leaders, the economy and bankers.

Although next week’s debate is supposed to be about the economy, stupid,   I doubt there’ll be much more light shed on their policies then than we’ve seen already.

While all the candidates have been remarkably frank about how massively stuffed the public finances are, they’re still pussy-footing around the problem which is still financial services.  There’s a lot of talk about better regulation and controlling bonuses, and the LibDems are pushing Glass-Steagall splits. What they’re not saying is that the sector is a bloated and inefficient drain on our economy.  It needs to go on a proper diet and lose a lot of weight, just as manufacturing did in the 1970s/1980s. The problem is that it looks healthy. It’s generating big  profits – back in the 70s, the bloated nationalised industries were turning in record losses, year after year. But financial services is different. Let’s not forget that the sector did make massive losses last year. The turnaround since 2008/9 isn’t a sign that it’s back in health: far from it.  When the giant nationalised industries were making routine losses, they were subsidised by the taxpayer year on year, but the scale of their losses wasn’t a patch on the losses made by the banks in 2008/9 – which we picked up.  Despite all the talk, nothing has been done to correct the structural problems which led the banks to their problems in 2008.  The money in the financial services system is still flowing from savers (whether they’re depositors or shareholders)  to bankers, instead of from savers to enterprises.

Back to basics: this is what is supposed to happen. Savers put money into the system; the system puts the money into enterprises; enterprises make profits; the profits are paid back to savers.

What actually happens: Savers put money into the system. The system bundles the money into fashionable instruments . It trades the instruments internally, and they show lots of paper profits. Savers seem happy, so they put more money in. The trades make money so the traders take commission. Enterprises don’t get much money because their real profits, from hard work making real stuff, are less than the artificial profits made by whizzing complex instruments around the “market”.  Then, every so often – in 2000, in 2008, there’s a “crash”. Savers lose out, the traders stop making money but they’ve already taken lots of commission and stuffed it up their noses.

In the run up to 2000, the fashionable instruments were investments in dotcoms. You might think that then, it was working properly – the money was going into enterprises. And yes, ten years on, some of those dotcoms are now making real money doing really useful stuff.  One or two are making lots of it. But the financial services industry wasn’t interested in those profits.  It wasn’t interested in the actual process of selling useful stuff  or services that people want. As far as it was concerned, the dotcom business model was: invest in a startup, talk a good talk, offer shares to the public based on the talk, sell your shares for a massive profit, walk away.

In the run up to 2008, the fashionable instruments were more complicated – collateral debt obligations, credit default swaps, whatever. But the fact is that anyone who bothered looking could see that a poor American on welfare was about as likely to keep up his mortgage payments as a dotcom with no business model was ever going to make a real profit.In both cases, there was collective deception. In dotcoms, it was “we don’t really understand this internet thing, but it’s going to be massive”. With sub-prime, it was faulty maths by people in financial services paid by their bosses to come up with the right answer and a belief that the property market would go on rising anyway so it didn’t matter if the sums were wrong.

The problem is that the financial services sector puts up a veil of complexity between saver and borrower, and makes profits behind that veil. But they are all illusory.  Go back to first principles:  unless enterprises make actual profits,  the money to pay bankers’ bonuses, or financial service sector profits has to come from somewhere else.  Which means it comes from savers or the taxpayer. And enterprises aren’t making much in the way of actual profits. Although we’re technically “out of recession”, real businesses are struggling.  So where are all those bonuses coming from? At the end of the day, it’s your and my pensions.

But why do we let them get away with it? Here we come back to politics. The system is massively rigged in favour of using the financial markets. If you want to save for a pension, you only  get tax benefits if you save in an authorised pension fund. These funds are run by financial sector insiders. The “fund managers” are traders who get commission-based bonuses; you pay them 1.5% a year as well.  And the funds fail – not often, but when they do, it hurts.  People who put their savings into Equitable Life are still suffering.  It’s not surprising that lots of people put their money into property. Frankly a buy-to-let property in a good location is still probably a better bet for a pension than putting money into a money-purchase pension fund. In fact, property is really the only easy way to invest without using the markets, and this also causes a distortion. It makes property disproportionately expensive with all the political problems of housing affordability that follows.  There’s no simple way to invest directly in enterprises.

If an enterprise wants to sell its shares to the general public, it is required by law to produce a prospectus, and the total cost of all this won’t be much less than a million pounds, paid to lawyers and investment bankers. Alternatively, it can stay private, and persuade friends and family to stump up the cash.

So the conclusion to this post is that the problem with the financial services sector is, bizarrely, over-regulation: but not over-regulation of the sector itself. Rather, it’s over-regulation of the savings and investment markets. This regulation is designed to protect savers, but it fails to do so. It tries to protect them by shielding them from the risk, but it would be better to make them more aware of the risk and encourage them to spread it themselves.

This is now actually possible. It will almost certainly need a major reform to the Companies Acts, but we have, in the internet and cheap IT, the way to do it now.  More posts on this will be coming soon.

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