Capital Failure

Adam Smith's 'invisible hand' relied on the self-interest of individuals to produce good outcomes. Economists' belief in efficient markets took this idea further by assuming that all individuals are selfish. This belief underpinned financial deregulation, and the theories on incentives and performance which supported it. However, although Adam Smith argued that although individuals may be self-interested, he argued that they also have other-regarding motivations, including a desire for the approbation of others. This book argues that the trust-intensive nature of financial services makes it essential to cultivate such other-regarding motivations, and it provides proposals on how this might be done. Trustworthiness in the financial services industry was eroded by deregulation and by the changes to industry structure which followed. Incentive structures encouraged managers to disguise risky products as yielding high returns, and regulation failed to curb this risk-taking, rent-seeking behaviour. The book makes a number of proposals for reforms of governance, and of legal and regulatory arrangements, to address these issues. The proposals seek to harness values and norms that would reinforce 'other-regarding' behaviour, so that the firms and individuals in the financial services act in a more trustworthy manner. Four requirements are identified which together might secure more strongly trustworthy behaviour: the definition of obligations, the identification of responsibilities, the creation of mechanisms which encourage trustworthiness, and the holding to account of those involved in an appropriate manner. Financial reforms at present lack sufficient focus on these requirements, and the book proposes a range of further actions for specific parts of the financial industry.WHAT WENT WRONG? ; 1. Why Trustworthiness is Important ; 2. How Changes to the Financial Services Industry Eroded Trust ; 3. The Limits to Compensation in the Financial Sector ; 4. A Short History of Crisis and Reform ; 5. Failures of Regulation and Governance ; TRUSTWORTHINESS, MOTIVATIONS, AND ACCOUNTABILITY ; 6. Trustworthiness and Motivations ; 7. Regard for Others ; 8. Trust, Trustworthiness, and Accountability ; PROBLEMS WITH THE LEGAL AND REGULATORY SYSTEM ; 9. Financial Crisis and the Decline of Fiduciary Law ; 10. Professional Obligation, Ethical Awareness, and Capital Market Regulation ; 11. Systemic Harms and the Limits of Shareholder Value ; CRAFTING THE REMEDIES ; 12. Ethics Management in Banking and Finance ; 13. Toward a More Ethical Culture in Finance: Regulatory and Governance Strategies ; 14. Trust, Conflicts of Interest, and Fiduciary Duties ; 15. A Warrant for Pain: Caveat Emptor vs. the Duty of Care in American Medicine, c. 1970-2010 ; 16. Restoring Trust