The British banking scandal reveals—again—just how wrong-headed our assumptions about finance are. Morality and self-interest are hopelessly at odds; add planetary crisis to the picture, and we're "lost," said one former JPMorgan executive I had a chance to interview last month.
Are banksters redeemable? The British rate-rigging scandal has been lying in plain sight. City of London bankers, upper crust, chummy types, were supposed to tell the truth about their own bank’s borrowing power and every day, based on those estimates, the London inter-bank borrowing rate or LIBOR was set. Now that regulators have spoken, it’s come to seem absurd that private bankers were expected to play fair, act responsibly and act in anything other their own self-interest—without oversight. But that’s just how the inter-bank lending rate setting worked.
As one former senior trader close to the scandal put it to The Economist, “There is no reporting of transactions, no one really knows what’s going on in the market…” The implications? “You have this vast overhang of financial instruments that hang their own fixes off a rate that doesn’t actually exist.”
Sans transparency, soaked in incentives, the bankers had every reason to hide their institution’s weaknesses, and that (it turns out), is all too often what they did. Now regulators have woken up, criminal investigations are about to start and Barclays chief Bob Diamond is likely to be only the first, not the last, chief executive hit. But what about the bigger story?
The LIBOR scandal itself will soon shift to courts and public inquiries, boring, complex and long enough for most regular people to lose interest. The bigger morality tale is already slithering down the details-tube.
Before it does, it’s worth seizing the opportunity to ask some bigger questions—like what are bankers for? What are banks for? If banker self-interest conflicts with the public world interest, what regulator on the planet can cope with that?
John Fullerton is a former managing director at JPMorgan. Finance drives economics, he says, and economics largely determines the fate of the planet, yet the resources of the planet are finite. “The notion that exponential growth can go on indefinitely in a finite planet is in violation with arithmetic and basic physics.” As long as growth is the sine qua non of market economic ideology: “We are lost.”
If we don’t redefine self-interest, said Fullerton, in this conversation recorded in New York in late June, “I think we will look back, and our grandchildren will ask us, What were you thinking?”
Today, Fullerton is the founder and director of Capital Institute, whose “Third Millenium Economy” project released a potentially useful report in the run-up to the RIO+20 United Nations Conference on Sustainable Development. You can download “Economics, Finance, Governance and Ethics for the Anthropocene," here.
Watch our conversation, and read the transcript below.
Laura Flanders: Let’s talk quickly about Rio. As we’re meeting, it’s pretty clear that not much came out of what was supposed to be the landmark follow-up to the Earth Summit of twenty years ago. Why so little agreement, why so little progress?
John Fullerton: Well, I think that timing is probably part of it. I think the world has enormous very near-term challenges that are really overwhelming the agenda of the politicians. So from the people I talk to I think the expectations about any breakthrough were very low…
What do you make of the idea coming out of Rio that now is the time to put a value on our natural processes—in order to induce people like you, people in the finance sector and business, to tread more carefully.
The idea comes from the classic neoliberal economics frame which is to say, if we value something we need to put a price on it so that the price of that gets factored into the economic system. Right now we don’t have a price on carbon, for example so we’re free to pollute the atmosphere with as much carbon as we want without paying for it and that’s clearly a problem. This idea of valuing ecosystem services is to take that same idea and apply it to a broad range of ecosystem services.
Such as bee pollination or a healthy water cycle, or such as the cleansing of rivers through natural systems
So you would say, “the work of all those bees is equal to this many million dollars?”
Yes, or what would it cost if we had to artificially pollinate our crops? If we had to breed bees bring them into agricultural zones, which people do and pay beekeepers to do that.
Isn’t this a horrible kind of concession to the idea that everything and everyone on our planet can be commodified and put a price on?
I have real mixed feelings about it. I think on the one hand, it’s taking the price system and saying well, we have externalities—we have things that are not being priced—so let’s internalize them into our economic system. That’s all well and good, but the logical extension of this thinking is that, A, we’ll never know enough to put a price on all these systems. I mean there’s an enormous complexity within natural systems that we don’t even begin to understand much less put a value on them. Secondly, and probably more importantly, by putting a price on these services it implies that we can actually consume them and use them up, and what I’ve been taught by ecologists is that there is no ecosystem services if there is no ecosystem function! What’s important is to preserve the function, which in many cases is actually priceless.
I am much more in favor of an idea of a safe operating space for the human economy, figuring out what are the unbreachable barriers and imposing real hard limits through policy to ensure that we don’t destroy critical ecosystem function which is the foundation of the entire human economy.
Well, this really goes to your personal story in a sense. You were once happily trundling along a very successful career track in the financial world. To start with why did you decide to go into finance? And secondly, why did you decide to leave?
The story of how I got into finance is kind of an interesting one. It was not the classic, boy-goes-to-Wall Street-to-make-fortune kind of story. When I went to Wall Street in 1982 I went to a commercial bank called Morgan Guaranty Trust…. My decision was inspired by a course I took in college. I had been an International Relations major, and the course was called the Economics of International Relations and the thesis was that global finance and economics would determine the course of international relations in the future rather than politics.... That idea turned out to be true, but certainly not in the way I had anticipated. But I went into to banking to really learn about international economics and finance and I had this sort of vague idea that I would get trained in banking and then go work in the World Bank someday and put the knowledge to good use.
And at what point did you say, I got to leave, this is not for me?
Well, it was sort of a long process.… As the business matured and I kind of grew restless to find something more aligned with my initial purpose of going to Wall Street. Frankly, when the merger with Chase Manhattan occurred, I’ll be very candid, my stock options vested. I didn’t have to walk away and leave a lot of equity at the door and the culture had shifted in a way that made me less comfortable working there so I got up one summer and I left with no real plan on what I would do and it was real frightening.
You went on to start a hedge fund. It’s only been recently, watching your career that it seems to me you’ve decided actually, the whole world of finance is on the wrong track. Can you talk about that?
This idea of aligning capital with social purpose really started while I was at Morgan and so I explored that after I left and did what is now called impact investing, investing some of my own funds and working on some projects with other people, particularly focused on the food and water issues. I began to learn a lot about the ecosystem crisis. And it was really only after studying the ecological crisis as a systemic issue that the conclusion of that study kind of led me back first to the economy—the economy is driving this ecosystem crisis and finance drives the economy—so if economy is creating the problem and finance is driving the economy then it sort of led back to finance, and this was before the financial collapse. I would begin to explore these ideas with some of my friends and people would look at me like, you know, you’ve lost your marbles and then the financial collapse happened and then suddenly people didn’t think I was so crazy anymore.
How do you define the crisis? How do you see it now?
The financial crisis, well, I think now it’s in its long gestation period. I think we had this initial eruption back in 2008, 2009. That seemed to have stabilized, but only through unprecedented central bank intervention, so in many ways the system is now on some kind of a support system that is tenuous at best, and of course what’s going on in Europe is nothing but frightening.
And what about the biosphere?
The biosphere has been left out of the conversation, and in many ways what our work at the Capital Institute is about is looking at a different context of our economic challenges. The unfortunate truth I’ve come to believe is that we’ve reached the logical conclusion of this expansionist economic paradigm. This is not a new idea. There are people who have been writing about this for decades, but the notion that exponential growth can go on indefinitely in a finite planet is in violation with arithmetic and basic physics and yet our economic ideology (and I call it an ideology quite intentionally), suggests that there are no limits to growth. And again as a finance person if there are boundaries or limits to growth and investment drives growth, then the implications are that we need to think very differently about how investment flows.
I have spoken with the economist, physicist and environmentalist Vandana Shiva about this and about the need for a new kind of economics in the way that we have developed a new understanding of physics. The two are related. Talk a bit about how we got mired in this Newtonian idea of economics; what that has done to our idea of the role of finance, and finally what might quantum economics look like?
Well, those are hard questions, but you’ve raised an issue that very few people in finance are aware of I would suspect which is that neoliberal economics is grounded in Newtonian Physics.
There’s a great book by Bob Nadeau that explains this but very few people are aware that the early classical economists were really philosophers and trying to equate to the natural laws of physics…Newtonian laws at the time. They believed that there must be equivalent laws that govern the economic sphere; Adam Smith’s “invisible Hand” being the most significant example of that. As the economic profession progressed, that flawed foundation was never really revisited. So when we had the advances in quantum physics, no one in economics said, “Well, wait a second, that means we’ll need to rethink everything about economics.” Where that leaves us is that we’re sort of up in the sky in a very abstract world where mathematics has dominated the economics profession and yet the foundation is really not grounded in anything solid. So we’re lost.
If you think about the way money is invested, the classic modern portfolio theory is an idea that the recent economic collapse has sort of proved to be inadequate.
The central idea of modern portfolio theory is that you can look at historical volatility of securities and divine something about future volatilities of securities, and secondly if you diversify your portfolio you can diversify out most of the idiosyncratic risk.… It says nothing about the systemic risk. So when the financial crisis happened, the correlations of all these different asset classes suddenly approached one: all asset classes dropped at the same time, and it essentially made the premise of modern portfolio theory prove to be wrong in real-life practice, and yet no one has come up with an alternative theory which is forward-looking, that takes on board the ecosystem.
So let’s talk about the irony that you would have the Rio +20 Conference happening in Brazil, with all of the people talking about the future of the planet at the same time the G20 meeting is happening in Mexico, with all of the world leaders talking about economic development If you had been looking for a clear display of how these two things have disconnected, there is one. How do we bring these worlds together and where do you see it happening?
“Holism” was coined by Jan Smuts at the beginning of the twentieth century. Einstein wrote Smuts a letter saying this idea and his idea of relativity would be the two most important ideas that would determine the course of civilization or something to that effect. And the idea of holism is that the whole is greater than the sum of the parts.
Just as you pointed out, we have economics policymakers focused on the financial crisis as if the financial crisis is disconnected from the ecosystem crisis. The solution to the financial crisis and our economic challenges—unemployment and depression—is to spur economic growth, but economic growth, at its root, is the cause of many of the ecosystem crisis.
But economic growth is putting people to work, is creating jobs. That’s all good stuff and that’s what we’re fighting for isn’t it?
We need to figure out a way to create full employment without being dependent on perpetual, material throughput, the growth of material throughput, and that, I believe, is the challenge of the twenty-first century.
That’s not a trivial question and I’m very aware of the challenge of trying to do this without simply trying to get back on the growth-band wagon. When we’re in a depression we certainly need to stimulate growth to get back to some kind of equilibrium.
So some kind of growth that doesn’t involve using stuff?
Very little material throughput is related to technology, to the news media, to programs like this. They generate data. They don’t generate need for iron, cement and steel. So we need to shift the economy for sure to a much more dematerialized economy, and some of this will come through technological innovation, but some of it will come through a realistic assessment of how much is enough, and where we’ll need to be more thrifty with the use of materials.
So, there’s what we’re making, but isn’t there also how it’s being made and the power relations between those doing the making and the economy and that financial world that you talked about that has very different types of goals and agendas than the planet?
Yes, so the premise of finance is compound interest, what Einstein called the most powerful force in the universe. Now compound interest, when that drives perpetual economic growth, is in conflict with the laws of thermodynamics at some point.
Explain what compound interest is in this context.
So compound interest is the idea if I invest my money today, I’ll earn some return. Let’s say I put it in the bank and earn an interest of 3 percent (remember those days when you used to earn interest on bank accounts). Compound interest is the idea at the end of the year if I put in $100 I’ll have $103 and if I invest $103 at the end of next year I’ll have $103 times 3 percent and at the end of the next year. It keeps compounding at 3 percent, and that looks like exponential growth, which is the root problem of the crisis of the biosphere.
We can’t have an economy fueled by exponential growth in money that grows material throughput at an exponential rate. So, to your point, finance is probably the most disconnected or reductionist practice. We segregate risk into simple buckets of risk and manage them separately rather than thinking of them holistically, and we think about risk in finance and financial investments as being the financial risks, the volatility of the financial assets. We don’t pay attention to investment decisions and the feedback loops they generate in the real economy.
If WalMart expands (to put it concretely), that means they pave over a huge area of farm land and generate demand for cheap goods that come from all around the world. That all has an ecological footprint, but the investment [decision] to do that is only measured in terms of its financial consequences.
How do we change it and where do you see initiatives that are hopeful?
Well, certainly one of the really hopeful areas and it’s small and it’s fringe but it’s growing is a field that’s called impact investing and these are investors such as myself that look at the problems in the world and look to create businesses and social enterprises that attack these problems. So the purpose of the investment is actually to address a social or an ecological challenge
You don’t want to make money?
Many of these are for profit models, but the mission is not to optimize the financial return, the mission is to earn inadequate financial return for the risk while optimizing or maximizing the social or environmental impact. And again, this is not the mainstream yet, but it is moving into the mainstream. Firms like Morgan-Stanley do have impact investment funds and there’s a whole long story about how real that is and what the impact is, but it’s a sign of hope, I think.
You talked at the very beginning about power of finance in decision-making. I’m happy to hear that…Morgan Stanley is doing social impact investing. But if they still have the same power in Washington to block regulations of these other areas, what’s changing in terms of power relations?
Nothing yet. I mean there is a mountain if change that needs to occur so that the real flow of capital which is banks, institutional investors is redirected away from this short-term speculative economy and directed into real investment that actually shifts the characteristics or the quality of the economy that we have.
We need capital to flow into sustainable energy and alternative energy and not into highly speculative short-term housing bubbles, which then when they collapse create the tremendous social dysfunction and the need to then stimulate growth in order to recover the unemployment rate!
As painful as the financial collapse has been for so many people it also creates this huge need to regenerate growth in order to get people employed again, which creates more of the ecosystem strain than we can no longer afford. So it has got really a double cost that hasn’t factored in as yet.
How would governance need to change?
Governance is a huge challenge in a now-interdependent global world where many of these ecosystem crises, some of them are local, like the pollution of the river is a local issue, but many of them, most notably, climate change, carbon in the atmosphere is a global problem. We’re not organized globally, we’re actually organized by nation state, and nation states operate in their interests. So we don’t really have a solution to how do we organize in these global issues, and the difficultly of a conference like Rio only shows how challenging this will be.
Elinor Ostrum who recently passed away, did a tremendous amount of work and the won the Nobel Prize for work on governing the commons, and she showed that commons at a local level can be managed locally, and there are lessons from that work that may be able to be applied on a global scale. But it’s probably the trickiest challenge we have.
Look at what is happening in Europe right now. They can’t figure out how to manage holistically in the interest of all of Europe because each nation state has their own interests and their constituency is demanding that they protect their interest. And so you’re seeing the whole European experiment moving closer and closer to a real serious crisis in my judgment because of the inability to get above parochial, national interests. And we have that challenge in managing the ecosystem crisis in spades.
There is a campaign right now for something called the Robin Hood Tax or Financial Transaction Tax. As somebody from the world of finance, are you for it?
I am in favor of the Financial Transaction Tax and I’ve been speaking about it and writing about it now for a couple years, working in particular with IPS in Washington. There’s little progress on this front in the United States. (Our treasury secretary has come out against it without really explaining why.) But there’s a strong interest in a financial transaction tax in Europe and most recently Germany, France, Spain and Italy, the heads of state have all come out in favor of financial transaction tax. There seems to be real momentum moving a so-called coalition of the willing to move forward with this policy even without a consensus.
And this would it impose a small levy on stocks, bonds and derivatives trading?
On the trading, and my reason for favoring it is not because it’s a “Robin Hood” tax, I am actually not a fan of that terminology. It’s because the speculation in the financial markets has exploded to such an extreme that the trading volume has actually destabilized financial markets.
There’s something called high-frequency trading which is the extreme version of this where traders trade by computer thousands of trades per second, which has nothing to do with investing in the real economy, and because of that speculative activity which economists confuse for liquidity and efficiency, it’s actually, in my judgment, very destabilizing, and so by having a very, very modest tax on speculative short-term trading activity, you actually discourage that activity and encourage longer term real investment at the margin while also collecting meaningful tax revenue which honestly we’re desperate to find sources of tax revenue these days.
I consider it almost a no-brainer—I mean, there’s no such thing as a non-brainer tax—all taxes will have consequences some of which we won’t anticipate—but this is a tax that makes total sense given what’s happened in the financial market.
Talk to your colleagues for a minute, John, people coming up in economics training and business schools and have one idea of what their role is and [that role] is to get as big of a return on their money as they can. There’s no difference in investing in something like Instagram that employs eight people and GM that employs 8,000. What’s your message to them about their role in the society in this moment?
Given the importance of how financial capital investment drives the economy and the economy [affects] the social ecosystem with both positive and negative consequences, there’s a tremendous responsibility that goes with how one invests financial capital at this point and time and like never before. I think those who control the significant pools of financial capital have a burden and responsibility to think holistically about the impact of those investment decisions beyond the financial return.
Just for their own conscience and karma?
Among other reasons, yeah. I think we will look back and our grandchildren will ask us, “What were we thinking when you were investing in some high-frequency trading thing, when you knew that we needed to shift the entire energy system of the planet off of coal and into alternative energy? What were you thinking?”
So redefine self-interest?
Yes, you redefine self-interest and you can actually think beyond self and understand that we’re all connected and that my self-interest is the common interest, and we are in the process of shifting from a total self oriented, individualistic culture to one that by necessity will understand that we’re all connected and that we’re all in this boat together.
Let’s hope so. John Fullerton, thanks so much.