We examine the present in light of the past
so as to better understand the future.
John Maynard Keynes

* With apologies to Karl von Clausewitz

Banking scandals and ethics

(First published as an editorial in Corporate Finance Review, Sept-Oct 2012)

From the editor

Another banking scandal, another conspiracy unmasked. Executives at an investment company, it seems, forged documents to help their firm secure $2.6 billion in loans to which it was not entitled. The money was used to buy property and assets belonging to the government, allegedly at knock-down prices. At least some of the money also seems to have stuck to the fingers of the parties involved. Thirty-nine people have been tried and convicted for their role in the affair, many have received lengthy prison sentences, two have been imprisoned for life and four have received the death sentence.

Hang on – the death sentence? For bankers? Of course, this isn’t just any old banking scandal. This affair, as reported by the international press in late July, happened in Iran. Now, amongst our many images of Iran, international financial scandals do not usually figure. But it seems no country is immune against the wave of financial scandals that have swept around the world. Indeed, less than a month later Iran featured in a second banking scandal, this one involving Standard Chartered.

It was the imposition of the death penalty that caused this story to stand out, though. While it is true that the scale of the fines imposed on institutions guilty of transgression has been shooting up, it is still relatively rare for top executives to pay a personal penalty, much less the ultimate penalty. The news provoked the usual knee-jerk reactions from bank-bashers – “string ‘em up, it’s the only language they understand,” and so on – but there has been a growing and much more serious trend of opinion in this direction for some time. Quite respected people are now openly saying that the only deterrent to bad behavior in the financial services sector is to make sure that guilty people do some serious time.

“The only way to get the bankers’ attention,” said one American analyst in a recent radio interview, “is to take anybody who is found guilty of rate fixing or fraud or false accounting, put him in an orange jumpsuit, and lock him in a ten-by-ten cell with a guy with tattoos on his neck called Marvin. Do that enough times and the rest will get the message.” Statements like this always find a ready audience – including among bankers. A recent poll in London found that more than two-third of bank employees do not believe the banks, including their own employers, are trustworthy. There is an increasing desire to see heads roll.

I am not convinced. I don’t believe in the deterrent effect, for a start. In the eighteenth century in Britain you could be sentenced to death, or exile to Australia, for stealing a loaf of bread. It did not stop swindlers from venturing some amazing frauds during the time of the South Sea Bubble. A lot of them were caught, and many did indeed do long stretches in jail; even the Chancellor of the Exchequer, equivalent to the Secretary of the Treasury, was incarcerated in the Tower of London where he died while awaiting trial. But enough people did get away with their frauds to lend encouragement to others, and so it has been and always will be.

People who commit financial fraud may be clever, even ingenious, but they are not rational. Any rational person knows that Ponzi schemes cannot go on forever and will eventually collapse. That did not prevent Bernie Madoff from trying it on. Others will try again in the future, convinced that they can succeed. A few will succeed, once again, just enough to encourage others to follow.

Two months ago in this column, discussing the fixing of interbank lending rates, I argued that we need a change in the culture of the financial services industry. Too much of the sector is dominated by what our colleague and friend Marianne Jennings once referred to as the “yee-ha! culture,” the culture of rough and ready enthusiasms, bandwagons and gold rushes, heroes and zeroes, a culture not really so far moved on from the old days of Ivan Boesky and “greed is good.” This is a sector where, perhaps above all others, rational thinking should hold sway, and yet it does not. We tried inventing tools to bring in greater rationality, like modern portfolio theory. Investors and bankers pay lip service to MPT, but the truth is that many, if not most, ignore it because they don’t think it is relevant to them. We tried importing mathematical tools and concepts through the quants, but a lot of those turned out to be useless too, some even downright dangerous.

And even if those tools had been sound, what is the point of giving rational tools to people who behave irrationally? You might as well give an iPad to a fruit bat and then expect him to use it to write War and Peace. We do need rational tools (preferably ones that work, please), but we also need rational thinkers in charge of them.

Back in 2008 there was a great outcry when it emerged that some senior figures in failed banks did not hold any formal qualifications in financial services. That is to entirely mistake the nature of the problem. A lot of those people knew a great deal about the financial services sector. What they don’t seem to know very much about is life. They don’t seem to understand the code of rights and responsibilities that hold our civilization together. They don’t seem to understand basic concepts such as entropy and evolution, natural forces that work upon us all and upon all of our works. They don’t understand that what goes around, comes around, that every action has consequences. They would know all of these things, if they knew how to think logically.

Few people involved in these scandals are amoral. There are some, and they should be weeded out. Most are subject to the same human impulses as we all are: greed, of course, but also fear, pride, ambition, desire for status and esteem. We have two choices. We can say, this is the way things are and always will be, and go on down the same path while public trust in us and our institutions continues to erode. Or we can accept the need for change. We can adapt, evolve into higher order thinkers who accept our responsibilities to our colleagues, to our clients, to the world around us. We can put trust back at the centre of our agendas because we recognize that without trust, no lasting or meaningful relationship of any kind is possible. That is the only truly rational view of the world. That is logical.

This of course brings me back to one of my pet subjects, the lack of fitness for purpose in our system of education particularly when it comes to matters of ethics and governance. I still recall the reaction of one my colleagues, a veteran economist and observer of human affairs, during a discussion concerning the need to teach ethics in business schools. After listening to the debate for some time he rose to his feet and thundered, “If we have reached the point where we need to teach ethical behavior to MBA students, then the world is in a bad way indeed.” Well, here we are. It is, and we do. Not normative ethics, not ethics based on the need to behave well or else be struck down by a lightning bolt, but practical, pragmatic ethics with commitment to understanding how and why honesty and trust are actually good for business. Trust creates wealth. There is the bottom line. We need to teach that mantra, over and over again, until the lesson sinks in.

Morgen Witzel

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Management Consultancy

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Oh, no, not another book on management!

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Another one bites the dust - reflecting on my new book on management failures