The Collapse of Ethical Behavior in Finance

Greycourt has written a thought provoking paper on the roots of the financial crisis. Poor risk controls, massive leverage and the blind eye which are generally named as the causes of the mess we’re currently in, were mere symptoms of a much worse disease: the gradual but ultimately complete collapse of ethical behavior across the financial industry.

By a collapse of ethical behavior we mean exactly what we say – that the actions of many, if not most, of the large American financial firms (and of the many foreign firms that succumbed to the “American disease”) would strike an ordinary person as unethical – repulsive and scurrilous. But we also mean something more specific to the long-term viability of the financial industry, namely, the disappearance of any sense of fiduciary responsibility to the ultimate client. Integrity and a sense of responsibility to the industry’s customers are at the core of what a financial industry must be all about; otherwise, it’s just a big Ponzi scheme.

Greycourt goes on to explain the ethical failures we’ve witnessed in subrime lending, among the subprime lending banks, in auction rate securities, among the GSEs, in public disclosures of financial firms, in shorting the securities you are selling to your clients and in the Paulson & Bernanke conspiracy of silence. I’m sure everybody can add a few items to this list of what they have seen in every day practice.

To solve these core problems of unethical behavior in the financial world, Greycourt suggests the following reforms:

1. The industry needs to adopt a laser like focus on its clients and their welfare, in any event placing client interests far above executive compensation interests;

2. Eliminate conflicts of interest and avoid even the appearance of those;

3. Demand ethical behavior across the board from executives to employees, even if that is inconsistent with short-term profits and this behavior needs to be exemplified and enforced by top executives.

That won’t solve all the problems that we’re currently facing, but it would certainly be a step in the right direction towards long term financial prosperity.