Sarum College
The Niblett Lecture 2011
Reflections on the Financial Crisis
Mr. Chairman I would like to thank you for your warm welcome to the
college. It is both an honour and a pleasure to be invited to give this
lecture and I am delighted that the Rt Revd Peter Selby, the
distinguished author of Grace and Mortgage, has agreed to be the
discussant. I should also say how proud I am to be a Fellow of the
College and to thank all those present, whether members of the
governing body or friends of the college for their support for its activities.
The subject I have chosen for this lecture is ‘Reflections on the Financial
Crisis’. I shall do so from a Christian perspective which is the heritage of
the college.
The financial crisis has become such a frequent news item, much like
sport or the weather, that you may well ask to which particular financial
crisis am I referring?
--------------------------------------------------------------------------------------------------------------------------This paper is based on an address given in November 2011 at Sarum College and subsequent
discussion at a meeting of Uniapac in Paris the following month.
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The global crisis through which we are living started in the summer of
2007 as a banking crisis. In this country the crisis started with
depositors in Northern Rock losing confidence in the bank and forming
large queues to withdraw their money, something which had not
happened since 1866. The crisis became far worse in 2008, resulting in
the collapse of banks such as Bear Stearns and Lehman Brothers in the
US and the rescue of RBS and Lloyds-HBOS in the UK. This led to a
loss of confidence and the worst recession since the Great Depression
of the 1930s. The banking crisis has been followed by a sovereign debt
crisis in which the governments of Greece, Portugal and Ireland have
had to be bailed out by the European Union and the International
Monetary Fund, and the credit rating of the debt of many Eurozone
countries as well as the US downgraded. Most recently there has been
a Eurozone crisis, exposing the faulty structures on which the Euro was
created and raising questions of whether the Euro can survive and if it
can, whether some counties will have to leave to enable it to do so.
The crisis however is far more than a banking, financial or economic
phenomenon. In one country after another the social fabric is being
challenged by public expenditure cuts, unsustainable levels of household
debt, rising unemployment, high youth unemployment, public sector
strikes, protests such as Occupy Wall Street and in some cities riots.
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The crisis has a political dimension. The governments of Greece and
Italy are being led by prime ministers who are unelected “technocrats”.
The pressures created by fiscal austerity has led to the growth of political
extremism and within the Eurozone the leaders of countries have
become openly critical of each others policies. The European Union will
almost certainly emerge from the crisis as a different institution – either a
more closely integrated political and economic union or one broken
down into blocs with some countries conceivably on their own.
The bottom line is that the financial crisis has led to a crisis of confidence
in modern capitalism which has been critical to our heritage of liberty,
democracy and prosperity.
In this lecture I would like to look at five aspects of the crisis.
Three Decades of Globalisation
The first is its context.
With hindsight the starting point for the crisis was not the collapse of the
investment bank Lehman Brothers in October 2008, or the speculative
bubble which developed in the years immediately preceding it, but the
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remarkable success of three decades of globalisation which raised
global prosperity and reduced global poverty. Between 1980 and 2007
world gross domestic product grew by 145%, an average of 3.5% a year
and it is estimated that during this time between 400-500 million people
were lifted out of poverty. These years saw the emergence of Brazil,
Russia, India and China with growth rates much higher than Europe or
the US, a dramatic shift in the global economy from West to East and a
change in the global balance between developing and developed
countries. They were also the background to the euphoria which built up
in the first decade of the new millennium.
The reason for the emergence of these countries was a radical change
in their policies. They abandoned state planning, state ownership, import
quotas, licensing regimes and price and wage controls. They moved
decisively to allow markets to function more freely. Because market
prices were allowed to reflect market conditions, capital and labour was
allocated more efficiently, productivity increased and so did economic
growth.
This change in policies resulted from courageous leadership. In 1978
Deng Xiao Peng opened up China to foreign trade and foreign
investment, and since then the Chinese economy has grown by 10% per
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year. In the early 1990s in India, Manmohan Singh introduced policies
away from a state dominated economy with a strong emphasis on
planning and import controls, the so-called ‘licensed rag’ a legacy of
British Fabianism, to a more market orientated economy. Since then
rates of economic growth have grown to 5-7% per year. The leadership
of Gorbachev in the Soviet Union led to the fall of the Berlin Wall and the
Iron Curtain, the break up of the former USSR and freedom for the
countries of Eastern Europe from Marxist economics. Since then all
these countries have moved to adopting market orientated approaches.
For just one of these events to have occurred over a few years would
have been remarkable. For all three to have occurred around the same
time was similar to sighting a black swan. The changes resulted in more
than two billion people entering the world economy as producers and
consumers. Asian countries produced cheap goods based on low wages
and exported them to the West, which in turn provided the basis for
continued economic growth, low inflation and full employment in Western
countries.
These policy changes had strong intellectual foundations. In the 1960s
and 1970s the Nobel Prize winning economists Milton Friedman and
Friedrich Von Hayek championed the case for the market economy and
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deregulation over state control and public ownership. Even though it was
against the received wisdom of the time they set out to show that free
enterprise economies were more effective in creating wealth than state
planned and state controlled economies. They pointed to the marked
contrast between the economic performance of Hong Kong and China,
East and West Germany and the Asian tigers and India, something
which was difficult to explain on grounds other than allowing markets to
work. For them a free market economy was not just the basis for
economic success but a necessary condition for greater political freedom
and the extension of democracy.
Margaret Thatcher and Ronald Reagan were persuaded by their
arguments. When they were elected as prime minister and president
respectively they introduced sweeping economic reforms to strengthen
enterprise and extend the role of markets in the economy. Price and
wage controls, capital controls and foreign exchange controls were
abandoned. Taxes were cut. Industries and public utilities were
privatised. Quangos were dismantled. In the financial sector cartels and
restrictive practices were abolished. Governments were encouraged to
keep tight control over money supply growth to keep inflation under
control. Public expenditure was controlled to allow room for tax cuts.
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Public sector borrowing was restricted to allow scope for private sector
expansion. Trade barriers were reduced to spread the benefits of
globalization. These policies were championed by the IMF and the World
Bank and became known as the “Washington Consensus”. For three
decades they formed the cornerstone of the world economy.
The success of these countries is because they moved from being
economies dominated by the state to ones which embraced the
principles of a liberal economic order. Earlier in the twentieth century the
success of the German economic miracle of the 1950s, the Asian Tigers
of the 60s and 70s, and the Chilean economy in the late 70s and 80s are
examples of the same move. More generally there has been the
extraordinary rise in the standard of living of ordinary people following
the industrial revolution which began in the eighteenth century.
The success of the past three decades along with other examples of
success in economic history raise an important question for theology. Is
there a theological underpinning for the success of market based
economies?
For some people and especially professional theologians, this question
may not only seem outrageously pretentious but an oxymoron. For them,
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market capitalism is without any theological foundation. They reject it
because they see it as an engine driving inequality, injustice, global
poverty and the destruction of the environment. From an ontological
perspective they see it as a toxic source of greed, alienation and
fetishism.
Ever since the industrial revolution of the eighteenth century theologians
in the Christian church have seen part of their mission to catalogue the
failures of capitalism rather than support its achievements or provide any
theological basis to explain its success. The list of theologians who since
the mid-nineteenth century have advocated some form of socialism
reads like a who’s who of the profession: F.D Maurice, Bishop Gore,
Emil Brunner, Paul Tillich, Reinhold Niebuhr, Walter Rauschenbusch,
William Temple. In our time, Harvey Cox, Ulrich Duchrow, Jacques Ellul,
Jurgen Moltmann. In Latin America theologians such as Boff, Gutierrez,
Segundo and Trujillo developed liberation theology as a synthesis of
Marxism and Catholic social thought. Until the publication of Centesimus
Annus in 1991, papal encyclicals dealing with social and economic
issues had, ever since Rerum Novarum in 1891 been highly critical of
market capitalism.
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As a result of this consensus the vocabulary and the framework used to
describe capitalism by theologians is typically borrowed from a Marxist
perspective. The key prism through which society is viewed is class,
based on economic interest. Wealth creation is seen as a zero-sum
game so that if some win others must of necessity lose. Capitalists win
and grow wealthy but do so because they are a source of poverty,
exploitation and alienation. Because of commodification and fetishism to
use Marx’s concepts consumerism has emerged as a diabolical culture.
I believe that there is an alternative theological approach which is far
more sympathetic to the market economy and which has its roots in the
ancient wisdom of the Pentateuch and is affirmed in the life and teaching
of Jesus. The fact of creation offers us a unique perspective on the
human person, endowed with liberty, by nature creative and resourceful
and with a God-given responsibility to take control and care for the
physical world.
The political economy of the Pentateuch offers us
pointers to a fair and just economy in which exploitation is outlawed and
each family retains a permanent stake in economic life.
Stated
differently this is the basis for sustainable wealth creation in a market
economy based on the rule of law and the protection of property rights,
in which the state has responsibility to ensure justice and provide for the
poor.
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In the narrative of the financial crisis which has developed we are in
danger of focusing so much on the weaknesses and failures of the
capitalist system that we are in danger of neglecting its success over the
previous three decades.
Causes of the Crisis
A second issue is the cause of the crisis.
The proximate cause of the crisis is obviously economic. For many
economists, bankers, civil servants, central banks and politicians the
financial crisis was a purely technical economic event. It was similar to a
huge systems failure, a massive brown-out, or a giant mechanical
breakdown. The banks were undercapitalised. They priced risk
incorrectly. They made bad lending decisions. They held far too little
liquidity. They failed to value their assets at market prices. Their
compensation structures rewarded short-term risk taking not long-term
value creation. Those banks which were too big to fail had to be
rescued at tax payer’s expense. The most serious problem was moral
hazard. Large banks attracted a higher credit rating and lower funding
costs because there was a perception that if they engaged in risky
activities they would be rescued. This proved to be an incentive to take
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ever greater risks. The result was a “heads, we win, tails you lose”
culture, in which gains were privatised and losses socialised.
For the banking system as a whole these are valid charges. Some banks
were more prudent than others. But no bank can say that it did nothing
wrong. If governments had not rescued banks, directly or indirectly,
such was the panic at the height of the crisis that the entire banking
system would have collapsed. Banks would have had to close their
doors to the public and cash machines would have remained empty.
Until normal service was resumed we would have been thrown into a
world of barter. For this state of affairs the banking system must accept
its share of responsibility.
It is important however that the failures of the banking system are seen
as part of a wider picture. The years leading up to the crisis were a
period of unprecedented prosperity. In the UK in the years preceding
the crisis we had 64 quarters of continuous economic growth,
accompanied by low inflation and full employment. At the same time
average house prices rose from four and a half times average earnings
to more than nine times average earnings. The euphoria this created
meant that irresponsible lending was matched by irresponsible
borrowing. In the mid-1970s the ratio of consumer debt (mortgages, hire
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purchase, credit cards) to household income was roughly 40-50%. By
2000 it had risen to more than 100% and by the time of the crisis it had
reached 170%. This ratio was higher than any other European country
and even higher than the US.
It was the growing prosperity of this era which led Gordon Brown, the
then UK Chancellor of the Exchequer to say with confidence that the
economics of boom and bust had finally been abolished. In the US, both
Democrat and Republican politicians, members of the cabinet and
officials of public agencies (especially those connected with Fannie May
and Freddie Mac, the state-sponsored mortgage institutions) urged
banks to increase lending to poorer families who were sub-prime
borrowers, so that the American dream of home ownership could
become a reality for low-income families and ethnic minorities. One
reason housing in the US was such an attractive investment was that
house prices had not fallen for 70 years.
As global prosperity grew so did global imbalances. Just before the
crisis the savings rate in China was around 40% while in the US it fell to
below zero. This was not because the Chinese are by nature more thrifty
than Americans but because China has a younger population, a nascent
welfare state and national health service, so that younger people need to
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save for retirement, health and care needs. The rise in the oil price from
$25 per barrel in 2000 to nearly $150 a barrel in 2008 was a further
cause of imbalance. These savings created huge balance of payments
surpluses in China and oil producing countries and correspondingly huge
balance of payments deficits in the US, the UK and Continental Europe
which in turn resulted in enormous inflows of money especially to the US.
Because the world was awash with money, interest rates fell to their
lowest level for decades and asset prices soared. This prompted a
search by investors for higher returns, which led to the development of
fiendishly complex financial products. Complexity however is the enemy
of transparency, so that even professional investors found these
products difficult to understand.
The reason I have gone into such detail on the build-up of debt and the
global imbalances in the years leading up to the financial crisis is to
show its complexity. The banking system played an important part in
triggering the crisis and this is no attempt to exonerate it from what it did
wrong. A fuller understanding of the crisis however must assign major
roles to other key participants: first, politicians (for encouraging bank
lending to sub-prime customers in housing), then central bankers (who
kept interest rates far too low for too long), third the rating agencies
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(which assigned triple A ratings to a large number of securities which
turned out to be backed by mortgages in default), fourth the regulators
(who failed to recognise the growth in leverage in the banking system)
and finally, the general public (who were delighted to carry on borrowing).
The economic causes of the crisis therefore are complex, global and
involve all the key players in the financial system as well as the
borrowing public.
The attempt to present the crisis simply as a technical failure of a
financial machine is a serious mistake because it also had an ethical
dimension.
The financial crisis began with a failure of sub-prime borrowers in the US
to repay their loans. At the time they were being extended these loans
were widely know as “no doc loans” (no documentation), “liars’ loans”
(false statements) and “ninja loans” (no income, no job, no assets).
When they applied for loans borrowers were either not asked or failed to
disclose their current and potential income, employment, assets and
debts. This was not a technical failure in the market for sub-prime loans
but an ethical problem. Borrowers did not disclose true information
regarding their income, employment and personal net wealth and
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mortgage providers were content to go along with the minimum of due
diligence. In other words reckless borrowing was matched by reckless
lending. The added dimension was that politicians actively encouraged
financial institutions to extend significantly their sub-prime lending.
This ethical failure was not confined to sub-prime lending. In the UK the
first sign of the crisis was a run on Northern Rock in the summer of 2007,
the first run on a British bank since Overend, Gurney and Company
collapsed in 1866. Apart from the problems inherent in its business
model, namely excessive reliance on short term funding, it transpired
that from 2005 Northern Rock had been publishing incorrect figures for
mortgage lending. Three senior executives who were subsequently fined
admitted hiding the true figures for mortgages which were in arrears. The
figures they published suggested that their arrears were only 50 percent
of the industry’s average, whereas the true figures showed that they
were more than 500 per cent higher than they reported. As a result the
capital they held relative to loans suggested a much stronger balance
sheet than was in fact the case.
The report into the collapse of Lehman Brothers drew attention to
“balance sheet manipulation”, known as ‘Repo 105’. This allowed the
bank to give the impression that the assets they held were approximately
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$50 billion lower than they actually were, that the amount of capital they
held relative to their assets was better than it really was which in turn
gave investor’s confidence to continue holding Lehman shares. This
again was not a deficiency in financial markets but a failure to meet
ethical standards.
In Ireland both the Chairman and the Chief Executive Officer of a major
bank were forced to resign following a failure to declare loans made to
themselves by their bank. At the end of each quarter in order to avoid
disclosure the loans were moved to another bank and then moved back
again after the reporting date. Subsequently along with the Irish banking
regulator and other senior figures in the financial sector they were forced
to resign.
In the face of examples such as these, and many more could be given,
the banking system has to accept that the compass which executives
used to guide them failed. They took too much risk onto their balance
sheets. They sought acquisitions at prices and with a lack of due
diligence which was reckless. They demonstrated a lack of attention to
detail. They pursued borrowers irresponsibly. The fact that banks were
forced into public ownership and directors removed was an extraordinary
censure of the banking system. There is sufficient evidence to suggest
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that in the run up to the financial crisis there was a serious lapse in
ethical standards throughout the whole of the financial system, even
though at the time this was not readily apparent.
One alleged ‘cause’ of the crisis is the culture out of which it grew. Since
the financial crisis there have been a number of plays, films, novels,
television dramas and documentaries dealing with its causes. Sir David
Hare is one of Britain’s leading playwrights and his play The Power of
Yes, which was put on at the National Theatre in 2010 is subtitled A
Dramatist Seeks to Understand the Financial Crisis. The central theme
of the play is the way the financial crisis has led to the death of the idea
that markets embody wisdom and decency. The underlying premise is
that capitalism as we know it is an economic system driven by a culture
of fear and greed. In one of the early scenes a financial journalist blurts
out “It’s greed isn’t it. It’s pure greed?” to which Harry a City lawyer
responds, “People literally driven insane by greed”. Financial innovation,
record profitability, mega bonuses, securitisation are all presented as
having created ever-greater hubris. Later the comment is made that
despite the crisis bankers still “don’t think they’ve done anything wrong.
No one feels apologetic. These people genuinely believe they’re the
masters of the universe”.
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A similar theme has been voiced by church leaders including the
Anglican Archbishops of Canterbury and York. Pope Benedict XVI
declared that greed lies at the root of all evil and it is this which is the
source of the current global economic crisis. Even people familiar with
finance have been critical of the cultural values exposed by the crisis.
Alan Greenspan, the former Chairman of the Governors of the Federal
Reserve System in the US, in a testimony before the Senate Banking
Committee stated that “infectious greed has become a threat to world
finance”.
The one word which is repeatedly used by playwrights, novelists, film
makers and bishops in describing the crisis is greed, the excessive
desire for money or material things. Within the Christian tradition the
charge of greed is extremely serious. It is one of the seven deadly sins
and Jesus lists it as an evil alongside theft, murder, adultery, malice and
slander (Mk 7:21). The Pharises were rebuked for being “lovers of
money” (Lk 16:14) and “full of greed” (Lk 11:39). Jesus taught that it was
impossible to serve God and Mammon, an Aramaic word for money,
which gave money the qualities of being a person and a god.
St. Paul writing a letter to Timothy says that “people who want to get rich
fall into temptation and a trap and into many foolish and harmful desires
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that plunge men into ruin and destruction. For the love of money is a root
of all kinds of evil” (1Tim 6:9, 10). In the letter to the early Christian
church at Colossae he writes that “greed is idolatry” (Col. 3:5) and to
Ephesus, that “the greedy person is an idolator” (Eph.5:5). No charge in
either Judaism or Christianity therefore could be more serious than
idolatry which is the violation of the first and second of the Ten
Commandments.
The charge of greed raises a series of questions. Was the financial crisis
caused by greed? Was the compensation of bankers a symptom of
greed? Was the increase in mortgages, credit card debt and personal
loans an expression of greed? Even if the crisis was not caused by
greed, were the years immediately preceding the crisis the result of an
excessive desire to accumulate wealth?
I have been and continue to be reluctant to use the word greed in
connection with the financial crisis for a number of reasons. First greed
has become an overused word. The Oxford English Dictionary definition
of greed is an inordinate or insatiable longing for wealth. Frequently it is
used as synonymous with possessions, compensation, or consumption
as if the very act of ownership, income or standard of living was in itself
a sign of greed. It is as if by definition any successful or wealthy person
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is greedy. Next, it fails to distinguish between genuine greed and the
legitimate aspiration of individuals and families to improve their materialwell-being and care for those dependent on them. Third, there is no onesize-fits-all City professional. Some are driven by greed. Others have
given their bonuses away. A number have set up trusts. Many take
giving seriously. I believe that the cultural issue is important but is much
deeper and more complex than simply greed and it is something to
which we will return later.
The Question of Debt
A third issue raised by the financial crisis is the question of debt.
One reason for this is the scale of the problem which has emerged right
across the board - for consumers, banks and governments.
 As we have seen UK consumer debt as a proportion of household
income rose from roughly 40-50% in the mid 1970s to 170% by the
time of the crisis. When the crisis came the consequence of this
was a rise in bankruptcies, repossession of homes and the growth
of loan sharks.
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 At the beginning of the twentieth century the leverage of banks,
that is the ratio of capital to assets was around 15-25%. By the
time of the crisis this had fallen to 5% and for some banks it was
as low as 2%. The size of bank balance sheets had grown from
around 4-6 times capital at the end of the nineteenth century to
for the Royal Bank of Scotland, more than 50 times capital, a
figure the Governor of the Bank of England Sir Mervyn King
described as ‘astronomical’.
 As governments bailed out the banking system, so their sovereign
debt relative to GDP has increased significantly. The generally
accepted ceiling for public sector debt to GDP is 60%.
Even
before the crisis the ratio in some countries, such as Greece and
Italy was well above a prudent level. By the end of 2011 overall
debt in the Eurozone rose to 87.2% of the area’s GDP. The debt
levels for many countries have reached dangerous levels: Greece
(165%), Italy (120%), Ireland (108%), Portugal (107%), France
(86%), UK (85%).
Debt has always been more than just an economic issue. It was
because of this that charging interest on loans was forbidden among
members of the Jewish community in the Old Testament. It was also the
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reason usury was banned by the early Christian church. In the first four
centuries of the Christian Church the condemnation of usury was
practically unanimous. It was condemned by the Church Fathers, such
as Clement of Alexandria, Cyprian of Carthage, Basil the Great, Gregory
of Nyssa, John Crysostom, Ambrose, Jerome and Augustine. It was
expressly forbidden by the church councils of Arles (314) Nicaea (325),
Carthage (348), Aix (789), Lateran (1179) and Lyon (1274). Reformers
such as Luther and Zwigli supported the ban on usury and even when in
the seventeenth century Calvin persuaded the church that charging
interest was not immoral he did not attempt to make a case for a free
market in credit. In Britain the Usury Laws which fixed maximum levels
of interest rates were only finally abolished in 1854. The Sharia law of
the Muslim faith to this day bans the payment of interest.
Incidentally the hostility of the church to usury led to the most appalling
anti-semitism. As the European economy expanded in the twelfth
century and the growth of credit was necessary to finance expansion,
Jews were permitted to engage in usury while Christians were forbidden.
In Passion plays the negotiations between Judas Iscariot and Jewish
leaders were portrayed as bargaining among Jewish medieval money
lenders. Bernard of Clairvaux who was leader of the Cistercian order
and granted the status of sainthood and whose hymns we still sing in
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churches today, described in the middle of the twelfth century the
practice of usury as “Jewing” and rebuked Christian money lenders as
being “Baptised Jews”.
The reason usury was banned within the Jewish community was
because of the serious problems from being in debt. In the Wisdom
literature (Proverb 22 Verse 7) it is stated that “the borrower is slave of
the lender”. The playing field for borrowers and lenders was not level.
The economy at the time of the Old Testament was primarily agricultural
and the community of which it was part, closely-knit. Unlike a modern
economy, it was an ‘embedded economy’ in which commercial
transactions were embedded in obligations of kinship and community.
People borrowed from a position of need in order to survive, not to
finance consumption or to raise capital for investment.
While charging interest in the Jewish community was forbidden, charging
interest on a loan to someone outside the community was not. The
difference between lending within the Jewish community and outside the
community was not because of racial prejudice but because the Jewish
community was an ‘embedded economy’ in which credit markets could
lead to serious hardship which was not true of arm’s length transactions
with foreigners.
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The fact that debt was viewed as a form of slavery in Jewish theology
was of immense significance when seen against the background of
Jewish history. The reason the Jews settled in Egypt was not because
of a military defeat or an invasion by enemy forces but because of a
serious famine which forced them to sell their land and themselves into
slavery, simply in order to buy bread. The Exodus was a liberation from
slavery in Egypt resulting from the scale of their debt. Later in Jewish
history during another famine Nehemiah, the Governor of Judah
expressed his outrage that poor farmers were forced to borrow money
and mortgage their property in order to survive and pay the King’s land
tax. He instructed the nobles and officials to immediately return the
fields, vineyards, olive groves and houses which the poor farmers had
forfeited repay the usury they had been charged.
In the New Testament Jesus made it clear that he had not come to
abolish the Law and the teaching of the prophets but to fulfil it. When he
spoke of usury his emphasis was on generosity. In fact generosity was
a core principle in the teaching and a core value of the Kingdom he
came to establish. He does not condemn the payment of interest and in
two of his parables, the Pounds and the Talents, acknowledges the
value of interest earned on deposits and of profits from shrewd
investments.
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In light of the financial crisis and the scale of debt, what are the lessons
we should take from the ancient wisdom of the Old Testament and the
practice of the Christian church for its first fifteen centuries?
One is that in all societies people who find themselves in difficult
circumstances must be able to borrow simply to survive. Credit markets
have a value to society. In today’s world credit markets allow people to
smooth out their consumption over their lifetime by borrowing when
young (typically through a mortgage) and replaying later, as well as
investing in home improvements and education and training. As a result
society must ensure that mechanisms exist by which people are able to
borrow in a way which is fair. This is especially true for low-income
families where the only option to the mainstream system of borrowing
and lending are loan sharks.
Another lesson is that the business of lending money at interest is not
intrinsically immoral. Usury was never labeled a sin in the Old
Testament comparable to theft or murder. It was forbidden in the
embedded economies of ancient Judaism and in medieval Europe
because the markets for credit at that time were highly personalised,
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highly localised and not well developed, so that borrowers faced only a
small number of people willing to lend.
Ensuring that credit markets are competitive will mean that for different
levels of risk, borrowers will face the lowest possible interest rates. By
insisting on transparency with respect to the terms of contracts
borrowers will not find themselves charged unexpected fees. Even in
competitive, transparent credit markets, however, if borrowers are forced
to borrow from a position of weakness, the playing field will remain
uneven. The abiding lesson from the Old Testament is that personal
debt has toxic potential.
The one area in which more could be done is to increase the provision of
credit for low-income families through strengthening the credit union
movement and other community-based finance initiatives. If credit
unions are to reach a critical scale, as they have in Australia, the
Caribbean, Ireland and the US it is doubtful whether this can be
achieved without a significant injection of funding from H.M Treasury.
The quid pro quo for this is that existing credit unions would be forced to
merge into larger bodies, to adopt more professional management
techniques and to install technology so that they can more easily
compete with retail banks.
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Finally, the financial crisis has forced us to ask some difficult questions
regarding debt. To what extent is the problem of debt due to a prevailing
culture of consumerism? Saving was once seen as virtuous. Deferred
gratification was an expression of self -control and will power. Do we
need to introduce rules which place limits on how much individuals can
borrow? Should mortgages for house purchase be restricted to some
maximum percentage of the value of property? Should there be fiscal
rules for governments? If we have rules for individuals what about
governments? In Victorian England no law was ever passed which
stated that governments should balance their budgets. What rules
should we attempt to introduce into the public finances? Should these
be incorporated as constitutional amendments?
Rebuilding Trust in Banks
The fourth issue I wish to raise is that of trust. The financial crisis led to
a huge loss of confidence by the public in banks. The legacy of this is
that the public have doubts over the competence of bankers to manage
their institutions, their judgment to avoid taking reckless decisions and
their commitment to place clients interests before their own. The task of
rebuilding trust is not easy and takes time. If trust is to be restored the
public must have confidence that their deposits are secure, that they
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know the risks banks are taking and that they are not being overcharged
for banking services.
For this to happen two steps are essential.
First, there must be a new regulatory framework. It must protect bank
depositors but given that banks are part of the market economy, it must
also allow unsuccessful banks to fail. No bank must be Too Big To Fail,
so that taxpayers will not in the future be forced to pick up the bill for
failed banks. Second, banks must convince the public that what they do
is of value to society and not just for themselves, that they are wellmanaged institutions and that the business principles which they
espouse are those which would be widely respected.
The financial crisis discredited the ‘light touch’ approach to bank
regulation. Since then regulators around the world have devoted
endless time and resources to reforming the regulatory framework of
banking. The US Congress passed the Dodd-Frank Wall Street Reform
and Consumer Protection Act. The European Union has proposed
radical reforms including a new ‘transactions tax’ on financial
transactions. In the UK the Financial Services Authority is being
woundup and replaced by two new regulatory bodies, the Prudential
Regulatory Authority and the Consumer Protection Commission, both
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under the oversight of the Bank of England. The UK government has
accepted most of the recommendations of the Independent Banking
Commission which recommended separating the more risky activities of
investment banks from the less risky activities of managing the
payments system and providing straightforward deposits and loans. The
European Commission is considering imposing new rules which could
have a major effect on European financial institutions. At an
international level the Basel Committee on Banking Supervision which
was set up in 1974-5 to deal with the banking crisis of that time has
proposed future reforms, known as Basel III, which will come in to full
effect in 2019.
Most of the reforms which have been proposed still require a great
amount of detail to be worked out before they become fully operative.
The reforms deal with major issues such as the activities which different
institutions can engage in, capital adequacy, liquidity rules, principles for
compensation, recovery and resolution proposals. Taken together these
are far-reaching proposals which change the landscape of the financial
services industry, provide greater confidence for depositors, increased
transparency for creditors and shareholders regarding the business of
financial institutions and increased focus on transparency and
accountability in remuneration.
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Earlier in the lecture when I looked at the cause of the crisis I was at
pains to point out that it was not simply like the breakdown of a machine
or some great brown out. It involved ethical and cultural considerations.
It is because of this that the second step in restoring public confidence is
so important, namely the leadership which the banks themselves show
by communicating their value to society and proving that they are
competent, prudent and trustworthy.
To achieve this it is not enough simply to pursue profit and act within the
law. There is another dimension – call it ethical, cultural, moral – which
will include ensuring that clients interests come first, that all relevant
information is disclosed, that conflicts of interest are properly managed.
Bankers have a duty of care to their clients, shareholders and staff. In
discussing a potential piece of business bankers must ask three
questions. Is it legal? Is it profitable? Is it right? Put differently, Can we
do this piece of business? Should we do this piece of business?
The management of highly successful institutions have recognised the
impact business culture can have on business performance. Research
has confirmed that though the relationship is not simple culture has an
impact on performance. This is one reason why in recent decades
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subjects such as corporate culture, human resource management, the
creation of meaning in work and the moral purpose of the organisation
have been given such importance. In the UK, Hector Sants, the Chief
Executive of the FSA, has gone out of his way to emphasise the
importance of the culture of a bank as a key driver of outcomes. “A firm’s
culture plays an important role in influencing the actions and decisions
taken by individuals within firms and in shaping a firm’s attitude towards
their customers”. The FSA has made it clear that it does not wish to set
out a particular culture to which institutions should adhere. Each
institution will have a unique culture which will reflect its history, its
people and its past challenges. The FSA is concerned however to
understand the cultures of the intuitions they supervise and to take
action when a culture threatens the viability of the institution.
Crucial to the creation of such a culture is leadership. Leadership has
the responsibility to articulate the values of the institution. Leadership is
about vision and purpose. It is about defining the nature of the business,
the standards which are expected, and setting the right example.
Leaders are the trustees of the values of a company. They must
establish the values, confirm inherited values, communicate those
values, take ownership of the values and then live those values.
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Building a culture and changing a culture is not easy. It takes time and
needs to be attended to each day in countless small decisions. There
are no easy levers to pull but there are decisions management must take
day in day out, week in week out, month in month out, which either
strengthen a culture or undermine it. One is to do with recruitment.
Competence, credibility, commitment, the ability to work in a team and
the ambition to do well are important: but the ability to earn revenue
must never be at the cost of character. The same criteria are important
in promotion. A person who is promoted swiftly because of the financial
success of the business he or she has built but who lacks character
diminishes a culture.
Perhaps the most important element of the culture of any financial
institution is the tone from the top. People in an organisation will pay
great attention to how serious leadership is about the matter of the
culture of the organisation. How often do they raise issues connected
with it? What do they mean by it? What kind of people do they promote?
Perhaps most importantly of all, do they themselves live it? One of the
founders of Service Master on whose board I sat for 15 years was
known for his remark, “if you don’t live it, you don’t believe it”.
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Crucial to the tone from the top is the role of the board. One of the key
responsibilities of board members is their role as trustees of the culture
of the organisation. This involves supporting management in its efforts to
build the right culture and when necessary challenging management. A
banks culture is not easy to assess and many boards do not have a
structured process for reviewing a firms culture in the way they do for
audit, governance, nominations and compensation. In this process
understanding the business and its drivers is absolutely essential as is a
review of employee and customer satisfaction and brand perception. For
banks the issue is how to recruit, promote and nurture first class
leadership which recognises virtue as the essential pre-condition for
implementing business principles.
The Crisis of Capitalism
The fifth and final issue I wish to raise in this lecture is the light the crisis
throws on the culture of capitalism.
It is important in thinking about economic life to separate the structures
of a market economy – private property, the rule of law, the place of
government, free markets, regulation - from the prevailing culture in
which it exists A market economy can be consistent with different ethical
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and cultural philosophies. The case that was made for the market
economy and against socialist economies in the 1960s, 70s and 80s was
not simply that markets created greater prosperity. It was that, but it was
also a philosophical perspective which placed great emphasis on the
individual’s freedom to choose in all areas of life and which opposed as
far as possible the state setting limits on personal choice. This
libertarian position echoed that of John Stuart Mill in the nineteenth
century and was best exemplified in the twentieth century in the writings
of Hayek, Friedman and, in the most extreme form, Ayn Rand.
The heart of this philosophy is set out in Hayek’s Constitution of Liberty
and popularised in Milton and Rose Friedman’s book, Free to Choose.
Its strength is its belief in freedom. Its weakness is an inadequate view
of social justice. It champions the free society. It finds it difficult to
outline anything approaching a just society. In his writing Hayek makes
this absolutely clear.
"Since they (i.e. differentials in wealth and income) are not the
effect of anyone's design or intentions it is meaningless to describe
the manner in which the market distributed the good things of the
world among particular people as just or unjust….no test or criteria
have been found or can be found by which such rules of "social
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justice" can be assessed….They would have to be determined by
the arbitrary will of the holders of power."
The view is about as different from the Protestant Ethic, the Puritan Ethic
or the views of the early Quaker industrialists as one could imagine. In
these ethical perspectives there was a relationship between virtue and
reward. The financial crisis has forced us to think about this issue and in
so doing has turned a search light on the prevailing culture and ethics of
modern western society. Have we embraced freedom to such an extent
that we are no longer able to champion justice?
We live in the West in an affluent society, whether judged by history or
relative to developing countries. Our economies are embedded in
societies in which the culture has been deeply influenced by
libertarianism, materialism and secularism. The market economy
depends for its effective working however on a certain kind of society
and a certain set of values or virtues. A market economy thrives if there
exists widespread distribution of wealth, a spirit of enterprise, and a
respect for the private ownership of property. A market economy needs
a foundation of personal virtues such as prudence, honesty, fairness,
moderation, self-discipline, respect for human dignity and public
spiritedness for it to succeed. These are not formed by the market but
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originate from outside it. These virtues underpin the market economy
and their source are strong families, religious institutions, vibrant
communities and schools that build character.
The crisis of modern capitalism far from being a technical economic
issue is a crisis of the libertarian, materialist and secular philosophies
which have come to dominate Western society. Viewed in a longer term
perspective their most distinguishing aspect is that they are inconsistent
with the values on which the market economy depends. There will
always be individuals who are greedy and the years leading up to the
crisis provided notorious examples. The problem however is much
deeper than the greed of some. I believe that the question which needs
to be asked of our society is the one posed by Durkheim, namely “what
is holy in our society and to whom?”
Conclusion
Let me now conclude.
In this lecture I have tried to argue that the financial crisis should be
seen not in the context of the last few years, or the bubble years which
preceded it but in the previous three decades of growing global
prosperity and poverty reduction; that the crisis had its roots in the
failures of banks, central banks, politicians, regulators, the rating
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agencies and irresponsible borrowing; and that underlying this was a
serious lapse in ethical standards and a culture uncritical of excess.
Restoring confidence in the financial system will not be easy.
Regulatory reforms are essential and being put in place. Banks are
being required to hold greater capital and liquidity and separate risky
activities form others. Poorly run banks must be allowed to fail and the
taxpayer must not again be in a position to foot the bill. The danger
however is overkill with a blanket increase in regulation but a failure to
distinguish those areas in which improved regulation is critically
important; unintended consequences will follow with risk being
transferred to the lightly regulated sector or overseas.
Finally the greatest challenge of all is in the field of culture. If banks are
to be trusted they need to develop cultures which are admired. This is
the greatest challenge facing the leadership of banks. More generally,
the financial crisis in its widest aspects has been a mirror held up to the
culture of our society, its ideals, its values and its habits, a subject I
know which is of great interest to the college and a possible subject for a
future Niblett lecture.
-ends
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