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.

EmailLinkedInShare/Save

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.

  

The crisis of inaction

A guest review by Bill Allen

 The crisis in Eric Helleiner’s title is not something that has happened, but something that hasn’t happened. The aftermath of a real crisis – something that has happened – can provide the opportunity for institutional change. Helleiner’s choice of title reflects his observation that there has been very little effective change in the panoply of international financial institutions since the financial crisis of 2007 – 08. Specifically, he claims that the G20 has achieved very little, that financial regulation has remained undesirably ‘market-friendly’, and that no effective international organisation for financial regulation has been set up.

 Helleiner is quite right about the G20, whose main boast – agreement on a doubling of IMF quotas – has not been ratified by the United States Congress. He could have gone a lot further. International institutions generally were not much use in the crisis. The IMF lent very little in 2008. The Chiang Mai Initiative, which had been set up in the late 1990s as a source of mutual liquidity support in East Asia, was not used at all in 2007 – 08. There is a reason for this. International financial institutions, despite having extremely talented staff and managers, are inherently slow in reacting to fast-moving situations and lack the ability to improvise. This reflects their governance structures, and the caution that democratically-accountable governments display when faced with any new invitation to put up money. Fear of moral hazard always trumps recognition of a new urgent need. There is no getting over this problem, and it will be a considerable surprise if the recently-announced BRICS financing facility turns out not to be purely ornamental.

Just as well, then, that the Federal Reserve was unilaterally ready, able and willing to provide emergency dollar liquidity in short order and in massive amounts when it was most needed in the autumn of 2008. Chairman Bernanke received democracy’s traditional reward for doing the right thing when he was attacked for lending money to foreigners by Congressmen who either could not or would not understand that the Fed’s actions were in the interests of the United States as well as those of other countries, and that the Fed had prevented what is now known as the Great Recession from turning into a repetition of the Great Depression.

Where does this leave the international monetary system? Helleiner notes that China is in favour of a system based more heavily on Special Drawing Rights, and bemoans the failure to create more SDRs. But getting agreement to increase the SDR issue is always going to be slow and difficult, no matter how urgent the need. And in any case, an SDR is merely a right bestowed on an IMF member country to get some real money (dollars, probably, or possibly euros) from another member country which is willing to take SDRs in exchange. As Richhild Moessner and I have shown, the expansion of the SDR issue runs the risk of undermining the liquidity of the IMF itself. The key issue is what counts as real money and who controls the supply of it.

Past experience shows that it is desirable for the international monetary system to be capable of expanding international liquidity quickly in a crisis. That means that international reserve currencies have to be managed by single countries, which are sufficiently enlightened to understand that what is in the global interest may also be in their national interest. On this criterion, the dollar is the only plausible reserve currency at present and in the foreseeable future. The euro and its managers have structural problems – no single government,constipated decision making, and a penchant for looking inwards rather than outwards: the European Central Bank was dangerously slow in extending swap lines when they were needed in 2008 – 09, and bizarrely confined its swap lines to EU member countries. The renminbi, often suggested as a possible challenger to the dollar, has the crippling handicap that there is no separation in China between the government and the judiciary. No responsible reserve manager could rely on the RMB as a large-scale repository of liquid assets. Helleiner also claims that Russia was ‘strongly committed to goal of ruble internationalization’ after the crisis (p 85), but if so, Russia did nothing about it, and incomprehensibly passed up the opportunity to win influence among former Soviet Union countries by offering dollar swaps from its large reserves during the crisis.

Unfortunately the outlook for the dollar as a reserve currency is not assured, despite the Fed’s masterly crisis management of 2008. There is the perennial problem of the budget deficit, and the new threat that the Congress will force the U.S. Treasury to default by refusing to increase the Federal debt limit. Without the dollar, the international monetary system would be thrown into chaos, and an undesired return to gold would be on the cards.

What of financial regulation? Helleiner wishes that financial regulation had become less ‘market-friendly’, but he seriously underestimates the amount of new bank regulation that has been introduced and does not seem to understand its effects. For one thing, he says virtually nothing about liquidity regulation, which has been introduced into the Basel regulatory apparatus. In practice, in the UK at least, liquidity regulation has forced banks to buyenormous amounts of government securities, and to curtail lending to private borrowers. It has subsidised government borrowing and taxed private borrowing, and arguably prolonged the recession unnecessarily.

More generally, Helleiner misses what I think is the key issue in bank regulation, namely theproblem of banks that are too big to fail. They were too big to fail in 2008 and they are still too big to fail. This fact has profound implications. Too-big-to-fail imposes contingent liabilities on governments. Naturally the governments want to minimise the liability; hence official regulation of finance. As Helleiner points out, regulators cannot always be expected to co-operate with their foreign counterparts. All of them are servants of their own states, and are obliged to act in the interests of their own state and in accordance with its laws. If those interests and laws don’t conflict with those of other states, then fine; if not, not. So governments want to ensure that their contingent risk is monitored by people they control: international co-operation is limited in scope. All this explains increased capital requirements, the introduction of maximum bank leverage ratios, and the new-found aversion to foreign bank branches and pressure for subsidiarisation of international banks, country by country.

If it could be arranged that financial companies were not too big to fail, then most official financial regulation would be unnecessary; private incentives would be better aligned with social welfare and corporate governance, lamentably feeble in many cases before the recent crisis, could be expected to be more effective. It is impossible to contemplate all parts of the financial landscape being arranged in such a way: for example, the clearing houses through which financial companies are now required to settle derivative and other transactions are inevitably going to be too big to fail. But is possible to contemplate a less concentrated banking and securities-dealing industry, both in the retail and wholesale fields. Paradoxically, heavier and more intrusive regulation protects big companies, because potential competitors cannot bear the heavy fixed costs that it imposes. We have got stuck in a concentratedfinancial system/heavy regulation world, but a dispersed financial system/lighter regulation world would be much better.

 Helleiner is concerned that the banking industry has too much lobbying power, and asserts that reforms have been watered down in consequence. He provides no evidence, merely referring to similar claims by others. He complains that ‘the G20 made little effort to develop international standards that might tackle the issue of the potential “capture” of regulatory process by private financial actors’ (p 126). The United States addressed this issue in 1991when ‘Prompt Corrective Action’ was enacted, removing regulators’ discretion in managing failing banks, but that did not prevent the recent crisis. How serious is the issue of regulatory capture now? In the years before the crisis, bankers, regulators and governments shared many of the same illusions about the durability of the boom. Bankers were respected, consulted, and knighted. Financial companies had a lot of lobbying power, since they paid a disproportionately large share of taxes, in Britain at least – tax receipts that were sorely missed when the financial companies stopped making profits. But now, in many countries, the main issue between banks and governments is the ‘deadly embrace’ in which governments depend on banks to finance their deficits while banks depend on governments to guarantee their deposits. The situation in those countries is a lot more complicated than Helleiner suggests. And, as already noted, some of the post-crisis regulation that has been imposed has, predictably, had unintended bad consequences; perhaps it would have been wise to pay a little more attention to the lobbying of the banking industry.

Helleiner laments the ‘soft law’ character of international regulatory institutions like the Basel Committee on Banking Supervision and the Financial Stability Board. He would prefer them to have powers like those of the World Trade Organisation, which has rules and settlesdisputes between its member countries. But such an arrangement in the field of financial regulation might not be conducive to financial stability. There are signs that these bodies have become fora in which the main issue at stake is not financial stability but the financial and political interests of national governments. How else can the absurdly generous treatment of government securities for both capital and liquidity purposes be explained, and the extremely lenient treatment of mortgages for the purpose of the Net Stable Funding Ratio? Arguably, the world would be a better place if Basel 1, 2 and 3 had never been invented, because it would have been clear to bankers that it was their responsibility to judge the adequacy of their capital, and not something that could be assessed formulaically by reference to a set of complicated rules arrived at as a compromise among national negotiators in Switzerland. The truth is that nobody has yet worked out how to do bank regulation properly, and it would not be a good idea to entrench present-day customs and practices in an international treaty.

‘More regulation’ may be a good slogan but there isn’t much substance behind it. Helleiner denies this, claiming that there are a lot of new ideas in ‘the new macroprudential regulatory philosophy’, which, he says, provide a ‘broad intellectual justification for many…regulatory initiatives…such as counter-cyclical buffers, tighter controls on liquidity and SIFIs, the extension of public oversight to new sectors, transaction taxes, and support for capital controls’ (p 127). Broad, indeed. By these standards, ‘the new macroprudential regulatory philosophy’ could provide intellectual justification for just about anything. Regulation of this kind would be like doing brain surgery with a penknife.

Many of the issues arising from the crisis are unresolved and contentious. Helleiner addresses a great many of them. He has a point of view, with which readers may agree or disagree, but he is well informed and his book is a serious contribution to the continuing discussion. It is well worth reading.

 Bill Allen is a former Bank of England director and is on the sdvisory board of the Cass Business School