There has been a lot of discussion about financial regulation recently, a topic that in past times would generally have elicited a gigantic yawn. The financial crisis that has afflicted the world over the last three years has changed this, just as it has changed many other things. This last week alone has seen Germany ban “Naked Short Selling” (not as interesting as it sounds, but some reason “fleshy” terms are widely used in financial circles) of many securities, the US Senate take a major step forward in passing new banking legislation and the new UK coalition government make reform of the financial sector a significant component of its proposals. The questions in my mind are:
- How much of the of this impetus is driven by short term political point scoring?
- Have we reached a point where financial innovation is being driven solely for the benefit of a narrow group of market participants?
- Is anybody still reading?
Question 1 is the easiest to answer; a lot of the changes are likely to be a political knee-jerk reaction, but that is politics for you. It also doesn’t mean that the reforms are necessarily bad, but it probably means they will be implemented badly and will be distorted by the influence of politically powerful lobby groups.
Question 2 is harder to answer and will illicit the widest range of opinions. I regret to say that I think we have reached such a point. Finance is supposed to be a “SERVICE” industry, but I believe that is no longer the case within many institutions. The traditional role of the financial sector was to bring the benefits of intermediation and expertise, i.e. pooling the savings of many individuals in such a way that this capital could be lent out for productive purposes, invested in growing business and for risk to spread. The pillars of the financial sector: banks, stock exchanges, insurance companies, mutual funds, all had such purposes at their core. This was not out of some long-lost sense of altruism, this was capitalism at its most basic, just like free-trade, with the whole system benefiting. The financial sector was the oil that lubricated the whole capitalist system, and without it, the system did not work. Now however we find ourselves in a place where many of the most powerful institutions play a zero-sum game; no longer does the whole system benefit, but someone wins and someone else looses. The Goldman Sachs/SEC case has had much publicity, but it is just the tip of the iceberg. For many institutions their key mission is no longer to grow by providing the best service and products to their clients, but merely to ensure that they are on the winning side on as many deals as possible. “Naked short selling”, “flash trading”, “naked credit default swaps” etc. do not serve any economic purpose; they are just ways of winning and losing, and examples of where the overused term “casino banking” is actually true.
This is not some diatribe against bankers bonuses; they are not the cause of the problems but a symptom. It is interesting to note that as remuneration in these areas has risen exponentially, returns to Joe Public on their pensions and savings has fallen. In much the same way as a few oligarchs have come to dominate the Russian economy by taking control of formerly state-owned assets, the western capitalist system has seen a huge transfer of wealth from the many to the few. This is not the same as Bill Gates and Steve Jobs getting rich on the back of creating products that are bought on mass because they deliver something people want; this is they win, the rest lose just because they were on the right side of a bet, and that bet is on a race where the odds have frequently been stacked in their favour. I am not sanding up shouting “this is not fair” (I don’t think it is, but that is not the point); I am saying that it is not healthy for society. These are not people who are building businesses, developing new technology and creating a legacy; they are not even the Robber-Barons of 19th Century America, who at least built industrial empires, albeit ruthlessly; no they are more akin to another type of Baron, those of medieval England, handed huge tracts of land and the lives of the people living on that land merely for “services to the king”. Just as such “Barons” built bigger and bigger castles, so today we see ever more luxurious homes in the finer parts of London, New York and Geneva. But just as castles produced benefits to the medieval economy, sucking resources from productive activities such as agriculture and trade, such is the case with the Knightsbridge penthouses of today.
OK, to bring today’s thoughts to a close, I believe that firms in the financial sector should refocus on the core principal of all businesses – providing offerings that benefit their customers, that their customers want, that are superior to their competitors offerings, and earning a fair return along the way.
Question 3? I doubt it.