THE LONDON TIMES: Morals can help to rebuild investor faith: “From Enron and WorldCom in the US to Europe’s Parmalat, trust in corporate management has been tested to breaking point. When we are no longer sure, even of the likes of Shell and other paragons of corporate virtue, what confidence can be left?” (ShellNews.net) 21 Feb 05

Economic agenda

By Gary Duncan

February 21, 2005

IT IS now some five years since the bursting of the dot-com bubble. As symbolised by the recent return of London’s FTSE 100 index to above the watershed 5,000, the markets are at last reviving from the devastation that the collapse caused to investor wealth.

However, although shares are on the rise once more, the same cannot be said of the confidence of millions of investors, nor of the public at large, in the broader financial system on both sides of the Atlantic.

In the years that followed the dot-com debacle, the public’s faith in financial markets and their participants was shaken to its foundations, not merely by the tech-stock bubble and its collapse, but by the startling series of financial scandals that followed.

From Enron and WorldCom in the US to Europe’s Parmalat, trust in corporate management has been tested to breaking point. When we are no longer sure, even of the likes of Shell and other paragons of corporate virtue, what confidence can be left? Here in Britain, the trust of thousands of ordinary savers has, meanwhile, been sapped by the home-grown imbroglios over endowment mis-selling and split-capital investment trusts, not to mention a number of lesser affairs that have bedevilled UK investors.

All of this has been profoundly damaging to the standing of the institutions and people upon whom we depend to generate wealth and protect our financial security.

For many, the image of the boardrooms and dealing rooms has never been worse. Sharp suits now merely suggest sharper practice.

How much does this generalised and deepening loss of faith matter? A lot. There are many complex factors behind what we have come to know in Britain as the “pensions crisis”. But a straightforward and basic factor is that people are failing to save enough for their old age because they have little or no trust in the means available for them to do so. It is not too hard to work out that the consequences will be severe.

It matters, too, that some of the closest and best-informed observers of the tech-stock implosion are giving warning that, in spite of those events, some may still have failed to learn that there is no such thing as a free lunch.

In a recent article, Frank Partnoy, professor of law at the University of San Diego and the author of an influential study of the dot-com debacle, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, argued that “perhaps it is 1999 again”.

Professor Partnoy wondered aloud about the recent resurgence in US stocks such as Google and Yahoo, and the factors behind the high ratings they enjoy from some of Wall Street’s biggest institutions.

The time may be ripe, therefore, to consider seriously the case for investing in our financial markets with a new, stronger, moral dimension.

To some, this will seem an odd proposition. There is a persistent and widespread belief that money and morality are awkward bedfellows. And yet the current context makes it apparent that the time must have arrived for a rethink of these antediluvian attitudes.

In a recent fascinating lecture at Gresham College, Avinash Persaud, a leading economist and investment manager, set out a compelling case for all of those involved in financial markets to stop to consider the ethics of their day-to-day professional practices.

As Professor Persaud observes: “Things have reached a poor state when your average saver would rather trust an estate agent with her savings than a financial broker.”

This is undoubtedly a reality in Britain today, and one that needs to be confronted.

Professor Persaud argued that there should be “no place to hide” from ethical responsibilities in the financial world.

His belief is that it is not enough for market participants to behave lawfully — they must act not just in a legal, but also in a moral, context. For an institution to drive a customer into bankruptcy by calling in a loan, allowing it to snap up the ruined company’s assets at a cheap price, is not illegal, but it is plainly unethical.

In his lecture, Professor Persaud suggested that, without a clearly delineated framework of ethics and where participants regularly question their own actions and are subject to scrutiny, a powerful negative dynamic can quickly take root in financial markets and institutions, which would foment and reward malfeasance. “Without some self-questioning, there is a slippery slope of ethical behaviour where bad practices become the norm, which creates a competitive cost to acting ethically, thereby sowing the seeds for the system’s eventual crisis,” he said.

Persaud goes as far as to suggest that such a downward spiral might even be “what we are witnessing in the New York Stock Exchange today”, although he emphasises that no institution has room for gloating or complacency.

The case for a stronger ethical dimension in the investment world is reinforced by the growing complexity of financial markets and institutions.

Partnoy cites the work of David Skeel, of Pennsylvania University, in his book Icarus in the Boardroom, which argues that, in the dot-com episode, analysts and bankers exploited this complexity to enrich themselves at the expense of the investors.

In 2002 it was Alan Greenspan, the Chairman of the US Federal Reserve, who argued: “It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed have grown so enormously.”

Against such a backdrop, the argument for an offsetting ethical imperative is all the more potent. And this need not be rooted in worthiness, but can be securely founded on economic self-interest.

As we are now seeing all too clearly, while a few may make short-term gains from shoddy practices in the financial world, the long-term economic costs to the wider community can be immense. And the potential returns that would flow from a more enlightened approach mean that it is underpinned by a financial, and not merely a moral, rationale.

As Persaud argues, a market that is known to be secure and run along ethical principles will be more trusted by investors. It will therefore be larger and more inclusive than otherwise, attracting a wider range of participants. And since bigger, deeper markets are more efficient and more liquid, they will offer a more diverse and cheaper range of financial options to those who use them.

“Markets known for strong ethics will be more successful than those in which traders hang up their morals at the door,” he says.

More generally, in a world in which ordinary investors have seen their faith in financial institutions drained, those that can demonstrate high standards of institutional behaviour and command confidence will be the ones to attract customers and funds, and so thrive.

In Britain, millions of people desperately want to see their faith in the institutions to which they entrust their savings and future livelihoods strengthened. Forging that renewed bond of trust will not only be a considerable challenge, but also an immense opportunity.