A smart speech for a politcian to make?

Mr Milliband, perhaps?

The time has come for us finally to drain the swamp that is the City of London and rebuild a new, prosperous, ethical and competitive financial sector that efficiently channels savings into enterprise, to build a productive economy that will support an ageing population in an uncertain world.

We are all to blame

All parties must share the blame for today’s mess; Labour no less than Conservative – Labour was in power when it was already apparent that things were not going right. We should have seen the warning signs – Equitable Life, and one mis-selling scandal after another. People were saying that things weren’t right back then, but too many of us swallowed the line that an unregulated system was always going to do best – and, to be honest, we enjoyed the false prosperity it created and the tax revenues it produced. It is cheap to reduce this to party political points; while they were in opposition, the Conservatives were hardly calling for tougher City regulation. But with hindsight, it is clear that mistakes began to be made in the 1970s and 1980s, when we started dismantling outdated defences erected in the 1920s and 30s, after a previous bout of sociopathic behaviour by the financial services industry. We didn’t build replacement ones that were anything like strong enough, we allowed inherently conflicted institutions to grow, giant financial conglomerates doing everything under one roof, and we relied far too much on regulation. Yes, you heard me right: too much regulation.

The limits of regulation

Regulation itself isn’t the answer. Regulation generates friction round the regulated zone. It needs regulators; regulators must be funded; and since there’s always more money on the dark side, regulators move. This is a serious problem in the Civil Service, particularly at the Treasury. The Treasury recruits the best and brightest graduates, but few stay more than a few years before leaving for much better paid positions in the private sector. There’s a problem of continuity, and the quality of institutional knowledge in the Treasury, a resource the politicians running the place depend on, leaves much to be desired. The FSA and the Bank of England share this problem – it doesn’t matter how you structure the departments involved, public-sector regulators can’t afford to retain the best and the brightest people needed to make regulation effective. Regulation becomes an arms race between the regulators and the regulated. We need an environment in which market forces, not regulators, do the regulation. But market forces have failed, because the environment is wrong. Mainly, they’ve failed because we let banks become too big to fail. Market forces depend on the real fear of failure – “moral hazard” is the technical term: markets work when failures fail, not when they’re bailed out. Most of our banks are now too big to fail. Lehman Brothers, a big investment bank with no retail division, was to big to fail without hurting everyone else. The world let Lehman Brothers fail and we are still feeling the after-effects, so the others, we bailed out.

We let them all get too big to fail. A financial sector with more smaller players would be much more resilient; failure would be absorbed. And because we are so dependent on the financial sector, failure of even a moderately-sized player can seriously damage the economy.

Suggested themes

So I am going to make a few suggestions for themes which should underpin a rew regime for the City.

  • First, transparency. No secret deals. Transparency is the simplest and easiest way to rebuild trust. And technology means we can be much more transparent than ever before. LIBOR, for example, shouldn’t be determined by banks’ – falsifiable – submissions, but directly from the actual loans made between banks, the details of which should all be published in near real-time. If the details of a transaction are published, it should be considered prima facie legitimate; if they are concealed, unpublished, withheld, we should assume that it is an illegitimate, unlawful or unethical one. A transaction to which either party is a body incorporated in a secret jurisdiction must be considered a secret one.
  • Secondly, separation of specialisms. Not just a Vickers-plus separation of retail and investment banking, but separating the different functions of investment banking so that there can be no conflicts within a single firm. There is an inherent conflict if the bank which helps you raise money through a share issue is also trading those shares and investing its other clients’ money in them. Stockbrokers should be stockbrokers, banks banks, and fund managers fund managers. This has the additional advantage that it leads to my third suggested theme:
  • Risk Redistribution. Smaller, specialist firms competing in their own sophisticated markets do not present a systemic risk to the system. If one fails, it doesn’t bring down the rest of the house. None of them is too big to fail, and we should expect failures from time to time. Occasional failure is one of the features of a successful market.
  • Fourthly, synchronous rewards: we need to ensure that the rewards earned by the City’s people reflect those earned by their clients, proportionate in both value and risk, and maturing in the same time-frame. Sales commissions on endowments and many insurance products are an example of a badly asynchronous reward, and we should not be surprised that there have been numerous examples of mis-selling.
  • and finally, localised liability. The City serves an important purpose and speculation in all sorts of financial instrument – from simple equities to complex derivatives – keeps markets liquid and provides a useful way for enterprises to hedge against unforeseen risks. But that risk should stay local; it shouldn’t be shared out, lost and absorbed by ordinary people’s savings. The people who gain most out of these markets should be those who play with their own money, not with other peoples’.

This a recipe for a very different City. It would be a much more sober place, but still an exciting one, where fortunes will still be made and lost, and mostly made, but mostly made over a lifetime rather than an afternoon. It will be an entrepreneurial City, one where it’s easy to set up in business, where competition is fierce and as a result, profits mostly low. Where the big bucks are made by hard work, not BSDs. Where professional pride in a job well done for your client outweighs pride in the size of your bonus. Where a few clear principles regulate everything, rather than books of complex rules. An outward looking City, where money is raised for enterprises and managed for savers across the country and across the world. A City that serves the nation, as it has done so well in the past.

A City we can be proud of.

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