Minsky’s law of ‘stability creating instability’ is widely used to describe the incremental increase in risk taking that eventually leads to repercussions in the economy and financial markets.
However, Minsky’s law can also be applied to human behaviour in other areas of our society.
The British phone hacking scandal that engulfed News Corp was a result of years of behaviour that went unchecked. Each passing year, journalists became more emboldened. The eavesdropping activity went from unacceptable to repulsive. Those committing the illegal activity and the management condoning it, obviously lost their moral compass in pursuit of increasing circulation and profits. The glare and shame of public exposure was the only way to make those responsible recognise just how far they had strayed from the standards expected of their profession.
The Commonwealth Bank is also having its Minsky moment. The Four Corners program and Senate inquiry into the operation of the CBA financial planning division has shocked most observers. There are many questions, but the one that comes immediately to mind is how could this systemic practice of poor advice, fraudulent behavior, and forgery happen in Australia’s largest financial institution?
The second question is why did the corporate watchdog, ASIC, drag its feet investigating the alleged claims of improper conduct within the CBA? ASIC apparently knew about the allegations for 16 months before it acted.
The third question (asked by an even more wary consumer) is if you can’t trust the CBA for financial advice, who can you trust?’
The actions of the rogue CBA planners and their superiors has cast a very dark shadow over the planning profession. For some people, it will have confirmed the low esteem they already had for financial planners. Others will now think twice before setting foot inside a planner’s door. The damage caused is immeasurable.
In an attempt to restore public confidence in the planning industry, the Senate inquiry, along with calling for a Royal Commission into the CBA financial planning division, made the following recommendations:
- ASIC should undertake intense surveillance of financial planning groups that have previously received enforceable undertakings from the regulator.
- Financial planners should have university qualifications and industry experience.
- The regulation of investment products need to be examined by The Murray Inquiry.
These are steps in the right direction, but they dance around the real issues — the sales culture that still pervades the industry and the unshakeable belief in the share market to deliver superior performance on a continual basis.
The complexity of our tax laws, the forever changing rules on superannuation contributions and income streams together with maximising entitlements from the social security system, means most people need an expert to guide them through the legislative maze.
The reality is the majority of financial planners are decent, honest people who are very capable of providing professional advice on these matters.
The industry’s Achilles’ heel is the investment process. The majority of financial planners are associated in some way with an institution.
A very small minority are truly independent. Their payment is based on an hourly fee basis, and they do not receive commissions or brokerages and are not aligned with or owned by an institution.
Why do institutions own (wholly or partially) financial planning businesses? Simple. Funds flow. Funds management is a multi-billion dollar business. The more funds under management, the greater the value of your business.
The best way to ensure a constant stream of funds into your investment product is to own the ‘pipeline’ or to be a truly great fund manager. The latter is a very exclusive club to which most institutions do not belong.
In my opinion, the best way to clean up the industry and to restore public confidence would be:
- Ban institutional ownership or association with a financial planning business. This is not as radical as it sounds. Imagine the public outrage if drug companies owned medical centres. Apply the same principle to the financial industry.
- Ban all commissions and brokerages (including those being paid from previous investments) from investment and insurance products. Planners will be paid on an hourly fee basis and/or a mutually agreed annual retainer.
- Education standards — in particular those applying to more complex investment structures that involve debt — need to be dramatically improved. At present, the US share market is setting all sorts of records in terms of historic valuation metrics, yet the investment industry is still advocating ‘shares for the long term’ from these over-stretched levels. When markets fall (and possibly, very heavily) from these levels, there will be more hand wringing over the financial losses incurred by unsuspecting investors. This could be avoided if the industry’s education providers decided to broaden the scope of knowledge available — delve deeper into how secular markets function, the psychology of how investors feel about losses versus gains, look at different valuation metrics and not just current P/Es based on forward earnings estimates, etc.
The near term prospect of any of the above happening is remote. Institutions have invested way too much money in the financial planning and funds management industry to suddenly go quietly into the night.
The lobbying power of the industry is immense. For instance, the loss of shareholder value caused by these changes would be the opening of their powerful political argument.
The disruption to the traditional financial planning business model would no doubt cause great unrest within the industry and result in the closure of many planning firms.
However, you have to balance the industry’s pain against the pain felt by investors who have suffered significant losses at the hands of unscrupulous planners. Removing remuneration incentives sales rewards is a step in the right direction to restore public confidence in financial planners.
Severe pruning now, hopefully, makes for a much stronger and healthier industry later.
Unfortunately, it will take the next great crash (GFC MkII) to evoke sufficient political willpower to move the industry in the direction recommended above.
Sadly, it will be a case of too little, too late. The next crash is likely to be far more severe than the GFC — markets are higher and the debt in the system greater — and the central bankers have run out of monetary ammo to support another market ‘reflation’ exercise.
The public outrage over wholesale and sustained losses will shame politicians, institutions and planners into cleaning up their act.
Hopefully, when this chapter of instability is behind us, we will have created some stability in the delivery of financial advice — a reverse Minsky moment.
Editor, Gowdie Family Wealth