Integrity, Risk and Accountability in Capital Markets

Regulating Culture

Justin O'Brien, George Gilligan, Justin O'Brien, George Gilligan

• Publisher: Hart Publishing
• Year: 2014
• Print ISBN: 9781849465670
• eBook ISBN: 9781782253563
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

The global economy is yet to recover from the aftershocks of the Global Financial Crisis (GFC). In particular many national economies are struggling to adjust to austerity programs that are a direct result of the toxic effects of the crisis. Governments, regulatory agencies, international organisations, media commentators, finance industry organisations and professionals, academics and affected citizens have offered partial explanations for what has occurred. Some of these actors have sought to introduce legislative and other regulatory initiatives to improve operational standards in capital markets. However, the exposure post-GFC of the scandal surrounding the manipulation over many years of the London Interbank Offered Rate (LIBOR) highlighted that the most important obstacles to counter the destructive potential of our global finance system are normative not technical. Regulating the culture of the finance sector is one of the greatest challenges facing contemporary society.
This edited volume brings together leading professionals, regulators and academics with knowledge of how cultural forces shape integrity, risk and accountability in capital markets. The book will be of benefit not only to industry, regulatory and academic communities whose focus is upon financial markets and professionals. It is of value to any person or organisation interested in how the cultural underpinnings of the finance sector shape how capital markets actually operate and are regulated. It is a stark lesson of history that financial crises will occur. As national economies become ever more inter-connected and inter-dependent under conditions of global financial capitalism, it becomes ever more important to know how cultural and other normative forces might be adjusted to militate against the effects of future disasters.

Part One

Regulating Culture in the Financial Sector – Structural and Historical Dimensions

CHAPTER 1

The Culture of Financial Institutions: The Institution of Political Economy

David A Westbrook

An expert’s questions tend to be bounded by the expert’s claim to special knowledge, ie, expertise, and usually institutional accreditation. So it is not surprising that when experts who think about the regulation of financial institutions are asked to think about ‘culture,’ the issue tends to be framed in their terms (what we know, or at least think we learned in graduate school or in the course of our professional careers). For example, how should regulators confront the culture within a financial institution so that the institution performs in accordance with societal norms, even when the law is unclear? This is a good question (the answer is seven), and as Justin O’Brien’s and George Gilligan’s excellent introduction to this book makes clear, variations on the question have been heard in recent years across the financial world.

As with all ordinary science, much is assumed, as the introduction also demonstrates.¹ The model question posed above assumes that we know what financial industries are, and what purposes their regulation serves. Not so long ago, for example, it seemed pretty clear what a bank is, and what the central bank’s responsibilities are toward such institutions. This is no longer the case; we now speak not only of shadow banking, but the central bank as dealer of last resort,² and we observe a pronounced unwillingness to follow Baghehot’s advice and let insolvent banks fail.³ Nor can it be said that we are clear on just what ‘societal norms’ financial institutions are to serve. Sticking with central banking (and by extension, the banking industry in operation) do we think that monetary policy ought to be conducted in accordance with real economic, as opposed to monetary, goals?⁴ For another set of examples, it is easy enough (tautological) to say that fraud is bad, but when we get down to brass tacks—what disclosure is required under what circumstances, or else the transaction be deemed fraudulent, with financial and even criminal consequences?— little agreement exists.

To a large extent, such mindlessness must be forgiven under the flag of Neurath’s boat, which must be rebuilt even while it is at sea.⁵ We cannot pay attention to everything at once, and if we seek to address something as nebulous as ‘culture’ in financial regulation, assumptions are going to have to be made. But it should also be acknowledged that our assumptions also may be convenient, or otherwise intellectually dubious. So before we stride off into the rough of financial institution regulation, and what has or has not been learned from the global financial crisis, and what ‘culture’ might mean, at least for the purposes of preventing or at least containing the fire next time, it is worth pausing to reflect on the fact that financial culture is not only, or even most importantly, the culture within financial industries, including of course their customers and regulators. That is, the most important part of financial culture may have very little to do with that on which we, as experts of one sort or another, are authorized to speak. ‘I’m sorry about the cancer, ma’am, but I’m a podiatrist.’

Financial culture also is the product of financial industries; it is the heart of contemporary political economy, what I have elsewhere called the City of Gold.⁶ The GFC matters in a way that, for example, the Silicon Valley bubble did not, not merely because of the former’s scale, but because the mismanagement of financial institutions led to the disruption of so many human relationships, most obviously employment relationships. Unemployment—or lack of employment opportunities—blights a generation. Unemployment correlates with suicide, divorce, and addiction rates.⁷ With massive unemployment (or worse, little employment prospects for the young, energetic, and sometimes violent) we may see a loss of faith in social institutions, a rise in ethnic animosity and virulent nationalism, an anarchist moment. ‘The best lack all conviction, while the worst/Are full of passionate intensity,’ as Yeats has it.⁸ This year, 2013, does not appear to be 1913, nor even 1933, though the situation in Southern Europe remains particularly dismaying. But to say that history teaches that things can be worse is a pathetic excuse. Members of the financial community (or at least its talking heads) tend to be all too blithe about recent colossal failures, and the harm that has been inflicted not only on ‘the little people,’ but also on the structures that sustain the lives of the privileged.

Understanding financial culture and the failings of the global financial crisis in social terms does more than to remind us of the human significance of events, significance that is perhaps easy to forget in technical discourses on institutional regulation. Indeed part of the point of this or any other expert discourse (consider here medicine, or the military) is to be able to discuss fraught questions, such as cancers, bombs, or indeed insolvencies, as if they were merely objective. And in recent years, the discipline of economics has struggled to define itself in scientific terms, understood to be concerned with objects, and thus in some sense outside of culture and by extension politics. So, from an economic perspective, one may speak of, for familiar examples, the independence of central banking, or a ‘ technical’ government, or make the claim that while it is clear what reforms need to be made, the problems are political.

But from the more traditional and perhaps defensible perspective of political economy, finance is social in the structural sense used by sociologists and anthropologists. Our financial institutions are absolutely central to the way we as people conduct ourselves and understand our lives. This may be most obvious in the United States, where so many social goods—including much education, health care, and retirement—are provided through institutions directly dependent on portfolio investment. But as the European debt crisis makes clear, in countries where social obligations are met by the state, governments are quite dependent on healthy financial markets, in turn dependent on healthy ‘private’ (!) financial institutions. Other examples abound. We securitize fixed assets. We pay for daily operations through credit arrangements, both as individuals (credit cards) and businesses (commercial lending and paper). As both individuals and especially institutions, we are comfortable with leverage, exchange rate risk, and all sorts of other dangers, in large part because we have developed derivative markets intended to hedge our risks. One could go on, but in short, we have capitalized our worlds; this is what it means to have a ‘social capitalism.’⁹ To put the matter differently: if the GFC represents a colossal failure of finance, it also demonstrates just how successful finance has been in monetizing contemporary economies, so that it seems rather quaint to talk about the distribution of goods and services and the problem of scarcity.

Thus while we still tend to teach finance in entrepreneurial terms (finance is progressive, because it allows people to do what they cannot do out of retained earnings), credit—sweet liquidity—is absolutely central to daily operations of leveraged (and interconnected, and vulnerable) governments, institutions and individuals. All of this makes the spectacle of young bucks at Barclays promising one another bottles of champagne in exchange for modest market manipulation¹⁰ seem like a farce, but symptomatic—Marie Antoinette dressing up as a shepherd. And this makes financial regulation an essentially custodial, or as is said in the banking context (now including the securities context)¹¹ ‘prudential,’ enterprise, like the provision of electricity or water.

At this point, the expert debate on the regulation of financial institutions does not seem so harmless. Without being sentimental, at issue is not merely how banks and other financial institutions are to be run, but our political economy, ie, little questions like whether kids in Spain will ever get a job, or just how many people in the US will be on food stamps. It would be intellectually convenient to say, with Foucault, that our claims to expert knowledge are also assertions of authority, power.¹² While there is a truth here, this point is easily overdone: bureaucrats want to live comfortably, which requires a modicum of authority, but not power in the sheer rushing sense of being Alexander. Few bureaucrats, including bankers, seek to conquer India or even be the big swinging dicks legend has it stalk Wall Street.¹³ More modestly, in bureaucratic fashion, we might ask, if social capitalism is the ‘culture’ of which financial institutions are the mainspring, then what sort of social capitalism may be hoped? That is, if we ask about the culture of our political economy, then what does that teach us about the culture we seek to foster in our financial institutions?

Regulators have turned to ‘culture’ in frustration.¹⁴ Through the GFC and now again with the Libor scandal, we observe market participants who simply do not abide by the spirit of the rules.¹⁵ They are, in a word, bad sports. So how do we as a society—and in particular regulators, charged with refereeing the markets—get financiers to be good sports? Or as a recent conference given by the law firm of Allens and the University of New South Wales Center on Law, Markets and Regulation phrased it, how do we regulate culture?¹⁶

In policy discourse, culture is commonly approached in two basic ways, both centered on the notion of assessing the significance of an action vis-à-vis a social frame of reference, the ‘culture’.

Lawyers tend to think of culture on the model of law, conceived of as a rule. So, cultures establish rules. Big general rules are expressed as laws (statutes, judicial decisions, constitutions); technical administrative rules are usually called regulations; the softest and most ‘cultural’ rules are deemed norms, eg, best practices, which may be important even in the absence of an official sanction. In this view, law is often understood to bound otherwise free behavior, much as a fence bounds movement. The law determines a ‘line,’ it is often said, which is not to be crossed. As with borders, the metes and bounds of real estate and mining claims, the claims of patents—the imaginary of the ‘line’ is ubiquitous in the law—the lines of financial regulation are themselves invisible. They are products of statute, regulation, and best guesses as to, as Holmes wrote, ‘what the judge will do in fact’—and as such are subject to professional divination (funny how Holmes’s emphasis on ‘fact’ so quickly requires ‘divination’—faith and a gift).¹⁷ In consequence, entrepreneurs often seek legal advice, and lawyers themselves may turn to regulators, eg, by seeking a no-action letter at the SEC, for some sense of where the law’s lines are. If, however, a transaction is deemed to be within the fence, then the actor is free to take the action. This imaginary is familiar, useful, indeed inescapable—but it must be recognized as only one way of imagining the law.

Economists tend to begin with rational actors who are incessantly attempting to better their situations. When contemplating an action, such actors evaluate the benefits (incentives) and harms (disincentives) they are likely to receive from taking, or not taking, the action. Many incentives are determined by other people. For example, a bank might not want to be known to take unreasonable risks, because a reputation for recklessness might dissuade people from depositing money or otherwise investing in the bank. In extreme cases, a bank could lose its licence. So, for the bank, the immediate expected profit (return on investment) must be balanced against somewhat more nebulous reputational risk if the investment goes bad, and people find out.

If lawyers unsurprisingly imagine culture to be like law, and imagine law as drawing lines that constrain otherwise free behavior, economists unsurprisingly imagine culture as a m...

Table of contents

• Cover
• Title Page
• Dedication
• Preface
• Contents
• Contributors
• Introduction: Regulating Culture: Problems and Perspectives
• Part One: Regulating Culture in the Financial Sector – Structural and Historical Dimensions
• Part Two: Regulating Culture in the Financial Sector – Incentives and Integrity
• Part Three: Regulating Culture in the Financial Sector post-Libor
• Part Four: Regulating Culture in the Financial Sector – Realities and Limitations
• Conclusion: Cultures of Redemptive Finance
• eCopyright