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The City - Five Years on the Naughty Step

18/09/2013 15:36 BST | Updated 18/11/2013 10:12 GMT

Perhaps the two most significant statements in the five years since the collapse of Lehman Bros, are by the former Chair of the Federal Reserve and the erstwhile Governor of the Bank of England. In October 2008, Alan Greenspan admitted that "I made a mistake in presuming that the self-interest of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders." In 2011, Mervyn King suggested that "I'm surprised the real anger hasn't been greater".

These admissions capture the tension between the rationality of conventional economic theory and human sentiment about the economic reality. This tension has increasingly been explored over the past five or ten years in the field of 'behavioural economics'. This emerging discipline recognises that the theory in our economic textbooks can't always be reconciled with the reality of human behaviour. Yet perversely, rather than adjusting the theory in the face of reality, behavioural economics presents this mismatch not as a failure of theory but a failure of reality - known as "behavioural failure"! Those pesky humans.

So perhaps I was mistaken to look for good news in the Financial Conduct Authority's first serious foray into considering how behavioural economics might impact on their work. (The evolution of the FSA into the FCA and the new emphasis on conduct neatly echoes the economist's increasing focus on behaviour.) In the wake of the Global Financial Crisis™ and after some reflection on the failures of our financial institutions, Greenspan's admission that the textbooks are wrong, some serious academic attempts to bridge the gap between theory and practice, I might have hoped that that the powers that be would take a more human and grounded view in ensuring that financial services are working effectively.

In fact, the authors of the paper could not be less sympathetic to the human perspective. In one astonishing passage, the paper suggests flatly that emotional bias in preferences is a mistake. Let's try that again - emotional bias in preferences is a mistake. I would find this hugely depressing except of course it would be a mistake to get emotional about these things. In short, what the FCA appear to be saying - with the lessons of the past five years in mind - is that:

  • moving your money away from investors in tobacco companies because you hate the suffering caused by lung cancer is a mistake;

  • investing in a local shop, pub or community centre because you love to support your local area is a mistake;

  • taking your money out of a bank to show your dislike for their working practices and moving it to another which is aligned with your values is a mistake;

  • putting money in a diverse range of investments, including those which offer security or guarantees because you are scared of losing it is a mistake; and

  • investing money in order to make a financial return because you want to live comfortably in your retirement is a mistake.

If I was inclined to get emotional, then I would admit that this paper is one of the most demoralising I have ever read. This matters because we need our financial services to be less, not more detached from reality. And we need the financial regulators now more than ever to be on our side. Instead, they seem to be using textbooks to explain how our hopes and fears, aspirations and desires to make the world a better place are simply misguided. At the heart of the organisation set up to protect us from the frightening power of our financial institutions is, well, no heart at all.

The authors' names are on the front of the paper on the FCA website. I know they won't mind either way what I think - it seems unlikely that they would be upset about me criticising their work in the public domain. But if they are, then I guess then that's their mistake.