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Nixon’s Mum

The financial services industry is untrustworthy … that’s how people see it.

A survey of over 3,000 people across 60 countries found that only a third believe their ‘primary investment contact’ acts in their best interests. Only a third! Of course we’d be startled if as many as a third believed their used car dealer acted in their best interests but ironically we in finance and investing need to be trusted more than do used car dealers. Not only is a car dealer’s past performance likely to be a reliable guide to future performance, but used cars can be tested for quality by identifiably independent experts, and one can insure against the risk of lemons.

None of this holds in financial services where the confluence of informational asymmetry and intrinsic uncertainty means quality can never be tested. For instance, half a century of data is famously needed to be confident that skill rather than luck best explained a manager’s outperformance. All we have had is trust, yet the ‘market’ for trust has failed; demand is increasing while supply is decreasing. The World Values Survey asked people in Britain ‘can most people be trusted?’ In 1959, 57% answered ‘yes’, but by 2000 that had collapsed to 31%.

Trust in the entire financial system has been battered by financial crises and bruised by Madoff-style schemes, both of which are too readily dismissed by the few-rotten-apples metaphor designed to comfort us, to distance us from corruption. Yet we all played a part in small but insidious ways. For instance we eternally qualify with the ubiquitous ‘little’, as in ‘we underperformed a little’, the strategy ‘failed to hedge a little’, and the one we all fear, ‘this might hurt a little.’ Weasel words undermine trust inch by inch. Let’s say it like it is. Some language goes further than merely undermining trust. Some destroys it. Listen to private bankers striving to increase their ‘share of wallet.’

Trust might be cautiously restored if people see ethical behaviour as the norm, if they see us in the business behaving ethically. Some argue we shouldn’t try, that ethics inhibits success in commerce, and that it’s too onerous. But where trust is a crucial ingredient of ‘getting to yes’, ethical behaviour is more likely to enhance success. And it isn’t too onerous. Just the opposite because society’s response to poor ethical standards is more regulation. Now that’s onerous.

Trust in financial services could be re-kindled if we practised two easily-stated pragmatic principles.

The Oedipus Principle. In commercial dealings always act and behave as you would in dealing (at arms’ length) with your mother. We may have complex relationships with our mothers, but most would neither take unfair advantage of them nor mislead them in commercial dealings. We wouldn’t lie to them, even though as children we all did.

The Nixon Principle. In commercial dealings always tell the truth, tell it quickly, and tell nothing but the truth. The adverb quickly is crucial. The longer you delay telling clients about screw-ups or misleading statements, the harder it is to come clean and the greater the suspicion of a cover-up, which when discovered permanently destroys trust. Judgement is needed in deciding whether to tell the whole truth. Sometimes not telling the wholetruth can be ethical, as might be the case if a long-short equity hedge fund named its shorts. Almost never are ethical decisions black-and-white, but blurring is no excuse for not exercising ethical judgement.

All principles of government, investment, commerce and ethics are easy to live by in normal times.  Our commitment to them is only tested when we’re under extreme pressure, and we mostly fail.  Suppose your child urgently needs a life-saving operation which you can fund via a sale that is far more likely to close quickly if you don’t alert the buyer to a half-buried escape clause that applies to a guarantee. Will you still hold to the principles of Oedipus and Nixon?

To embed trust in commerce we also need to exorcise the neo-liberal economic rationalist agenda that preaches selfishness as a virtue and justifies it on the grounds that the invisible hand will serve the common interest. Adam Smith knew the limits to his profound and beautiful metaphor; he warned that free markets ineluctably result in collusion and corruption. Financial markets, being “demons of our own design” must be regulated … wisely. Unfortunately wisdom is in short supply.  Would you trust a seller of mortgages regulated by ASIC’s requirement that a credit contract be merely ‘not unsuitable’ for the purchaser? That’s but a slight nudge ahead of caveat emptor.  ‘Most suited’ or ‘the best’, but ‘not unsuitable’?

Exorcism must be brought to bear on Milton Friedman’s rationalist view that a firm’s sole social responsibility is to make (legal) profits. Freidman is doubly wrong. First, a firm’s aim should be to produce goods and services of sufficient quality that people will want to purchase them. Profit is a consequence of production rather than the aim. Once profit becomes the aim, as it has on Wall Street, unethical behaviour becomes readily accepted and resources are directed to accounting trickery rather than to production. Profit as the aim allowed Wall Street to legally sell ‘No-Doc No Income No Job’ negative amortisation mortgages to poor unemployed people (and then to blame them.) Second, were Friedman right, companies would be the only institution in society whose sole constraint is to obey the law. We rightly expect more than that from our schools, our governments, our hospitals, and from each other. We expect them and us to behave considerately, reasonably, ethically – high standards we all fall short of from time-to-time.


Dr Jack Gray is a Director at the Paul Woolley Centre for Capital Market Dysfunctionality, Faculty of Business, University of Technology, Sydney, and was recently voted one of the Top 10 most influential academics in the world for institutional investing.



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