Ethics in the Time of Financial Capitalism
Nicola Bilotta
Abstract: The 2007/8 financial crisis revealed fragilities in the international banking system. The degeneration of financial instruments and products signal the failure of current regulations to maintain stability in the financial systems of developed economies. This article first presents Minsky’s theory, which argues capitalism is endogenously unstable. Second, it examines the evolution of management incentive schemes demonstrating how they no longer accomplish their functions of reducing moral hazard and transaction costs. To establish a bond between finance and ethics, this paper proposes the implementation of two sources of ethics: extrinsic public regulations and intrinsic moral auto-regulation.
Introduction
The financial crisis revealed the fragility of the capitalistic system. This article returns to theoretical basics to examine the role of ethics in capitalism’s foundations observing that capitalism, as practiced today, is in need of an infusion of ethics. Two potential sources for ethics are proposed, one extrinsic and one intrinsic: public regulations controlling the financial sector, and moral auto-regulation amongst bankers and traders.
Keynesian theorists argue market disequilibrium is the result of a failure of aggregate demand. The Marxist approach instead claims a cyclical crisis is perpetuated by the contradiction between the development of productive forces and the relationships of production. The degeneration of the financial system, however, encourages us to contemplate the recent economic crisis and its roots. Sapelli (2011) talks about “financial nihilism” to explain worldwide contemporary economics, in which banks are more sales entities than lenders.
The descent of the financial sector can be traced back to the 1990s, when great liquidity started flowing to finance instead of the real economy. Another crucial moment was in 1989, when the Stock Exchange Commission (SEC) allowed banks to produce derivative financial instruments, transforming banks from enterprises, which gained profits by lending, to supermarkets hawking financial products.
“E’ saltato il nesso fra economia e morale. L’economia, anche se appare come un universo reificato, è frutto di infinite scelte di comportamento personale (The link between the economy and morality is broken. The economy, even if it appears as a reified universe, is led by endless personal behaviors)” (Sapelli 2011, p. 14). This paper explores the link between morality and the financial crisis through (i) Minsky’s theory and (ii) the evolution of manager’s incentive schemes. Flanders (2015) argues, “It is not a Minsky moment, it’s a Minsky era, or: inevitable instability.” The first section presents Minsky’s theoretical approach. Financial fragility is not due to endogenous instability, as neoclassical thinkers propound. Instead, the weakness is due to (i) inadequate institutional regulations and (ii) money manager capitalism. The second section demonstrates the degeneration of the manager stock options system. Employee stock option schemes originated to mitigate moral hazard and opportunistic behaviours. However, these days the character of incentives takes a different form. Current stock option incentives encourage managers to look for short-term profits rather than long-term prospects.
Our economic system suffers under the tyranny of stock market capitalism. Financial actors and entrepreneurs are not judged by their ability to generate national wealth or jobs. Performance is judged by trends of companies’ stock prices. Financial markets have lost their moral auto-regulation, devolving into systems without ethical brakes. Finance is not inherently evil. Whether finance is good or bad depends on human agency. As Levy says “the purpose of an economy is to produce consumer goods and services efficiently and to distribute them in accordance with some principle of fairness” (Levy 1984, p 14). To escape the era of financial alchemy, as Mervyn King (2016), former governor of the Bank of England, labels current financial practice, we need to re-establish a bond between ethics and finance. Implementation should combine public and auto-moral regulations. The former implies (i) re-enabling a legal separation between commercial and investment banks and (ii) limiting the power of what Marx called, the financial aristocracy. The latter suggests the need for self-enforcing moral constraints.
Section I: Minsky’s Theory of Financial Degeneration
Nicola Bilotta has a BA and a MA in History from Università degli Studi di Milano and a MSc in Economic History from the London School of Economics. He works as a Global Finance Research Assistant at The Banker (Financial Times) and collaborates as an external researcher at ISAG (Istituto di Alti Studi di Geopolitica e Scienze Ausiliari).
