Of Character and Capitalism

Via the indefatigable Mark Thoma, our attention is drawn to an odd piece by Robert Skidelsky. I was left mostly bewildered by the article, but I was intrigued by the author's discussion of the virtues that are and are not inculcated by market capitalism:

Consider character. It has often been claimed that capitalism rewards the qualities of self-restraint, hard-work, inventiveness, thrift, and prudence. On the other hand, it crowds out virtues that have no economic utility, like heroism, honor, generosity, and pity. (Heroism survives, in part, in the romanticized idea of the “heroic entrepreneur.”)

The problem is not just the moral inadequacy of the economic virtues, but their disappearance. Hard work and inventiveness are still rewarded, but self-restraint, thrift, and prudence surely started to vanish with the first credit card. In the affluent West, everyone borrows to consume as much as possible. America and Britain are drowning in debt.

One thing to remember is that there is no such thing as "capitalism". In the real world, there are actual practices and institutions, the details of which bear consequentially on both moral and economic outcomes. There are infinity of possible capitalisms, and at any given moment we are living just one. A stylized graph of supply and demand always hides more than it reveals.

The capitalism we are living right now is rather a nightmare, due to a credit, um, event. So it seems a propos to remember that credit analysis traditionally includes an explicitly moral component. Remember the "5 Cs of Credit"? Character, capacity, capital, collateral, and conditions. Character.

Here's a famous bit of financial history, as recounted by Jean Strouse in the New York Times:

Asked by the lawyer for a congressional investigating committee in 1912 whether bankers issued commercial credit only to people who already had money or property, [J. P. Morgan] said, "No sir; the first thing is character." The skeptical lawyer repeated his question and Morgan, in Victorian terminology, elaborated on his answer — "because a man I do not trust could not get money from me on all the bonds in Christendom."

If you think Morgan, the arch plutocrat, was just telling a nice sounding, self-serving lie, think again. Think about a world in which there was no SEC, FDIC, or Federal Reserve; in which there was no technology sufficient to prevent a person from simply disappearing, changing his name, starting over somewhere else. Morgan invested vast sums, and though he was a powerful man, he could always be taken. When parting with a dollar, he could not be so lazy as to presume a courtroom would ensure its repayment. Morgan had to trust.

Since Morgan's day, in pursuit of efficiency and safety, we've built up institutions designed to automate and certify the evaluation of character. When we lend money, we don't ask to meet the person who promises to repay us. We look for a nod by a regulator, the AAA brand provided by S&P or Moody's or Fitch, perhaps a FICO score. But those are not markers of character at all. We don't take them to be. We understand that banks engage in regulatory arbitrage, finding ways to stretch their balance sheet as far as possible for yield despite whatever regulatory regime is in place. We know that credit issuers (and bond insurers) do what they need to and no more for their rating, that perfectly dishonorable individuals attend to their FICO scores to maintain access to credit. Actual character is completely washed out of these proxies. The capitalism we have is one that presumes that all actors are sharks, that business is business, and that it is irrational to take any less than you can get away with unless you will "incur costs" from decertification. I'm not sure that J.P. Morgan would be willing to lend to any of us, and it's not because we're worse people. We just live in different times, a different world.

We shouldn't go back to the world as it was at the turn of the century. When character evaluation was a personal exercise, it necessarily depended upon social connections, whether someone you know and trust can vouch for someone you don't yet know, whether you can be sure that disgrace and dishonor would be costly. And we definitely should not adopt a moralistic attitude towards debt nonrepayment right now, just when a throng of irresponsible lenders are demanding "responsibility" from borrowers whose calls they would not even take a year ago. (For the record, I think that "jingle mail" is perfectly acceptable under present circumstances, and that the recent "bankruptcy reform" was a cruel mistake.)

But I do think that it's an interesting technical question, going forward, whether we couldn't set things up so that the criteria by which investors decide where to put their money map more closely to what we would recognize as trustworthiness or character. "Abolish the SEC and the Fed and the ratings agencies!" is not a sufficient proposal. Crises due to misplaced trust long predate those institutions, and are a large part of why they came to be in the first place. Morgan was successful not because he did what everybody did, but because he did what almost nobody did, despite the lack of ratings by S&P to stand-in for due diligence. Investors have always been hopeful and lazy in good times.

T.S. Eliot once wrote, "It is impossible to design a system so perfect that no one needs to be good." Perhaps the art is to come up with a system, however imperfect, under which being good is the best way to succeed.