How to Fix Wall Street
Regulation Alone Can’t Right the Financial System
"I'm making this decision on principle, just to see how it feels."
©The New Yorker Collection 2003 Leo Cullum from Cartoonbank.com. All Rights Reserved.
Another bubble is brewing. Only this time it is a regulation bubble. As agencies and officials vie with one another to impose ever more stringent rules and oversight, they are driving up reliance on regulation far beyond anything that is rationally sustainable and, in the process, generating new risks. If we truly want to prevent another financial crisis, we need a corrective action plan that addresses problems at all levels of the system, including a renewed commitment to responsible behavior by those individuals and (surviving) firms whose actions created excessive risk in the first place.
The crisis is often discussed as purely a technical mishap involving housing prices, complex financial instruments, risk modeling, and monetary policy. But it is also a story of easy money and lazy ethics. Garden- variety offenses such as misleading sales practices were apparently rampant. Perhaps most troubling from an ethical point of view was the seemingly careless, if not reckless, decision- making in the upper echelons of many financial organizations.
Admittedly, good judgment and sound decision-making are not typically thought of in ethical terms. In a free society, individuals are at liberty to make thoughtless, uninformed, and even self-destructive decisions so long as they do not injure others, and we should be cautious about turning honest mistakes into ethical failures. But when people are acting as fiduciaries or when their decisions affect the lives and well-being of millions of people around the globe, reckless judgment becomes a matter of public concern and negligent decision-making, a breach of public trust.
Any plan to restore confidence in the financial sector and prevent a repeat of past mistakes must address the leadership and organizational failures that led to shoddy ethics and careless judgment in so many firms. While external regulation can discourage certain well-defined types of bad behavior, it cannot ensure good behavior. Nor can it guarantee the good judgment and sound decision-making that we so desperately need from today’s financial and other business institutions.
For that, we need business leaders who are committed to building companies that meet the three-part test of economic, legal, and ethical performance. The first step should be a rigorous, top-to-bottom review of the firm’s decision-making and management with a special focus on its pay systems, information flows, control functions, and governing beliefs. As my research has shown, poor decisions and breakdowns in corporate responsibility can often be traced to one or more of these factors. Above all, the review should ensure that decision-makers throughout the company are guided by an ethical framework that recognizes their obligations to the firm’s constituencies.
When financial sector executives met with President Obama last spring, they called for an end to the anti– Wall Street rhetoric coming from Washington. In the absence of a sincere recommitment to self-governance and organizational responsibility, the rhetoric is unlikely to abate. A visible show of leadership that goes to the fundamental values driving the nation’s financial firms would help restore public confidence in the sector and move us closer to an effective program for preventing another crisis. But, so far, nary a tweet.
— HBS professor Lynn Paine chairs the MBA Program’s Leadership and Corporate Accountability group.
