The CEO of Barclays recently acknowledged the damage to the firm as a result of its transgressions and said: “Trust is a very easy thing to lose, and a very hard thing to win back. In my view it will take several years – probably five to ten – to rebuild trust in Barclays.”
Meanwhile, J.P. Morgan has been on a treadmill of settlements, resulting in tens of billions of dollars of costs to the firm (or, if you will, to its shareholders). Once viewed as having skated through the financial crisis relatively unscathed, its reputation has been tarnished by subsequent revelations.
The list could go on but, given the performance of bank stocks over the last few years, you might ask, “Who cares?” Many observers have come to the belief that the firms are specifically in the business of stepping over the legal and regulatory lines – and that fines and damaged reputations are just a cost of doing business for them.
Surveys show that trust “in the financial system” has collapsed over time. But that “system” is very complex and involves a wide range of firms and professionals. Those in research and asset management, for example, might feel that they have been tarred unfairly with the same brush as the banks. But we are all in this together.
The natural governors on the investment banks are the large asset management firms. But they have been missing in action – in fact, they tend to exacerbate destructive trends rather than impede them. Consider the subprime mess. Had there been a buyers’ strike when underwriting standards deteriorated, we wouldn’t have had much of a crisis. An absence of buyers would have meant that the paper-making machines would have shut down well before reaching the level of insanity that was attained.
But that didn’t happen. Largely that is because the investment business runs on relative performance and career risk trumps investment risk in decision making. Therefore, the excesses don’t get trimmed, they get enhanced, as everyone chases what’s working and money that comes in the door gets invested almost without regard to long-term opportunity.
You could argue that just as the investment banks won’t change what they do without pressure from the asset management firms, the asset management firms won’t change what they do without pressure from asset owners, specifically the biggest institutional investors. But that pressure is lacking too, because the same relative performance (and therefore relative behavior) yardstick is used, at least until the next calamity.
Breaking these cycles is one of the most daunting problems facing the investment profession. The CFA Institute’s Future of Finance initiative includes a number of important facets and it should be commended for stepping forth and trying to improve the standing of the industry and the profession. But it needs to engage and mobilize the large asset owners and asset managers that wield the economic power in the markets. Investment professionals need to step up too. If we don’t, we are doomed to keep dancing the proverbial dance.
In response to the recovery in the markets, individual investors have gotten more bold and money is flowing into asset classes that are deemed to be riskier. Let’s pause and imagine that some unforeseen event causes another sharp pullback, the third in fourteen years. What would that do to the already-low levels of trust in the financial industry?
The truth is that other than some new regulations for the investment banks, not much has changed since the crisis in terms of how the business works. Another sharp blow to the markets would only enhance the belief that the industry has a culture of speculation and that it’s an inside game where those taking the fees win and those with the assets lose.
Rebuilding trust in the financial system is not the regulators’ job or the banks’ job, it’s our job. We best get started.