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Finance & Development
A quarterly magazine of the IMF
September 2007, Volume 44, Number 3

Book Reviews

In search of the moral high ground

Avinash D. Persaud and John Plender

Ethics and Finance
Finding a Moral Compass in Business Today

Longtail Publishing Limited, London, 2007, 215 pp., £19.95 (paper).

Financial markets are often taken to be places in which unbridled self-interest dominates and the participants recognize just one value—money. Each investor wants the best rate of return, each bank wants the highest return on equity, and analysts and traders want the biggest bonus—and everybody will do whatever it takes to get there. Yet financial markets, like society itself, rely on shared ethical standards. Written rules and their enforcement are necessary although, by and large, people and institutions voluntarily constrain themselves. Even when there is little chance of being caught, people do not do certain things they feel are unethical.

Persaud and Plender have written a practical guide to encourage investors and other market participants to abide by ethical standards and to recognize where ethical conflicts may arise. They pointedly avoid philosophical abstractions, arguing simply that ethical behavior is both important in itself and essential for the functioning of markets. They also suggest that ethical behavior is in the interest of the financial institutions and individuals involved. Although the trade-off between being ethical and making money can seem acute in the short term, it will look much less acute if a longer-term perspective is taken—one in which containing reputational risk and maintaining a level of trust among market participants are important.

In various chapters, Persaud and Plender address the specific ethical conflicts that may arise in areas such as investor protection, speculation, and accounting, and discuss the roles of independent directors, auditors, and regulators. The authors concentrate on ethics in financial markets and do not address issues relating, for example, to the treatment of employees. They illustrate their points by citing well-known recent examples of unethical behavior in financial markets and include both executive summaries and structured questions that financial market participants should periodically ask themselves—a first for this kind of book. Indeed, reading between the lines, the authors seem to say that many instances of unethical behavior could have been avoided if the perpetrators had ever stopped to think for a moment.

The authors' main concern and clearest message centers on conflict of interest, in which an agent takes advantage of the people he or she is meant to be serving. They suggest other criteria for ethical behavior, such as whether others are put at a contrived disadvantage or suffer unmitigated harm, concepts that are not very well explained in this otherwise clearly written book, which is free of both pomposity and oversimplification. The way I understood it is that financial market participants should not cause significant harm to those who have no connection with a transaction or to those who cannot reasonably be expected to protect themselves from it.

The book has several messages for policymakers, in particular for financial sector regulators and supervisors. First, regulators themselves need to maintain ethical standards, for example, by avoiding explicit or implicit "capture." That is to say, they must not become beholden to those they are meant to regulate, acting in the interests of the regulated industry rather than of the public at large.

Second, regulators need to pay more attention to ensuring that incentives within financial institutions are aligned with ethical commitments. Many ethical lapses occurred when employees of financial institutions were given (or created for themselves) incentives that generated conflicts of interest. Whereas egregious cases involving company boards and senior management are best known, there are instances of even junior employees being given incentives to fleece their clients.

Third, and perhaps most problematical, regulators and market participants need to be aware of the risk of regulations replacing ethics. Additional regulation typically follows a scandal involving unethical behavior. Not only does the regulatory burden increase, but market participants come to rely more on regulations and on corporate ethics officers than on their own sense of what is right and wrong. Financial market players like to complain about "regulatory overload," but this book will have achieved something if it makes even a few of them realize that if they take responsibility for their own ethical behavior, all that extra regulation may not be needed.

Daniel Hardy
Division Chief
IMF Monetary and Capital Markets Department

Reading the fine print

Rosa Maria Lastra

Legal Foundations of International Monetary Stability

Oxford University Press, Oxford, 2006, 600 pp., $199 (cloth).

Rosa Lastra has produced a highly insightful and readable work on international financial regulation. This book should appeal to lawyers, economists, financial sector specialists, policymakers, and, perhaps most of all, those interested in the intersection between these different disciplines.

The book is well structured. The first part focuses on the national level and addresses developments in the monetary and regulatory functions of national central banks. The second part moves to the European regional level, analyzing the complex structure of the European System of Central Banks (ESCB), comprising the European Central Bank and the national central banks within the euro area. And the third part focuses on the international level, and in particular on the role of the IMF. The comparative analysis is enhanced by the common approach that Lastra applies to each part, starting by setting the historical context, then moving to an in-depth analysis of the institutional framework, and culminating with an assessment of the financial architecture in terms of financial supervision, regulation, and crisis management.

The limits of central bank power

Each part of the book is notable for its originality. In the first part, Lastra sets out boldly in recognizing that, while the central bank's statutory objectives include price stability, the bank is still carrying out a government function, even if it is a function that is best achieved through substantial (but ideally not complete) operational independence from political influence. This framing of the issue provides a fresh perspective on a subject that, in the hands of others, can become a stale debate on the seemingly irreconcilable tension between central bank independence and accountability. However, although the author strives to introduce the experience of developing and emerging market economies into some aspects of the discussion (for instance, when she touches on currency boards and banking crises), readers might benefit from a more systematic reference to the comparative practices of central banks in such economies.

In the second part, Lastra describes how the ESCB operates within the European Union's constitutional and administrative context. Using currency issuance to further develop the theme of monetary sovereignty, she provides a clear analytical anchor to guide her readers through the otherwise challenging ESCB institutional framework.

Making sense of the IMF

In the third part of the book, which focuses on the IMF, Lastra masters the substantial challenge of explaining the legal and regulatory framework as it pertains to the Fund. As the author acknowledges in her preface, "the unique nature of the [IMF], the economic character of most of its functions and operations, the idiosyncratic and rather opaque terminology that applies to its activities and financial structure . . . and the specific knowledge required to understand the legal aspects of those activities (a knowledge that is traditionally the reserve of [IMF] lawyers and a few academics who venture into its study) explain the relatively thin body of doctrine dealing with the complex issues of public international monetary law."

Notwithstanding advances in the IMF's publication of internal documents over the past two decades, understanding of the IMF's legal framework outside the institution remains sketchy, at best. The author, aided by her long professional association with the IMF Legal Department, patiently guides the reader through some commonly misunderstood legal issues: for example, the legal obligations of the IMF and its 185 member states with respect to surveillance, why Stand-By Arrangements are not contracts, and the legal basis for conditionality in IMF financing. Notably, Lastra's historical account of the evolution of the IMF's role in the international monetary system from the international regulator of "exchange rate stability" to the guardian of a "stable system of exchange rates" is highly relevant in light of the recent revision of the IMF's operational framework for surveillance over member countries' exchange rate policies. Lastra's work is sure to inform the debate on the evolving role of the IMF.

The legal foundations of institutions at the national, regional, and international levels are important but often neglected aspects of the functioning of monetary and regulatory systems. By deepening our understanding of these relationships, Legal Foundations of International Monetary Stability represents a significant achievement.

Thomas Laryea
Assistant General Counsel IMF Legal Department

Economics the Caribbean way

Sir Courtney Blackman

The Practice of Economic Management: A Caribbean Perspective

Ian Randle Publishers, 2006, 448 pp., $50 (cloth).

Dr. S.B. Jones-Hendrickson

Essays on the Organization of Eastern Caribbean States (OECS) Economies

iUniverse, Inc., 2006, 328 pp., $24.95 (paper).

There is a paucity of economic literature on the Eastern Caribbean, so the publication of two books reflecting on the realities of that region is most welcome. The Practice of Economic Management, written by the founding governor of the Central Bank of Barbados, Courtney Blackman, provides a clear and concise description of economic issues affecting the Caribbean within a broader political context. S.B. Jones-Hendrickson's Essays on the OECS Economies reflects on the economic evolution of the region from 1980 to the present.

Both authors provide the reader with useful insights into the peculiarities of Caribbean economies and the role of policymakers in helping shape their countries' economic development. For Jones-Hendrickson, the closer union of the OECS in the early 1980s played a pivotal role in laying the basis for their economic development. For Blackman—who incorporates other disciplines such as sociology and history into his analysis—the Caribbean region's economic experience is driven, in part, by its history and pervasive culture of weak economic management.

Blackman argues that many of the economic problems experienced in the Caribbean are a result of mismanagement by policymakers who often appear more intent on satisfying short-term demands of the electorate than focusing on more long-term issues such as fiscal reform and expenditure control. His essays are heavily prescriptive with a host of proposed policies, and he sometimes appears to be at odds with more traditional prescriptive approaches to economic policymaking.

Jones-Hendrickson follows a similar line of argument. He argues that the expansive fiscal policy pursued by the governments of the OECS often is driven by political considerations as they attempt to meet the electorate's growing demand for public goods. The result has been escalating fiscal imbalances and ballooning debt. In contrast to Blackman, however, Jones-Hendrickson focuses on more standard economic fare in describing the economic problems of the Caribbean.

Both books serve as useful guides to understanding the dynamics of policymaking in the Caribbean. In the end, however, Blackman almost completely dismisses mainstream economics in defining the problems of small developing economies. Blaming economic failings almost exclusively on weak management seems a bit simplistic, given that human and technical capacity, cultural norms, and a country's history (particularly its colonial past) all play a role in determining economic outcomes.

Thomson Fontaine
IMF African Department

Camilla Andersen is Book Review Editor..