The Puritan Gift

In many respects, the global financial crisis was regarded as a crisis of morality. It now appears to be morphing into a fully-fledged eurozone banking crisis. By way of solutions, we need better bankers, better central bankers (or perhaps none at all) − and better politicians. 

“The duration of the slump may be much more prolonged than most people are expecting and much will be changed both in our ideas and in our methods before we emerge. Not, of course, the duration of the acute phase of the slump, but that of the long, dragging conditions of semi-slump, or at least sub-normal prosperity, which may be expected to succeed the acute phase.”

– The economist John Maynard Keynes, writing in 1931.

Much as I dislike given Keynes credit for anything, in this case, he happens to have been right about the global financial crisis, more than 70 years before it happened. Or, as the economists Rogoff and Reinhart put it, financial crises are long-drawn-out affairs and their aftermath tends to linger dangerously, for years rather than months. With roughly $15 trillion of government debt around the world now trading on a negative yield, and with deposit rates at zero or negative across the eurozone, the “new normal” increasingly feels like a 1930s-style “distinctly unnatural”.

Facing significant, but as yet somewhat intangible financial crisis, human nature is not helpful. We can only stand so much grief, and then after a sufficient period, sunny optimism kicks in, whatever the objective reality. And let’s not forget that for many equity investors, especially in the US markets, there has been no crisis since 2009 – rather, one of the longest bull runs in history. Another problem facing the modern investor above and beyond the groupthink inspired by effortlessly rising markets is the mob-like status of modern communications. The internet has given a voice to millions with nothing to say. Finding meaningful and relevant (investible) signals within the relentless barrage of noise is an ever-growing challenge.

This would seem to be the case as regards the ever-expanding sovereign-debt crisis. Most governments are, to a greater or lesser extent, functionally bankrupt. And yet bond investors are rushing to lend them more money at those negative rates. The only way to account for this seeming madness is to look at it through the prism of a crisis in money. As the financial analyst and historian Russell Napier points out, government bonds even on negative yields (eg those issued by Germany) make sense if the alternative is negative-yielding bank deposits that also leave you exposed as a creditor to those same banks, but without any hope of a positive nominal return for incurring that risk. This problem has been exacerbated by the EU’s introduction of the BRRD, (the Bank Resolution and Recovery Directive), in 2014. This time round, if you are unlucky or unwise enough to be exposed as a depositor to an insolvent EU commercial bank, they don’t get bailed out – you get bailed in. The ghoulishly inclined can see the recent history of Cypriot and Portuguese banking for further details.

How did we get into this extraordinary mess? As I argue in my book Investing Through the Looking Glass, just about everybody played a part, but I would single out bank executives, politicians and central bankers for special credit in the debacle. Bank executives horribly mismanaged their businesses, but rather than have those businesses painfully restructured and lose their jobs in the process, they pleaded innocence and got politicians and central bankers to bail them out instead. Central bankers then ran with the ball in a game that politicians professed to ignore (namely fiscal stimulus, as opposed to wild monetary experimentation), and brought interest rates to where they sit today. The free market essentially got mugged, twice.

We can use a more delicate phrase than an outright mugging, namely ’market failure’, which puts in an appearance in Yale University Endowment chief investment officer David Swensen’s excellent guide for individual investors, Unconventional Success. The title is an allusion to Keynes’famous observation that fund managers, courtesy of endemic groupthink, tend to prefer (and to deliver) conventional failure over unconventional success. Swensen himself is famous for steering the Yale endowment through many years of impressive investment returns. He uses the term ’market failure’ in the context of a managed fund industry that involves the interaction between sophisticated, profit-seeking providers of financial services and naive, return-seeking consumers of investment products. The drive for profits by Wall Street and the mutual fund industry overwhelms the concept of fiduciary responsibility, leading to an all too predictable outcome: except in an inconsequential number of cases where individuals succeed through unusual skill or unreliable luck, the powerful financial-services industry exploits vulnerable individual investors. According to Swensen:

“The ownership structure of a fund management company plays a role in determining the likelihood of investor success. Mutual fund investors face the greatest challenge with investment management companies that provide returns to public shareholders or that funnel profits to a corporate parent – situations that place the conflict between profit generation and fiduciary responsibility in high relief. When a funds management subsidiary reports to a multiline financial services company, the scope for abuse of investor capital broadens dramatically. In contrast, private for-profit investment management organizations enjoy the option of playing the role of a benevolent capitalist, mitigating the drive for profits with concern for investor returns.”

The financial crisis of 2007 to date as yet unknown has taken the role of investment banks to new levels of surrealism, quite beyond the realm of satire. Not content with ripping off clients, banks −not limited in the scope of their operations to pure investment banking −have now shown themselves quite adept at ripping  off taxpayers too. If deficit exists, it is not in free market terms, because as we have seen, no such free market exists. The deficit is rather a political and regulatory one. It has taken 10 years or so for the waves of popular anger at the banking bailouts to wash onto the shore of popular opinion, but they have now finally landed. Brexit and the election of Donald Trump are just two of the belated consequences to date.


The remedy would be to return to the sort of managerial culture cited in the Hopper brothers’ magisterial study of the American economic golden age, The Puritan Gift (I.B. Tauris & Co, 2009). Such a return would largely banish consultants and supposed experts from the body politic and corporate, and reintroduce the concept of personal responsibility. The Hopper brothers’Principle Seven for good corporate practice states unequivocally: one man, one boss −no sheltering amongst multiple co-heads and amongst collective (lack of) responsibility.

In The Puritan Gift, the Hopper brothers also identify the proximate cause for the crisis as:

“…an excess of borrowing by government, businesses and individuals.. Increasingly, reckless lending and borrowing – two sides of the same coin – have characterized most aspects of American [and western] society for the last thirty years…

This abuse of credit across the whole of society coincided with, and could not have occurred without, a deterioration in corporate culture occurring in the last third of the 20th century. In the ‘golden age of management (1920 – 1970), executives had learned the craft of management ’on the job’ from more senior colleagues. As they progressed up the ladder of promotion, they would also absorb “domain knowledge” about the activity for which they were responsible – to borrow a term favoured by Jeff Immelt, [the now discredited] chairman and chief executive of General Electric. Starting in the late 1960s, however, a new concept appeared on the corporate scene: that management was a profession like medicine, dentistry or the law, which people were ’licensed’ to practise at the highest level if they had studied the subject in an academic setting. Business-school graduates and accountants started the trend; others would follow in their footsteps.”

Whether considering the managers of listed businesses or the managers of discretionary funds, investors should be well served by identifying those conforming to a moral as opposed to a purely self-interested approach. Decent moral behaviour is to a degree subjective, but to paraphrase what Justice Potter Stewart famously said of pornography, we know it when we see it. Reforming banking- sector pay will only be the start of an overdue cleansing of the Augean stables. When banks compete properly for business and run the risk of genuine failure in so doing, the market will be on its way to being fixed. But as things stand, banks in collusion with central banks are distorting the term structure of debt markets (and through inflationism, all other asset markets too) and giving investors a delusional sense of safety with regard to sovereign bonds.

Both financial signals and financial signalling are all wrong. When monetary-policy rates and supposedly market-led interest rates are as low as they currently are it is not a sign of confidence, but a reflection of absolute terror on the part of the crippled institutions that have been buying them in preference to any form of more constructive lending. It is a moot point as to whether the next financial crisis is now upon us, in the form of imminent financial failures by eurozone banks and German insurers and pension funds. I would argue, rather, that the last financial crisis was never resolved in the first place.