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Rachel Harvey, PhD Headshot

Avoiding the Next Financial Pile-Up: The Values of Loyalty, Honor, and Duty to Market

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With the eruption of the LIBOR crisis, the spotlight turns again to the "usual suspects" -- financial institutions, greed, and predatory dealing practices. As recriminations and analyses of yet another financial pile-up begin anew, the public appears, once more, to be little more than "financial roadkill."

It is increasingly obvious that an aggressive, bonus driven, and opportunistic culture was a critical factor leading to the manipulation of LIBOR. As noted by many media and financial analysts, codes of conduct emphasizing trust and personal integrity broke down. While clearly important factors, a foundational element underlying such trading "rules of the road" is currently being ignored. For financial markets to function properly and credibly, participants must possess a sense of social responsibility toward maintaining a stable and trustworthy marketplace -- a sense of custodianship, or "duty to market."

In the wake of recent events, this conception of "duty to market" seems in the realm of make believe. Yet this ethos did exist in a market at the heart of the international monetary system throughout most of the 20th century. My research on the London Gold Market documented the presence of this culture and its emphasis on the values of loyalty, duty, and honor among market makers.

The manifestation of these values -- such as maintaining a narrow trading spread or continually quoting a two-way price -- are familiar to present-day traders. While these elements were the cornerstone of this gold market, the traders' sense of duty went further than contemporary concerns. Market participants volunteered personal time to strengthen and protect the market infrastructure. Profiting at the expense of customers was frowned upon; as was "bleeding the market for the margins." While traders had a duty toward the balance sheets of their firms, they also recognized a collective responsibility toward maintaining the integrity of the market.

Historians have revealed that the ethical qualities characterizing the London Gold Market were not unique. They were inscribed in the social and institutional order of the City of London in the post-World War II years as "Gentlemanly Capitalism." Often this term refers to an "old boys club," a staid culture, or the iconic expression of trust -- "my word is my bond." While all this is true, this culture also shunned greed and emphasized mutual responsibility through paternalistic employer-employee relations. It also understood that markets were made and doing so required, at times, personal sacrifice in order to preserve the market's integrity.

This ethos of "duty to market" did not simply emerge from traders' enlightened self-interest, nor was it found in their collective recognition of their long-term interests. It was a post-World War II version of lex mercatoria which was heavily influenced by British institutions, such as the grammar and public schools, and the late-nineteenth and early-twentieth century gentlemanly ideal. Reinforcing this ethos was the Bank of England. The work culture and regulatory style of the central bank embodied the values of loyalty, duty, and honor. Working in tandem, this constellation of class, institutions, and culture stressed the sense of collective responsibility toward markets.

The lessons to be learned from this history are to identify the strengths of this gentlemanly financial order that are applicable today. Namely, duty to market is the foundation of a well-functioning market. Only when combined with supervision, regulation, and codes of conduct stressing trust and personal integrity, can systemic failure, fraudulent practices, and rate manipulation be curtailed.

Yet as the growing LIBOR scandal has shown, if a market's culture and the institutions shaping its participants do not embrace and promote values of social responsibility, then the foundations of exchange will always be unstable, prone to manipulation, and even to financial malfeasance.