We currently find ourselves in the middle of a financial meltdown unparalleled since the Great Depression. The extent of the crisis and the fear of further losses are prompting dramatic policy reversals. Only a few weeks ago, the Treasury made clear its opposition to bailouts, and its willingness to let Lehman Brothers fail as a signal that the financial system was fundamentally robust and could stand a severe shock. The failure of Lehman set off a train of unanticipated events, however, and a big rescue of the giant insurer AIG was needed. Shortly thereafter, a massive $700 billion program was established to take bad assets off the balance sheets of banks, but that proved to be totally inadequate in stemming what has become a global panic.
Crises are frequently an opportunity for making dramatic policy shifts. The urgency of the situation means that debates and discussions get cut short, and that we settle for stopgap measures. This is unfortunate, for crises should be an opportunity for a more profound reflection on why and where we went wrong.
What is the best way of thinking about a financial meltdown? Finance involves a dense network of contracts—legally enforced promises. But the problem is that it is often in the self-interest of some of the participants to renege on the contracts. Big bailouts encourage people to think about the possibility of getting out of the promises they have made without suffering the consequences. That is why no one likes them—until, that is, it becomes clear that too many people have made too many promises that they simply cannot fulfill. At that moment, we hope that someone else will take on all the responsibilities. In modern times, we expect the government to appear like the rescuing cavalry at the end of an old Western.
The current debate has become crudely polarized between a dwindling minority who see markets working efficiently and justly, and those who think that the correct response to market failure is an expansion of state regulation and control. By now the former group includes almost no one. The complex pyramid of financial intermediation appears to be discredited and almost universally execrated, not just by the usual suspects, moralists and Anglican church leaders, the French President or the German Finance Minister, but also by the American political mainstream. In the United States, traditionally the home of free market capitalism, both the presidential candidates and their vice-presidential nominees have made ”greed” on Wall Street the central culprit.
It is common to observe a pendulum swing between the market and the state: with a strong orientation toward the market in the nineteenth century, and then reactions against it in the anti-trust Progressive Era and during the New Deal. After the 1970s, the pendulum began to swing in the opposite direction, towards deregulation and liberalization. The apparent disappearance of national frontiers as a barrier to transactions (the phenomenon often described as globalization) returned the world to an appreciation of the relative virtues of the market and of regulation not seen since the nineteenth century.
A longer term look would ask: Is there anything before this nineteenth and twentieth century—and now twenty-first century—oscillation between the state and the market? Anything that might help us sort out our current dilemmas?
Indeed there is, and we need not pose the dilemma as one between markets and states, for there exists a long tradition emphasizing the importance of ethics in the conduct of a business life that is both efficient and just. Its most sophisticated exposition occurred in Thomist elaborations of Aristotelian ethics. Eighteenth century Enlightenment thinkers also made ethical conduct a central feature of their political economy. These traditions did not supply simply utilitarian reasons for behaving ethically, but they did emphasize that ethical behavior brings many benefits, and that an unethical society is dissatisfied and destructive.
The Conditions of Trust
By the beginning of the twenty-first century, however, these older approaches became largely extinct. Instead, new sorts of institutional answers—legal and corporate—had evolved to address the type of questions once addressed by the ethical tradition. The older tradition is not useless, and we would do well to reconsider its merits.
In the first place, a strong ethical framework answered a critical and quite practical question that is central to the operation of a market economy and in particular of financial markets: How can I trust the person with whom I am conducting a business transaction? In the Aristotelian tradition, businesses developed simply as an extension of the household, the oikos, and the kind of trust that was required for business dealings developed simply as an extension of personal honesty and reputation. There was no distinction between personal and business behavior.
Markets depend on promises about future conduct that clearly may be broken when circumstances are not conducive to the keeping of the promise—and so they entail risk. If the contract is one that is often repeated, between partners who know each other, there is an obvious self-interest involved in not reneging on it. But such immediate self-interest does not exist in the case of once-only transactions, especially if the business partner is separated by a long geographic distance—then there is a multiplication of the incentives to cheat. On these grounds, Aristotle was skeptical about the possibilities of long-distance trade, which he thought provided temptations for immorality and abuse. Later, in the Enlightenment, a highly influential school of thought developed according to which commerce was the originator of a civilizing impulse. This tradition tended to celebrate local commerce, which brought people into regular contact and thus educated them. At the same time, it tended to disparage commercial contacts with very different types of people, who lived a long way away, and which were necessarily much more occasional. The market was far from an abstraction, but rather a daily education in civics.
In the course of modern economic development, the traditional approaches were overtaken by a new view which appeared to hold out the possibility of faster economic growth. Two features offered a new stability for the network of promises. First, the regulation of business conduct through legislation emanating from states which had a new kind of legitimacy founded on popular sovereignty took the world away from the rapacious sovereigns of early modern Europe. Secondly, and equally transformative, was the growth of the modern notion of a business corporation which could internalize its ethical problems, and could appear to be fully rational.
These developments brought an answer to the problem of trust that did not depend on personal honesty. It was institutional innovation rather than personal behavior that allowed the establishment of relations based on confidence over a long distance. In consequence, business conduct was separated from personal conduct and so judged by different measures. Different spheres of human activity carried expectations of different behavior or even multiple personalities. A business man would be calculating and aggressive in his firm, and warm and emotional with his family at home. (This was a contrast to an old world, in which there was often no physical separation between home and work, and in which—incidentally—women played a much more prominent role.)
The primary cause of a new confidence about business dealings came from changes in the legal environment. It was the law rather than an advanced ethical sensitivity that provided a shared backdrop that made for a newly enhanced sense of security in commercial transactions and allowed for an explosion of economic activity. An influential interpretation (”law and economics”) of British and American development sees in the common law a legal form that made these societies uniquely and unprecedentedly successful.
Almost every modern interpretation of the preconditions for successful economic development emphasizes the importance of the effective enforcement of property rights. States should refrain from destroying expectations of stability by simple expropriation, or by monetary experimentation. Where, by contrast, there is no legal security or the legitimacy and dependability of the political system is eroded by widespread corruption, potential entrepreneurs will have no faith that their property rights will be respected, and in consequence they will hold off from entrepreneurial activity.
The Corporate Person
A further critical historical shift that facilitated the development of the modern economy involved an extension of the notion of who should do the contracting. The introduction of the modern limited liability joint stock corporation made possible a much broader range of contracts: with the providers of finance (thus solving a finance issue that had previously restrained economic development); with suppliers and customers; and with workers. Though there were corporations in medieval and early modern Europe, they were highly restricted in what they might do.
Companies acquired a legal personality and could be held accountable for their actions. When a company does something wrong, it—rather than the individuals who made the error—is responsible for the consequences of the decision. But the notion of a firm as analogous to a natural person soon extended into many different areas. At the same time, new techniques of branding helped to give the impression that there also existed a corporate personality, a corporate culture, and a corporate social role. Companies began to think that they needed corporate biographies that told the story of how their structure and image molded the personalities of their employees. A strong corporate culture was widely thought to be important in motivating employees as well as customers.
In the twentieth century, the corporate image played a central role in the creation of consumer culture. Companies that dealt with large numbers of customers particularly needed to cultivate an image that was personal, either by the adoption of an animal or human emblem, such as the Exxon tiger, or by naming the firm after a real or fictitious person. To take some of the best known retailers in the modern United States, Martha Stewart is a real person (with real regulatory problems) while Ann Taylor is a fictitious person. Even if the firm was not named after its chief executive, the celebratory CEO became in the last quarter of the twentieth century, especially in the United States, an easy path to establishing a corporate identity. The path was pioneered by Lee Iacocca’s charismatic use of his own personality to rebrand the staid image of Chrysler. Especially by the 1990s, CEOs such as General Electric’s Jack Welch or Hewlett Packard’s Carla Fiorina became a standard part of the new American way of doing business.
The corporation became a way of splitting up and repackaging responsibilities, in the same way that investment banks and their Structured Investment Vehicles became ways of re-bundling assets. In consequence, in part because of legal and regulatory issues of corporate responsibility, and in part as an extension of a motivational and marketing device, the analysis of behavior and personality moved from the individual level to that of the corporation. The analysts of this development often used medical and psychological language: companies as well as individuals could be healthy or sick, complacent or neurotic or even psychotic. If the company was a real personality, put together by skilful PR strategists, then the individuals working in the company did not need to behave like real or ethical people. In a flattened business structure, where the corporation cannot be effectively controlled hierarchically, the individual personality matters much more. The individual is a whole person, whose activities cannot easily be segregated into public (business) and private.
The need for trustworthy individuals is even more acute in a technological age. For industries where a quick pace of technical change and globalization make governmental regulation ineffective, the differences between systems of values and cultural norms become much more apparent. We have lost the idea of a common culture and a common morality. In consequence, there is an even greater need for ways of guiding individual behavior so that it is trustworthy and constructive, but the intensity of the new demand overstrains those mechanisms, the government and the corporation, that are supposed to provide it.
The problem of trust cannot simply be unloaded onto governments and regulatory agencies, which are in no position to grasp the complexities of the problems they are required to solve. It is in these circumstances that a much older tradition has a crucial part to play in a quickly changing and very modern world, and in holding together a world that seems to be rapidly coming apart.