Investors, bankers, regulators: who is responsible for the financial crisis? The Financial Crisis Inquiry Commission (http://fcic.law.stanford.edu/report) underestimated the role of investors and focused too much on 'financial institutions' and 'regulators.' The commission's minority, or 'dissenting,' report only partially resolved the imbalance as it blamed investors for creating a 'credit bubble' which made their role seem transient. In reality, the behavior of investors is the long-run driving force behind the financial crisis and financial markets.
It is investors' money that financial institutions manage, and it's investors' demand for a rate of return on capital that is the source of, now discredited, 'financial innovation,' including mortgage-backed securities. The mentality that characterizes investors is purely monetary, or 'capitalist,' and because the financial services industry acts as their agents, investors become detached from real business issues such as quality of product and service. This detached mentality is also connected with their inability to judge risk. Low wages across the globe have helped investors accumulate wealth, and if an investor has $100 billion, a $10 billion investment does not seem such a big risk. The FCIC blamed reckless risk taking on financial institutions, but the root of it is investors and their need for returns.
Focusing too much on banking and financial institutions is not limited to FCIC. Charles Ferguson's award winning documentary Inside Job (2010) blamed financial institutions for buying off business school economists. Ferguson is right to highlight business school failings, but wrong to blame financial institutions. The process of shaping economic ideas in ways that are congruent with the accumulation of capital has a long history. Professor Rob Bryer of The University of Warwick traces the process back to Irving Fisher who developed the concept behind modern financial theory, the 'time value of money.' The years between 1880 and 1930 were characterized by labor unrest in the U.S. William Jennings Bryan, a presidential candidate, declared: "You shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold." Irving Fisher developed a theory of interest and profits calculated to calm the situation by presenting a picture of economic harmony. Recent efforts made by the banking sector to buy off economists look relatively minor when viewed historically. The independence of business schools is important, and they should strive for a high level of professional detachment, but the finance industry alone is not the cause of the problem. The root of the matter is the powerful economic interests of investors.
Modern economics has become an ideological tool, seeming to promote the free market and economic opportunity, but doing so in ways that actually perpetuate wealth and privilege. Economists' focus on 'utility' and 'time value of money' generates a partial and inadequate understanding of economic reality, clouding the balance between cooperation and conflict that exists in all societies. As Naomi Klein has shown (The Shock Doctrine), ideologues and zealots pursue extreme policies when the natural counterbalancing fabric of society is temporarily damaged. Appreciating the depth and the historical roots of the ideological tendency in economics and society makes it easier to comprehend how governments are brought within the sway of investors. Here again, Inside Job tends to overemphasize the role of financial institutions in corrupting politicians and regulators.
Although economists' ideologies divert attention from social processes, events such as the financial crisis reveal the true picture. Prosperity and inequality have increased the importance of investors and their ideologies have, to an extent, permeated society, but the tide is turning. Managers and knowledge workers realize that value creation is not purely monetary but depends on quality of product. Economists' theories are retreating and new ideas like political economy interpret the 'free market' in its social context. Politicians can see the damage done to businesses and communities and they are looking for ways to rebuild. Consumers can see the limits of borrowing and are putting their personal finances back on a sustainable footing. Investors can see the danger that their elaborate veil of secrecy may be slipping.
It is not just Wall Street that needs to be occupied and reformed, but Main Street, and the process is already underway in finance, retailing, manufacturing, education and politics. Perhaps this is the time for business schools to step forward and take a radical lead. Managers have the powerful combination of technical knowledge and commercial experience and business schools can help shape a new breed of manager that understands business in its social context and uses this perspective to shape sustainable, ethical and long term business growth.
The Morning Email helps you start your workday with everything you need to know: breaking news, entertainment and a dash of fun. Learn more