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The Culture of Finance--Why Financial Innovation Failed

Posted by: Bruce Nussbaum on January 13, 2010

The Financial Crisis Inquiry Commission is meeting today in Washington to hold hearings on the recent financial crisis and economic meltdown. The Commission will ask Wall Street’s top brass—Lloyd Blankfein of Goldman Sachs, Jamie Dimon of JP MorganChase, John Mack of Morgan Stanley and Brian Moynihan of Bank of America—questions about what went wrong. What the Commission really needs to do is ask what is wrong with Wall Street’s entire culture of finance. The populist rage, from both left and right, at Wall Street is not due to specific actions taken by banks and bankers but at the rise of a speculative, short-term, transactional, culture that rewards individuals with enormous bonuses. This trading culture, over the past 15 years, has replaced a different financial culture which was relational, focussed on the long-term, investment, and, most importantly, aimed at economic growth for many stakeholders—corporations, employees, and the nation as a whole.

The goal of the Commission, and of Congress, should be to replace Wall
Street’s short-term, transactional, trading culture of finance with a long-term, relational, investment culture. This isn’t difficult. In fact, the US did just this after the Great Depression, when traditional banking was separated from speculative trading by the Glass Steagall Act of 1932. Under the Clinton Administration, proponents of efficient market theory combined with heavy bank lobbied successfully to repeal

Glass Steagall. Paul Volcket, ex-Federal Reserve Chief, argues that Glass Steagall should be restored. Volcker is right. The social goal of finance (yes, there is a socio-cultural goal for finance) is long-term investment and economic growth.

A second step Congress should take is to end the financial incentives for transactional speculation. Culture is defined, in many ways, by the rewards bestowed on behavior. Change the rewards, the behavior changes. Washington has created a Wall Street reward system based on the principle of "Too Big To Fail." No matter what mistakes bankers make--and they clearly made horrendous mistakes over the past decade--taxpayers will always rescue the biggest banks from the consequences of their actions. This incentive for speculation should end.

Another major step in changing the dominant culture of financial speculation would be to end quarterly profit announcements. This Wall Street practice is a device that reinforces the culture of transaction and rewards trading, not investment. Regulators should require annual profit announcements. It is that simple.

Finally, the Commission should examine ways of changing incentives for financial innovation. Innovation has been given a black eye because of the debacle in finance. Virtually all financial innovation in the past two decades has involved slicing and dicing transparent, long-term investments, especially mortgages, into opaque, short-term trading vehicles to better suit the needs of a speculative financial culture. At the very least all financial vehicles, including CDOs, need to be traded on open markets so they can be properly valued.

But, more importantly, new forms of financial innovation are needed that are directly at people and the economy, not bankers and speculation. For example, Yale professor Robert Shiller has long proposed home equity insurance. Had it been available, much of the housing crash might have been avoided.

The financial innovation of recent years reinforced the culture of financial speculation now dominant on Wall Street. The Financial Crisis Inquiry Commission should focus on reforming this culture and returning Wall Street to a culture of long-term investment and economic growth.

Reader Comments

Mark Montgomery

January 14, 2010 7:51 PM

As long as mega banks can act as hedge funds, even if not insured by the U.S. citizens through incompetent regulators, capitalism cannot function properly.

In essence the mega banks have become global market manipulators, not federally insured market farmers who should be creating sustainable economics.

Their interests are in fact directly conflicting with that of the U.S., as are increasingly global companies who look for profits particularly in corrupt markets with large populations for growth.

What we are experiencing is something few understand -- it's more similar to a global socialized oligarchy than market based economics or government dominated socialism like that found in Scandinavia. It more closely approximates the old U.S.S.R. than what our Found Fathers envisioned, or the intent of the Constitution.

If and when the government to include Congress wants to get serious, we've already shared the solution with CIOs, the WH, and senior members of the Senate and House.

Kyield has the capacity to hardwire accountability, prevent systemic crises by automating and auditing red flagging-- tying to credible sources previously suppressed-- internally and externally.

The system also has the capacity to align interests -- including compensation schemes, with long-term metrics rather than short-term get-rich-retire-to-another country schemes.

We better get serious folks -- the U.S. is already showing signs of bubble making in the stock market, with official help -- many of us who were very accurate in forecasting previous crises don't believe the U.S. can survive another. Which brings up the question -- is that the intent?

It increasingly appears so based on actions alone.

Steve Portigal

January 14, 2010 8:20 PM

Maybe slightly meta, but I feel like it's not even a question that there is a significant cultural aspect to these issues (as per the subject line of this post). I have this feeling that in the past, the only ones who would have been pointing out the cultural factors would be the social scientists. But culture is - thankfully - part of mainstream business thinking about groups, decisions, systems, etc. Hurray!

Gong Szeto

January 15, 2010 5:46 AM

as long as there is a buyer, there will be a seller. as long as this is true, i am not sure how much can be reformed.

any reform that you describe will require government intervention of the galactic-sized cajones variety. i do not see this evident in the current administration. is there a grassroots movement afoot strong enough, no, smart enough to outsmart the financial oligarchy? nowhere.

lastly, wall street serves investors. do investors want anything resembling what you are asking for? if they do, i have not read about it.

i wish what you are advocating could be realized. apologies in advance for being pessimistic, but the single-celled creatures that make up wall street are actually in an enviable position. they have a very simple "program" - make as much money as possible. there is no argument or ambiguity. no crisis of conscience or confidence for that matter.

the same cannot be said for government. what is the purpose of government? the same cannot be said for society. what is the purpose of society? here there is much debate. wall street does not suffer from this.

you imply that wall street should serve the interests of society (long term investment, economic growth). i would argue that their version is the inverse of your wish - that government (lack of oversight) and society (liquidity, our money) serves the interests of wall street. this is not about trading culture at all (they are the simplest of the single-celled organisms) - it is about this colossal inversion of moral priorities.

lastly, financial innovation did not fail. worked like a charm. for wall street.

the culture of speculation can be found everywhere, not just wall street. blackjack, bingo, lottery,'s embedded in our culture. our culture that worships at the altar of the me-win.

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