantic, Gao pointed to the skyrocketing leverage ratios of investment banks as evidence of a disturbing economic trend. “Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking.”

When called to give a presentation to the State Council under Premier Zhu Rongji, he explained derivatives using the metaphor of mirror images. You have a product with value, such as a book, and you sell that. Then you sell a mirror image of the book- the stock- in order to get money to make more books. Then you sell a mirror of that stock debt, and a mirror of the mirror of the mirror. Each individual product seems to make sense; collectively, the whole enterprise is inflationary.

Gao also sees a big problem with the compensation scheme for the financial sector: “People in this field have way too much money. And this is not right. It distorts the talents of the country.” He cites friends of his who should have gone into productive scientific fields but chose finance or law instead, because they pay so much better. When highly gifted people ignore their unique talents and do something completely different for the sole purpose of chasing more money, everyone loses.

Integrity in Regulation

The failure of governments to regulate in the last few years is not simply a matter of putting the right regulations to paper. It’s about willingness to hold the financial sector, and industry at large, accountable, to impose meaningful consequences on individuals and companies whose profits have come at the expense of their country and the global economy at large.

Let’s say you’re a manager in a large company. You have a group of employees who, despite plenty of warnings, have made a series of business decisions that have brought the company to the brink of bankruptcy. Should you:

a) Fire them and hire more competent employees?
b) Dock their pay until they correct the mistake?
c) Resign for your own failure to adequately supervise them?

Well, no matter which option you chose, you have a damn sight more business sense than US and European governments, whose approach was to give them a multi-trillion dollar bonus and send them on their way. The GFC and Recession bailouts were hardly the first time that taxpayers in a Western country have paid for the sins of the financial sector, but it was by far the worst, and it sets an appalling precedent. The moment you declare a bank, an investment firm, a car company “Too Big To Fail,” you turn your country into a big slush fund to underwrite corporate greed and incompetence. You are saying that the free hand of the market is a concept that keeps government from interfering in the economy- except to save industry from the results of its own bungling.

But what was the alternative? Accountability. Think about it. Trillions in bailout money, plus more in “quantitative easing” (pretending the economy is stronger than it is by printing more money). And you give it to the very people who created the crisis was in the first place, rather than letting them meet their natural end and investing in businesses models that do work, infrastructure, employment, not to mention debt and mortgage relief for ordinary people? Sure, big crashes hurt, and the state would have to take on responsibility for making sure the people with toxic mortgages get relief and the automotive workers get a new employer. At least that bailout money would go to the public and not to Wall Street. But the clean slate, the opportunity to design a more effective, more regulated financial sector which knows it had better hold itself accountable- that is priceless for long-term stability.

And that is the reason why Iceland, which seemed to be foundering in financial meltdown a few years ago, is well on track to recovery. They let their ailing banks collapse, prosecuted bankers for financial wrongdoing, devalued their currency to increase competitiveness, kept their social welfare model firmly in place and systematically rebuilt their economy and banking system.

 

Meanwhile in the United States, a recent survey of the financial sector by Notre Dame University has found that the number of people in the sector who have witnessed or would be likely to commit financial malfeasance outnumber those who would be likely to report them, especially given the proliferation of nondisclosure “gag” clauses in contracts. In short, the incentives to break the rules still outweigh the potential consequences of getting caught.

And that’s only part of the problem. The regulators are cozying up to the very people they’re supposed to regulate, and there’s a reason: a revolving door exists between the Federal Reserve and Wall Street, and many former “Fed” people go to Wall Street to make their fortunes. The result is that critical reports get suppressed or rewritten, and Fed employees who rock the boat can get the sack. In such a climate, the law on paper and the law as it is enforced are hardly ever the same thing.

Conclusion

Integrity was not simply lacking in a few unscrupulous people, the Bernard Madoffs of the world who were actually breaking the rules. Instead, integrity was ruled out of the very mode in which business was conducted. This is why the Global Financial Crisis happened in the first place. Unfortunately, with a few exceptions, that same lack of integrity was implicit in the response to the crisis, and remains implicit in the post-crisis business world. Until our sense of integrity outweighs the blind faith we put in corporations, financial institutions and the market itself, we will not be able to create a framework of laws and corporate culture that can create a stable and resilient economic basis for our global society.
Perhaps we should also be asking ourselves to what extent all this is the fruit of our modern culture of political correctness, where no one is ever to blame and no one is held responsible for their actions. We’ve become afraid to “tell it like it is” and afraid to require accountability on the part of people in power. Until we wake up, the downward spiral will continue…
~ Dr. Symeon Rodger




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