Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 6

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.

 

RELATED ARTICLES

Does the public hate us?

Accounting may finally be sexy

banner

Most viewed in recent weeks

Is it better to rent or own a home under the age pension?

With 62% of Australians aged 65 and over relying at least partially on the age pension, are they better off owning their home or renting? There is an extra pension asset allowance for those not owning a home.

Too many retirees miss out on this valuable super fund benefit

With 700 Australians retiring every day, retirement income solutions are more important than ever. Why do millions of retirees eligible for a more tax-efficient pension account hold money in accumulation?

Reece Birtles on selecting stocks for income in retirement

Equity investing comes with volatility that makes many retirees uncomfortable. A focus on income which is less volatile than share prices, and quality companies delivering robust earnings, offers more reassurance.

Is the fossil fuel narrative simply too convenient?

A fund manager argues it is immoral to deny poor countries access to relatively cheap energy from fossil fuels. Wealthy countries must recognise the transition is a multi-decade challenge and continue to invest.

Superannuation: a 30+ year journey but now stop fiddling

Few people have been closer to superannuation policy over the years than Noel Whittaker, especially when he established his eponymous financial planning business. He takes us on a quick guided tour.

Anton in 2006 v 2022, it's deja vu (all over again)

What was bothering markets in 2006? Try the end of cheap money, bond yields rising, high energy prices and record high commodity prices feeding inflation. Who says these are 'unprecedented' times? It's 2006 v 2022.

Latest Updates

Retirement

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Retirement

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

Interviews

Why short-termism is both a travesty and an opportunity

On any given day, whether the stockmarket rises or falls is a coin toss, but stay invested for 10 years and the odds are excellent. It's at times of market selloffs that opportunities present for long-term investors.

Investment strategies

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

No excuses: Plan now for recession

The signs of a coming recession are building, especially in the US. In personal and business decisions, it's time to be more conservative and engage in risk management until some of the uncertainty is resolved. 

Strategy

The fall of Volt Bank removes another bank competitor

The startup banks were supposed to challenge the lazy, oligopolistic major banks, but 86 400, Xinja and now Volt have gone. Why did Volt disappear so quickly when it had gained deposit support and name recognition?

Strategy

Three main challenges to online ads and ‘surveillance capitalism’

Surveillance capitalism refers to the collection and use of consumer data to further profits. Will a renewed focus on privacy change the online-ad business model, or is it too entrenched?

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.