Debunking the White Tornado

When I was a kid, a large consumer products company ran a TV ad campaign for it’s line of detergents, likening the effect of the product to a white tornado, a great whirlwind that would sweep in and clean anything, erasing even the most embedded filth. Perhaps it is this kind of marketing that contributes to an apparent belief among foreigners, particularly Americans, that adding something clean to something filthy makes everything clean.

I call this belief The Great White Tornado Theory.

The Great White Tornado Theory is used most often in China by advocates of foreign participation in China’s financial industry. Listening to the tales of embezzlement, corruption, and malfeasance among China’s banks, securities brokerages, and other sectors, executives of international firms shake their heads, tut-tut sadly, and remind media, policymakers, and each other that if ethically managed (read “foreign”) companies were allowed to fully participate in the market, by competitive force and dint of example they would help eliminate unsavory practices.

It’s an attractive theory, and as an advocate of greater competitiveness in China, I want to agree. A lot of my friends do, as do many people whom I respect deeply.

But both the theory and those who expound it have some credibility problems with Chinese audiences and impartial observers.

What’re We Doing Here?

Let’s say for a moment China were to allow open foreign participation in, say, the securities brokerage sector. Once we get past the rhetoric and the high-minded ideals, foreign firms are not coming to China to clean the place up – they’re coming to make money. After making investments in staff, high-priced offices, and years of lobbying, headquarters in New York, London, or Tokyo are not going to be telling their China teams “okay, guys, go out there and help build an ethical market.” No, the word from HQ is going to be “get out there and start making us a mint, or we’ll fire you and find somebody who will.”

The pressure to perform will be intense, and the competition – intensified by the arrival of foreigners – will make performing extremely difficult. The pressure to engage in common but unsavory practices to get business and drive results will be intense. In such a cauldron, the question of making the ethical choice and the profitable one will not come down to the name on the door or the pedigree of the firm – it will come down to the character of the individuals making those choices, and to how willing firms will be to sacrifice profits for ethics.

If the situation in other industries and places is anything to go by, the prognosis is not good.

Doing Like the Romans

The experience of other industries in China suggests the path that foreign securities firms might take.

There are those who believe that only a very limited number of foreign firms engage in unethical practices in China, and there are others who have confided with me that they believe it impossible to make a profit in China without bending your morality a bit – the system is simply rigged against that. In reality, China can be extremely hard on ethical corporate practices. As Peter Goodman wrote in The Washington Post last August:

“American business leaders often describe their China operations idealistically, suggesting that their presence here will compel Chinese competitors to adopt more ethical business practices. But in one key regard, the dynamic operates in reverse, with U.S. companies adopting Chinese-style tactics to secure sales, as they compete in a market in which Communist Party officials routinely control businesses, and purchasing agents consider kickbacks part of their salary.

Managers of U.S. companies say they are caught in a dilemna: They are answerable to shareholders on Wall Street and home offices that demand a piece of an increasingly lucrative Chinese market. Yet they are also held to account at home by the Department of Justice and the SEC.”

In short, when in Rome, companies are not acting like the Greeks. Foreign firms in the telecommunications, medical equipment, airport security, software, and computer hardware industries have all been accused of, have admitted, and/or have been fined for practices that are not only unethical but are indeed illegal in the U.S.

For the finance industry, is there anything to suggest that the record would be different?

The Record Elsewhere

A scan over the checkered history of the financial industries in the U.S. over the past two decades does nothing to suggest that there is something about an international institution that inhibits impropriety. The savings-and-loan scandal from the late 1980s, the insider-trading convictions of people like Ivan Boesky, the tainting of research by investment bankers, the growing options pricing scandal, boiler rooms, pump-and-dump schemes…all evidence drawn from the front pages of America’s largest newspapers, all representing ethical lapses in finance, and all taking place under the aegis of the toughest regulatory system in the world.

Taking the show on the road hasn’t helped. Failures in ethics and systemic controls at places like Morgan Stanley Japan Securities and Goldman Sachs Japan make clear that financial firms are not above rolling around in the mud with the locals like Mitsubishi Securities and the Murakami Fund in the name of profits. Indeed, if Japan is any model, one could argue that it is not foreigners who will clean up a market, but local regulators with sufficient political air cover to do the right thing.

So again, I ask – if foreign financial firms can find themselves in hot water at home for not doing the right thing, what evidence is there that they will have a cleansing effect on China.

Right Impulse. Wrong Reason.

Foreign participation in China’s financial sectors will be a good thing for a lot of reasons – it will increase competition, diversify services, and force everyone to work harder for the customer’s business. The institutional capital and investment mentality the foreigners bring with them should do much to stabilize the punter-driven technically-based markets, and possibly even bring some accountability to bear on listed companies.

Creating a cleaner market, however, is not one of those reasons.

The government knows all of this – there is a growing understanding among regulators that a well managed market requires an independent third-party overseer with prosecutorial powers in addition to whatever self-regulation can be put into place. (That’s not radical, anti-free market thinking, by the way – that’s theSecurities Exchange Act of 1934.)

For that reason, anyone who suggests to a government official in China that foreign participation will have a cleansing effect on China’s financial industry is merely flushing his own credibility down the toilet. Drop the argument already – it weakens a case that is strong enough on its own merits.

Nota Bene

The fact that The Great White Tornado Theory is specious and a lousy argument for open financial markets does not release financial institutions from the implicit obligation to do well and do good. Do not come to Rome and do as the Romans – come to Beijing with the full cognizance that the ability to know right from wrong – and to act on that knowledge – is a long-term competitive advantage.

Chinese companies and individuals are not going to be comfortable with placing their financial futures in the hands of institutions who engage in nefarious practices. All a foreign firm can offer today that a Chinese firm cannot is trust, the comfort that a customer is putting his faith in a professional whose ethics are above question. Lose that, and the Chinese financial industry will be a rat race and the foreign firms will be the first targets when the regulators grow new teeth.