• Public debt as a way of life that undermines our social compact and intergenerational responsibility
• Overly complex regulation that has become dysfunctional to the point of increasing the fragility of our economic and financial system
• Laws that are so complex and ill-written that instead of the rule of law we have the rule of lawyers
• States so overbearing that civil society withers into a mere no man’s land between corporate interests and big government

These are the historical perspectives on our times of Niall Ferguson, Professor of History at Harvard University, Senior Fellow at Oxford University, and author of numerous widely acclaimed books, including The Ascent of Money (2008), Civilization (2012), and most recently The Great Degeneration (2013).

Historians often achieve a comprehensive view of economic affairs that eludes more narrowly focused experts. The perspectives that Ferguson brings are always thought provoking and at times uniquely insightful. Building on former U.S. defence Secretary Donald Rumsfeld’s famous topology of “known knowns,” “known unknowns,” and “unknown unknowns,” Ferguson adds the category of “unknown knowns”—scenarios that are quite well known to students of history but which are ignored by everybody else.

Public debt and the social compact

Ferguson argues that excessive public debt is a symptom of the breakdown of the social contract between the generations. Edmund Burke, the famous Anglo-Irish statesman, political theorist, and philosopher, described the state as a partnership between those who are living, those who are dead, and those who are to be born.

Ferguson maintains that the enormous intergenerational transfers implied by today’s public debts and current fiscal policies are a shocking breach of that partnership. He observes that, owing to the fecklessness of voters in recent decades, any Western government that seriously tries to reduce its structural deficit usually ends up being driven from power. Career politicians who pander to the electorate to serve their own ambitions serve to widen that breach of partnership.

Many Western economies are currently stagnating under their burden of debt, and Ferguson argues that their legal systems and institutions have degenerated to the point that rent-seeking by elite groups dominates their economic and political processes. In the end, he suggests that, barring some miracle of economic growth, the current path that Greece and other Mediterranean economies are pursuing towards some subset or combination of default, deflation, or inflation may well be trodden by a great many Western democracies in the future.

Principles vs. prescriptive regulation

Regulation must be simple and well enforced to be effective, says Ferguson. He believes we should stop exhausting ourselves by drawing up hopelessly complex codes of “macro-prudential” or “counter-cyclical” regulation, of which Dodd– Frank is a prime example, containing 243 rules, calling for 67 studies and 22 periodic reports, and covering issues such as race and sex discrimination and climate change in its 9,000 pages. We should also stop failing to enforce them effectively. Instead, he urges that lessons be taken from the history of finance and banking in the United Kingdom. The U.K. was the dominant country in finance in the late nineteenth century, and its financial industry was described by Walter Bagehot in his 1873 book Lombard Street. In that world, rather than mere compliance with detailed rules, individual prudence and the preservation of strong trust in the financial system was the recognized advisable course. The crucial rules were principles, not prescriptions, and the authorities enforcing them were powerful and ready to act.

Ferguson is a strong believer in the importance of trust and corporate reputation in the regulation of the financial system. In his book High Financier (2010), he extols the meticulous business methods and strict ethical code that set apart the legendary financier Siegmund Warburg, founder of the firm S.G. Warburg & Co., from the speculators and traders who inhabit today’s financial world.

This topic of reputation is also studied by Jonathan Macey, a professor at Yale Law School, in his book The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street (2013), which analyzes the failure of financial markets to enforce the standards of conduct needed to reassure public investors. Macey states that justice has not been served nor integrity restored in the five years since the financial crisis. Among the extensive evidence he cites are the continuing major roles in the financial system played by the leading rating agencies and accounting firms, whose opinions on mortgage-backed securities and banks’ financial health turned out to be so compromised and misleading. He also cites the continuing success of Goldman Sachs, which has not been affected by its creation and sale to clients of its Abacus fund, a portfolio of mortgages designed to fail.

Macey suggests these circumstances exist for three reasons: (1) clients now place their trust only in selected individuals, not in the firms they work for; (2) clients, who used to rely on a firm’s reputation, now tend to rely more on a firm’s ability to assemble customized products for buyers seeking results, such as the ability to hedge a particular risk; and (3) a vast profusion of laws, regulations, and direct government interventions has provided a substitute for reputation, albeit a toxic and inadequate one.

Macey maintains that financial intermediaries no longer need to invest in building their reputational capital. Instead, they invest in regulators whose career prospects are increasingly tied to their ability to advance rules that are both vague and highly technical because this increases their value to both government and private employers. As a result, he claims, “a revolving door exists between the U.S. SEC and powerful positions at top law firms and banks.” Macey believes the system is now so fundamentally flawed that more regulation will lead only to more damage to the system. In his view, only the rebuilding of reputational capital can restore broad public confidence in the system.

Rule of law vs. Rule of lawyers

The legal landscape is an integral part of the institutional setting in which we live our lives. In the U.S. and the U.K., Ferguson argues, the growing complexity and sloppiness of statute law (legislated in large part by politicians who are lawyers) and the intrusion of prescriptive civil law into principles-based common law have led to the rule of law being replaced by the rule of lawyers, i.e., those who are most adept at using and adapting the statutes of the law to their own advantage. This has led to a decay in the institutional framework of Western life, which Ferguson fears may be remedied only from outside the realm of public institutions by the associations of civil society—in other words, by citizens acting collectively. Ferguson indicts our era as one of negligence and complacency and notes that while the Arab world struggles to adopt democracy and China attempts to move from economic reform to the rule of law the West is squandering its accumulated and centuries-old institutional inheritance. Arresting the breakdown of our civilization, Ferguson argues, will take heroic leadership and radical reform. He states that, while this may be achieved peacefully, history tells us that the possibility of serious disruptions and violence cannot be ruled out.

Overbearing government

Ferguson sees the state and the private sector as interdependent, but he strongly objects to the exaggeration of the role of the state. Overcomplicated government regulation can be the disease of which it purports to be the cure. In particular, he criticizes statements by the current U.S. administration that imply the government has played a vital role in building every small business and in creating the middle class in America. He cites the work of nineteenth-century historian and political thinker, Alexis de Tocqueville, who in Democracy in America (1835 and 1840), argued that the state, with its seductive promise of “security from the cradle to the grave,” is the real enemy of civil society and usurps the place of associations such as organized religious groups and countless social, charitable, and benevolent associations. Such associations once served to make America great and sadly are now all on the wane.

Learning from history

In his book, Why the West Rules—For Now (2010), Stanford Professor of History and Classics, Ian Morris, examines the patterns of history and what they reveal about the future. Morris concludes that, after centuries of Western domination, the West will lag the East in social and economic development in the 21st century. Morris argues that historians are in the best position to draw together the grand narratives of social and economic development, to explain the differences that divide humanity, and to throw light on how we can prevent these differences from destroying us.

Ferguson believes that until we understand the true nature of our economic and social degeneration, we will be wasting our time applying quack remedies to mere symptoms and mistaking transitory fluctuations for signs of recovery.

Although he is only 49, Ferguson has been accused by critics of writing an “old man’s book.” However, this is not entirely surprising. To be dismissed as being over the hill has become something of a standard put-down of anyone who argues for caution, principled behaviour, and simplicity in public affairs. Typically, it is applied by technophiles, change-junkies, and members of the cognitive elite who feel that they are more able to cope with the complexity of the modern world than others. They are often grossly misguided, as events since 2007 have shown.

Winston Churchill said “the further backward you can look, the further forward you are likely to see.” Around the same time, the prominent intellectual and writer Aldous Huxley wrote: “Men do not learn much from the lessons of history, and that in itself is the most important lesson of history.” The lessons of history are mostly qualitative, not quantitative, and that makes them particularly hard to learn in numerically driven fields such as finance. However, historians can provide us all, and investors in particular, with advice that is often more valuable than economists’ or investment analysts’—but only if we are capable of taking it.