Boom and bust boil down to ethical choices – let's hope politicians make the right ones
Published 29/04/2014 | 02:30
Why is finance so often associated with unethical conduct? Was Ireland's economic crisis an ethical one? Did we stop asking ourselves what was right and wrong in the run-up to the crisis, and just consume for the sake of it? Debt-financed household consumption grew like a rocket taking off from 2002 to 2007, a 35pc increase, then trailed off as the boom turned to bust.
The Regling and Watson, Honohan, and Nyberg reports into the banking crisis all make mention of improper incentives in the financial sector in the lead-up to the crisis, but stop short of calling what went on unethical. Today, any director of a financial institution must be 'honest, fair and ethical', but this requirement didn't take effect until after 2005. Horses and gates come to mind.
That said, while finance exposes people to a lot of improper incentives, it is a stretch to assume those in the industry are characterised by higher levels of greed, laziness, peer pressure or stupidity than other sectors.
In the journal 'Economic Affairs', Ellen Sternberg examined whether US financial services were inherently unethical. She defined a business as ethical when it maximises long-term owner value subject to distributive justice and ordinary decency. Sternberg found the source of the unethical behaviour was a 'pervasive irrationality – mainly by government – a systematic substitution of wishful thinking for a proper understanding of the objective reality that underlies markets and morality'.
In other words, we all partied.
A conference organised by Dr Martin Mullins at the University of Limerick examined these ethical issues in finance last week. My colleague Dr Elaine Doyle showed that people act differently in different environments – the frame you happen to find yourself in determines how you behave. The complicity of the regulator in their failure to act as the last backstop against poor behaviour was highlighted in a way I hadn't seen before. During the Anglo trial, the 'deferential' attitude of the regulator came up repeatedly.
The real question is: where from here? Is the profit motive so strong in finance that, once the storm passes, things calm down, and people forget how bad the last crisis was, the moves toward unsustainable levels of debt will start happening again? Is it inevitable that the next crisis will happen; Irish and European central banks left to mop up the mess?
The cycle of financial accumulation, implosion and repression was identified by Hyman Minsky in the 1960s and previously by Karl Marx in the 19th Century. If we believe Minsky's story, finance will begin to come back to blow up our economies as soon as the public forgets.
In a landmark book, Stanford's Anat Admati and Martin Helwig suggested a solution to the problem: force banks and other financial intermediaries to use a lot more equity funding relative to debt to finance their investments, reducing the likelihood that if they blow up, the taxpayer won't be as likely to be on the hook.
The trade-off is that banks won't lend as much into the real economy, meaning that when you go for a loan, you won't get it, even if there is a very good chance you'll pay it back.
Because you don't get the loan, you don't contribute that to the economy, and so the economy doesn't grow.
The bankers have several points of leverage over politicians and regulators, but this is the strongest. Requiring banks to be safer using simple regulations will result in slower growth.
The politician therefore faces an ethical choice: comply with the bankers, push credit into the economy, hope it grows, and keep their jobs, or slow growth and potentially lose their jobs.
It's a big choice. In a speech at Georgetown University, the former Taoiseach Brian Cowen made this point: "Budgetary policy should have leaned more heavily against the wind. But let's be clear about what that would have meant. It would have meant higher income taxes, lower levels of employment and higher unemployment. It would have meant less spending on education, healthcare, research and development, infrastructure and social welfare. These expenditures at the time were widely seen as highly desirable."
In the end, the choices to be made all have ethical consequences. The question is, do we have the right people in the really important jobs to make them?
Stephen Kinsella is Senior Lecturer in Economics, University of Limerick