Chapter 9

A Crisis of Ethic Proportions⁷⁴

I recently received a letter from a Vanguard shareholder who described the present global financial crisis as “a crisis of ethic proportions.” Substituting ethic for epic is not only a fine turn of phrase; it accurately places a heavy responsibility for the meltdown on a broad deterioration in traditional ethical standards.

The fields of commerce, business, and finance have hardly been exempt from this trend. Relying on Adam Smith’s “invisible hand,” through which our own self-interest advances the interests of our communities, our society had come to rely on the marketplace and open competition to create prosperity and well-being.

But that self-interest got out of hand. It developed into a “bottom-line” society in which success is largely measured in monetary terms. Dollars became the coin of the new realm. Unchecked market forces totally overwhelmed traditional standards of professional conduct, developed over centuries.

The result has been a change in our society, from one in which “there are some things that one simply does not do,” to one in which “if everyone else is doing it, I can do it too”—a shift from moral absolutism to moral relativism. Business ethics has been a major casualty of that shift in our traditional societal values, and the idea of professional standards has been lost in the shuffle.

We seemed to forget that the driving force of any profession includes not only the special knowledge, skills, and standards that it demands, but the duty to serve responsibly, selflessly, and wisely, and to establish an inherently ethical relationship between professionals and the society they serve. The old notion of trusting and being trusted—which once was not only the accepted standard of business conduct but the key to success in the marketplace—came to be seen as a quaint anachronism, a relic of an era long gone.

The proximate causes of the instant crisis are usually laid to easy credit; the cavalier attitude toward risk of our bankers and investment bankers; “securitization,” in which the traditional link between borrower and lender was severed; the extraordinary leverage built into the financial system by derivative securities of mindboggling complexity; and the failure of our regulators to do their job.

But the larger cause was our failure to recognize the sea-change in the nature of capitalism that was occurring right before our eyes. That change, simply put, was the growth of giant business corporations and giant financial institutions controlled not by their owners in the “ownership society” of yore, but by agents of the ultimate owners in today’s “agency society.”

The managers of our public corporations came to place their own interests ahead of the interests of their owners, and our money manager agents—who in the United States now hold some 70 percent of all shares of public companies—blithely accepted the change. Indeed, they fostered it by superficial security analysis and research, by ignoring corporate governance issues, and by trading stocks at an unprecedented rate, an orgy of speculation without historical precedent.

Adam Smith presciently described the characteristics of today’s corporate and institutional managers (many of which are themselves controlled by giant financial conglomerates) with these words:

Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail.

The malfeasance and misjudgments by our corporate, financial, and government leaders, declining ethical standards, and the failure of our new agency society reflect a failure of capitalism. Free-market champion (and former Federal Reserve chairman) Alan Greenspan shares my view. That failure, he said in testimony to Congress last October, “was a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” As one journalist observed, “That’s a hell of a big thing to find a flaw in.”

So what’s to be done? We must set about establishing a “fiduciary society,” one in which our manager/agents who are entrusted with the responsibility for other people’s money are required—by federal statute—to place front and center the interests of the owner/principals whom they are duty-bound to serve, by focusing on long-term investment rather than short-term speculation, by providing appropriate due diligence in security selection, and by pressing corporations to govern in the interest of their owners, all reflecting their ethical responsibility to society at large. It will be no easy task.