Other people’s money

Catching up with post-holiday stuff has slowed me down, but I finished John Kay’s new book, Other People’s Money: Masters of the Universe or Servants of the People? on a flight back from his native Edinburgh yesterday. It is characteristically excellent, drawing the main threads out of the complexities of modern financial history and the post-crisis consequences, and writing with beautiful clarity and style. It’s up there  with John Lanchester’s Whoops! as a guide to understanding what has happened in finance. I agreed with every word. I don’t suppose he’d want the job, but it would be marvellous if we could put John in as Chancellor to sort things out.

The book tells the story of the financialisation of the British and global economies in its first section, and the transition from relationship-based financial services focused on customers and the real economy to transactional and trading-based financial entities.This progressive shift in behaviour, values and institutions affected the whole of the corporate sector. The book offers a telling contrast between the 1987 and 1994 annual reports of ICI:

“ICI aims to be the world’s leading chemical company, servicing customers internationally through the innovative and responsible application of chemistry and related science. Through achievement of our aim we will enhance the wealth and well-being of our shareholders, our employees, our customers and the communities which we serve and in which we operate.”


“Our objective is to maximise value for our shareholders by focusing on businesses where we have market leadership, a technological edge and a world competitive cost base.”

This has happened across the whole of the business sector throughout the west. It’s tragic. Risk taking at the expense of others, bonus culture, income inequality, short termism, declining business investment, overly-detailed regulation having utterly adverse consequences, and the taxpayer still in line to prop up the whole edifice if – or rather when – the financial sector gets hit by another tail risk it can’t cope with. As Kay underlines, and as Admati and Hellwig pointed out so clearly, and even Alan Greenspan now admits, the banks have far, far too little equity capital and too much leverage. The summary here of Deutsche Bank’s balance sheet is terrifying.

The book is particularly clear about the inadequacy of banks’ current levels of shareholder capital vs debt on their balance sheets, and the nonsense of the Basel risk weightings, and banks’ claiming they can achieve 15% return on equity – always done by reducing the amount of equity in the denominator. Kay writes: “Return on equity is an inappropriate performance metric for any company, but especially for a bank; and it is bizarre that its use should have been championed by people who profess particular expertise in financial and risk management.” Bizarre, or perhaps just cynical.

So what to do about it? Especially as financial markets start displaying the kind of declines that could, potentially, wipe out a frail bank’s mimimal equity? The book has good answers. Kay starts with a set of principles for reform, including shorter chains of intermediation before the final customers, more focused and specialist financial institutions, a prioritisation and demonstration that the financial institution has its clients’ interests at heart (hello, Goldman Sachs), criminal and civil penalities applied to individuals (not fines on institutions), simpler regulation. Above all, politicians should abandon the illusion that the finance sector is special compared to other sectors of business. After all, the numbers don’t make sense; it has certainly not contributed as much to the economy as is claimed, and is not financing industry or serving the needs of investors.

In detail, the book favours structural remedies, not more and more regulation of behaviour – that is an arms race between banks and regulators that the former, with their ability to extract vast rents and hire lawyers/lobbyists will always win. Kay sees ring fencing of retail activities from investment banking as a ‘first step’. I agree: the too-big-to-fail-subsidy will always be too big for as long as there are any links. There needs to be a structural separation, and deposit guarantees only for utility retail/small business banking. He also puts great weight on individual civil and criminal responsibility.

Towards the end of the book comes one of many eye-popping quotations from Goldmans executives:

Sen C Levin (D, Michigan): When you heard that your employees in these emails and looking at these deals said, “God, what a shitty deal!)… do you feel anything?

Mr D.A.Viniar (CFO, Goldman Sachs): I think that is very unfortunate to have on email.

No wonder Kay concludes: “The finance sector of modern western economies is too large.” Spot on. It takes too many of the best graduates, distorts pay across the corporate sector, fails to innovate on behalf of its customers, and exposes taxpayers to unsupportable risks. Financial conglomerates need to be broken up, banks need to hold much higher levels of equity capital.

Financialisation has even damaged unfairly the standing of the role of markets (and economics): “The intellectual misconception behind the thought that prosperity might be enhanced by trade in baseball cards has been associated with an economic model that misunderstands the (important) role that markets play in enabling complex modern economies to manage information,” Kay writes. Prices are important signals – just not the prices on the trading room screens.

Shrinking the finance sector takes the book in its final pages to the influence of money and lobbying on politics. Which politicians are going to serve the people instead of the masters of the universe? Unfortunately I haven’t heard even the Labour leadership candidate my Tory best friend has renamed “The Gift that Keeps on Giving” addressing this. As for the American system, utterly bought by big money, beyond hope.

Meanwhile, I hope lots of people will read Other People’s Money and then send it on to their elected representative with suitable passages highlighted, saying – if you want my vote next time, act on this.



Life beyond shareholder value

The peerless Izabella Kaminska (@izakaminska) of the FT linked this morning to this Andy Haldane speech, which I’d only skimmed when he made it. The speech discusses the consequences for corporate governance of the way the limited liability corporation has evolved, giving primacy to a narrow view of shareholder value. It cites en passant some terrific books both recent – Anat Admati and Martin Hellwig in The Bankers’ New Clothes, Colin Mayer’s Firm Commitment – and less recent – Berle and Means’ The Modern Corporation and Private Property and Schumpeter’s Capitalism, Socialism and Democracy.

The speech looks at the historical context of the emergence of limited liability, especially in banking. The need to which it responded was of course the increased capital requirements of the time, the Industrial Revolution getting well under way. With either partnerships of unlimited liability, banks in particular were unable to respond to crises by raising new capital. (Not that it proved straightforward in 2008-9 even with limited liability.) The speech ends with a discussion of potential corporate governance reforms, including clawing back bonuses, and modifying company law to reflect wider stakeholder interests, in addition to shareholders’ interests.

The history made me ponder, however, whether the limited liability public company largely ought to go the way of the megalosaurus? Already the growth of private equity suggests there are other financing channels chipping away at the monoculture. Perhaps when legislators ever get around to doing something, one of the corporate governance reforms needed is to reduce the role of limited liability public companies in the economy.

Meanwhile, I’m reading John Kay’s latest, Other People’s Money, an excellent read which follows up on his short-termism review, to which the Andy Haldane speech refers. A review to follow.

A tale of modern Russia – and London

The latest instalment in my holiday reading has been Peter Pomerantsev’s Nothing is True and Everything is Possible: Adventures in Modern Russia. I’d started it on the train home from the bookstore where I bought it a few weeks ago and only saved the bulk for the holiday with the utmost exercise of willpower. It’s a brilliant book. Pomerantsev, a TV producer and writer brought up in the UK and living in London again now, spent some years working for a Moscow TV station. His account of the people he met through his documentary making and in everyday Moscow life is utterly illuminating about the state of Russia.

It would be impossible to do justice to the book by summarising it. Just read it. Mainly of course the book is about Russia. But it is also terrifying about the scope in the modern world for manipulating belief through the media, the combination of techniques from Goebbels and post-modern spin doctoring.

Above all, though, the final part of the book made it clear that today’s Russia is only possible because of today’s global financial system and especially today’s London, with the bankers, accountants and lawyers who are totally complicit in the handling of corrupt Russian money – not to mention all the armies of service businesses happy to feed on it.

When David Cameron recently made his speech saying London was no place for dirty money I was surprised nobody called him out on the hypocrisy of the sentiment, because London is of course the world capital of dirty money, among other things destroying the functioning of our capital’s housing market. Perhaps if the UK government turns out to be serious about eliminating the flow of illegal and corrupt funds, it will only be the case that some other offshore financial centre is willing to pick up the role. So be it. I’ll be surprised if it turns out Mr Cameron really meant it, however, given the extent to which the City depends on that flow of money. But he ought to – we should not allow gangster states the credibility of being able to use our capital city to cleanse their money.

Now onto another novel – Kamel Daoud’s The Meursault Investigation.

Railways and plutocrats

This is a bit off-topic i.e. isn’t an economics book, but I enjoyed Iain Sinclair’s latest, London Overground: A Day’s Walk around the Ginger Line. It’s an absolutely characteristic dyspeptic take on what’s happening in the unfashionable parts of London, the places linked by the tarted-up, more-or-less linked-up overground rail lines where Londoners can afford to live, if they’re lucky, pushed ever-further out by the tide of foreign plutocrat money drowning the housing market, leaving swathes of the city deserted because of the absentee landlords.

Sinclair’s work is an acquired taste but I love it. This is not one of his best – not up to London Orbital standard –  but it does feature one of my favourite things, a Victorian-built railway. Sinclair writes of the “functional elegance of Victorian arches” – indeed. And then there’s the anger, the anger, about the money: “Dirty money was never so bright, so blatant. So protected by the politics of no-nothing quiescence.” This week the Chancellor of the Exchequer said we should stop the banker-bashing; but I’m with the Governor of the Bank of England, saying there had been ‘ethical drift’, and the time really has come for the money people to regain their social licence to operate.

UK bank profits are back to their pre-crisis peak

Earlier this week I attended the ONS’s regular Economic Forum, and the recent changes to the National Accounts provided one of the main subjects discussed. The slides included this one showing the old and revised profits of the financial sector in the UK:

Financial sector profits, ONS

The revision incorporates a change to the reference interest rate used in the ‘FISIM’ methodology for the finance sector (see my GDP: A Brief But Affectionate History for more on this, and also Banking Across Boundaries by Brett Christophers). Although this does not remove the absurdity that the sector’s biggest contribution to GDP growth came at the end of 2008, as the financial crisis burst upon us, it has led to sensible revisions – including the downward revision in financial sector profitability shown in the chart here, with the new red line below the old blue line.

However. it is equally striking that recent profitability has been revised up significantly, and in the most recent quarter has matched the earlier peak.

This confirms anecdotal evidence (i.e. bankers and business people I chat to) that banks have been taking advantage of low headline interest rates to increase their interest and profit margins. While they moan about the regulatory burden, this doesn’t seem to have affected their profits or bonuses at all. I hope the Competition and Markets Authority will be looking at the new ONS profitability data in its decision about whether to launch a market inquiry into the banking sector – it is due to publish its decision any time. And good luck to Colette Bowe, announced today as the new chair of the Banking Standards Review Body, set up by the banks to make them all behave better – a very impressive woman but a massive task. My firm belief is that the market structure will need to change if the ethics of people working in the sector are to improve; they aren’t all bad people, but they face terrible (from society’s perspective) incentives.

The ONS Economic Forum was full of other interesting information – including news that it will start to publish wider well-being indicators alongside the quarterly national accounts data (the third release) from December. Sarah Connor of the FT has written this up.