Expenses have caught MPs with their pants down

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Values of integrity, of public service, and of responsible stewardship of the money of others can never be replaced by rules or imposed by regulation.

The Australian economist, Joshua Gans, recently described a problem central to the current financial turmoil. How could he persuade his young son not to wet his pants?

Believing in the power of incentives, Mr Gans offered a reward if his son could keep his pants dry for seven nights. The boy simply removed his pants. The prohibition was on wetting pants, not on wetting the bed. Young Gans was learning a skill that would equip him well to be a British MP, or a senior executive in a global bank.

Many MPs need second homes to perform their duties. Such rules were not intended to allow less honourable members to build a property portfolio by charging the taxpayer to refurbish a succession of second homes. These members argued that what they did was consistent with the rules.

The Basel banking principles attached varying capital requirements to different types of assets. But it was easy to rearrange how assets were categorised, even as the underlying risks remained the same.

The Gans household elaborated the rules to close the loophole, only to discover that their child was able to construct yet more ingenious methods of circumvention. Britain’s Committee on Standards in Public Life, and the Basel Committee on banking supervision, have the same experience. The Gans problem solved itself eventually – the boy grew up. We are not usually so lucky. Revenue authorities have been in pursuit of tax avoidance ever since income tax was introduced. They have never quite caught up, and they never will.

Regulation by rules invites compliance with the rules rather than the objective of the rules, and the more extensive the rules the easier it is to lose sight of the objective. Many MPs plainly believed that since there were rules on what they could claim, any claim within these rules was legitimate. The Basel directives can be seen, in retrospect, probably to have done more harm than good. Banks took the view that capital sufficient to comply with the regulations was sufficient for their business needs. Surplus capital was for wimps.

Much of what the financial services industry today describes as compliance is no more than the system of internal control that any well-run institution would itself impose. But when control becomes compliance, business necessity becomes bureaucratic obligation. Everyone in the organisation can make common cause in minimising its practical effect.

Simpler rules may be less harmful than complex rules, but they can only work when the simplifications correctly exemplify underlying values. St Athanasius, fleeing the unrighteous, was asked if he had seen the traitor Athanasius. “He is not far away,” the prospective saint replied, accurately but misleadingly. His persecutors rushed off in the wrong direction.

The correct defence of Athanasius is surely not that he avoided a lie by ingenious circumlocution, but that the circumstances justified lying. Adam Smith mused whether it was right to break an agreement with a highwayman to whom one had promised one’s money in exchange for one’s life, and Kant wrestled with the problem of misleading a potential murderer. But only a philosopher would see a difficulty. Truthfulness is a state of mind rather than observance of prohibition of falsehood.

The problem of Kant’s categorical imperative is how to behave well in a world in which others do not. It is hard, perhaps impossible, to remain honest when the culture is corrupt; hard, perhaps impossible, to live on an MP’s salary when others exploit the allowance system and accept dubious consultancies; hard, perhaps impossible, to manage a bank prudently when your competitors inflate profits by operating differently.

That is why values of integrity, of public service, and of responsible stewardship of the money of others can never be replaced by rules or imposed by regulation. And why the test “would you feel comfortable if your activities were disclosed?” is a powerful guide to conduct. MPs tried hard but unsuccessfully to avoid that disclosure. Such a test would have killed plans to shift banking business to off-balance sheet vehicles at an early stage. And required young Gans to keep his pants on.

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