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The ethical dimensions of the financial crisis and rationality – by Ricardo Crespo and Irene van Staveren

The meaning of the term “crisis” in the economic literature is not without ambiguity. As a general feature, macroeconomic crises are events marked by “broken promises” that shatter the expectations that many agents had entertained about their economic prospects and wealth positions. The large change in the economic (and possibly also, social and political) environment naturally leads to reappraisals of the views of the world upon which agents had based their expectations, plans and decisions, and to a reconsideration of theories and models on the part of analysts. Crises are “memorable” events with potentially long-lasting consequences on attitudes and beliefs. They require a reinterpretation of past experiences and a re-statement of propositions concerning the way in which the relevant systems are assumed to work.

                Concern for the study and the understanding of crises is actually older than macroeconomics as an established discipline and it has operated historically as a strong motivation to investigate in the field. Modern macroeconomic theory, on its side, has increasingly become committed to a set of analytical and procedural presumptions, which lead to look for representations of macroeconomic behavior as the result of well coordinated (except for some noise which acts as an additional constraint) optimal decisions of agents, equipped with rational expectations, that is with knowledge of the probability distributions relevant for their plans. These research criteria, sometimes elevated to the rank of methodological prescriptions, can be seen as the outcome of past debates on the theory of macroeconomic fluctuations and inflation, which generated dissatisfaction with earlier theories. At the same time, their application to the study of crises, as if they could claim a universal range of validity, has been subject to paradoxes and problems in the interpretation of salient facts, which seem to call for new searches. The crisis has been the acid proof leading to discard these theories. If the expectations were rational we would not have had a crisis. Then, the analysts begin to discern other kinds of reasons embedded in the process:

                (i) An excessive liberalization of the banking rules and the financial sector regulation (lower capital requirements, no limits to joint ventures and mergers and acquisitions leading to banks with extremely large assets on their balance sheets) facilitate irresponsible loans, mortgages and investments.

                (ii) The Central Banks’ controls fail, partly due to lack of knowledge of new financial products (securities), partly due to limited international cooperation, and partly due to too close connections with banks.

(iii) The provision of wrong incentives through disproportionately high bonuses to bankers, traders and managers of the financial sector based on short run profits, ignoring high risk and long run viability of financial institutions, clients, and whole economies; as well as through golden handshakes even in cases of bad performance.

                (iv) The moral hazard role of government which tends to save big banks and firms because they are too big to let them fall: bankers and entrepreneurs know this and they therefore take excessive risks.

                (v) Technical problems such as difficulties in understanding the technicalities of mortgages operations, or systems of financial evaluations.

                (vi) A tendency to hide risky positions in the accounting proceedings. This, for example, was the case for Lehman Brothers, which was factually bankrupt half a year before its fall, thanks to accounting tricks.

                (vii) Failing rating agencies that provided too rosy assessments of banks.

                (viii) A monetary and fiscal policy that foster consumerism through low interest rates and taxes, in particular for the rich. For some analysts the monetary excess is the main cause of the crisis, leading to over-liquidity, while others emphasize how more inequality in income distribution was driving the over-liquidity.

                This list entails reasons that are beyond narrow economic rationality: within them we can find psychological, sociological and moral reasons. According to Max Weber’s classical classification, we can distinguish four types of rationalities guiding social actions: instrumental, value-rational, affective and traditional. Instrumentally rational is the action aiming at allocating means for the attainment of the actor’s ends. When this allocation is the best possible we have a specific kind of it: maximizing instrumental rationality. Value-rational actions are determined by conscious beliefs in the intrinsic value of some behaviour: they follow moral criteria. Affective are the actions guided by the actor’s affects and feelings, i.e., psychological springs. Traditional actions are determined by ingrained habituation, by mainly sociological reasons. Economic rationality is an instrumental maximizing rationality. However, Weber argued that, although one specific form of rationality might prevail in a specific action, rather all human actions are oriented by various types of rationality. This is thus the case of economic actions and instrumental maximizing rationality: this rationality prevails in economic events, but it often goes jointly with other forms of rationality. As all social phenomena, economic phenomena are complex and we may analyze them from all four Weber’s perspectives of rationality: instrumental, moral, psychological, and sociological.

                We can detect the presence of these rationalities in phenomena by the ordinary discourse used to describe them. Descriptions are rarely pure descriptions. They frequently bear connotations going beyond mere description. We can find some of these connotations in the list of reasons for the crisis. Although we are not able to evaluate the exact impact of the moral aspects of the crisis it seems that many moral terms are intermingled in the list.

                In effect, the list includes terms with moral resonances. For example, “to hide risky situations”, “excessive liberalization”, “extremely high bonuses”, “irresponsible loans.”” failing control”,  “wrong incentives” , “moral hazard”, “too rosy assessments” and “consumerism” add  qualifications to the economic facts including but also going beyond economic analysis.  It was remarked that during the crisis, we had cases of fraud or greed; but most often, we have had laziness, a tendency to close the eyes when performing risky actions and to irresponsibly go on without reflection when something wrong was hinted. It is clear that in this crisis there was much mediocrity, work badly done, disregard for others, and complicity with egoist or pragmatic concerns. Moral decline influences people’s psychology: when the crisis was triggered, partially due to inadequate ethical conduct, people lost trust in the economic sector’s modes of operating and its financial systems.

                Economic rationality only considers the best way of achieving preferences, regardless of their specific content. The characteristics of the conducts assessed above –e.g., that are hiding, that the liberalization is excessive, that the bonuses are extremely high, the loans irresponsible, the incentives wrong, that we are falling in consumerism or that we are lazy, egoistic or pragmatic– are traits of preferences that are irrelevant for economic analysis. However, as John Stuart Mill has highlighted, although the highly abstract character of political economy helps to understand economic affairs, given that life is complex, it often has little empirical relevance. Mill actually maintains that we have to consider other motives if we want to know the motives of real world facts. The description of the facts of the crisis indicates that we have to consider the moral dimension.


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