Reflections on my time in the City (pt. 3)

In part 1 and 2, I evaluated the financial system as I see it. This part will look at potential solutions to some of the issues raised. They are not complete solutions, but areas where I think the most effective impact can be made.

Note: for a more academic exploration I would suggest the following: the Kay Report, the Vickers report, Basel III and New Economics Foundation. They do the proper work – I am merely offering opinion based on anecdotal experience!

Contain the locusts

 

 

As discussed in part 2, one of the problems with the finance system is that it creams off too much in fees for the value it creates. Rent-seekers (the locusts) need to be treated as if they were monopolies and face some form of regulation. Rent seekers are fund managers, m&a bankers, bulge bracket lawyers etc. To re-iterate, the vast majority of the people are good at their job: committed, diligent, energetic with strong interpersonal skills. They should be rewarded – the problem is the level of reward. The best analogy I have is that of the US doctor, who does an amazing job and is one of the best doctors in the world. However, because of the closed nature of the system and the information asymmetry (people in the system know more than people outside of the system) the US has the most expensive healthcare system in the world.

 

The question of how to combat these fees this is difficult – surely we let the market decide? Some ideas are

1. Accepting recommendations from Kay report i.e. that rewards for executives should be based on more longer-term measures (stops short term fee creaming)
2. Adopt the Scandinavian system whereby everyone’s income is published. Whilst initially uncomfortable, over time this would lead (indirectly) to more awareness of the fees that certain people and businesses are able to charge and get away with.
3. In the end I think the most effective and sustainable solutions are market based. Educating people about personal finance – about where one’s savings go and the fees charged can go a long way. Movements such as moneysavingexpert.com are good examples. If people shop around and don’t let financial institutions get away with high fees, the system will be forced to adapt.

Filling the gaps – effective, visionary sources of funding

I talked in part 1 about the difficulties that the current finance system has in supporting long-term (risky) investment. Some finance systems, such as found in Rhine capitalism, seem to address such gaps. The following are ideas I think could be utilised to reform the Anglo-Saxon model:

 

1. Development banks are banks that have more than the financial returns of their investors, depositors etc in mind. There are traditionally found in emerging market economies (e.g. the World Bank, the Asian Development Bank, the China Development Bank). In the UK, institutions such as the European Investment Bank (EIB) and the Green Investment Bank (GIB) provide important funding for long-term investments that the private finance sector will not fund. Such banks need to be better supported and have a wider mandate. Vince Cable’s business bank is one such idea. In addition, NEF have some interesting ideas about how central banks can provide an important source of funding for such banks. Whether RBS or Lloyds could be re-shaped to become more like Germany’s KfW (Germany’s development bank) is another avenue to explore.
2. Trusts and Academic Institutions (and Government) – it's not just the financial system that can write big cheques. Institutions such as the Wellcome Trust fund billions of pounds of scientific research. Our great Universities are a great source of research and development as well as venture capital. Finally, the government (even though it has its own short term stakeholders, i.e. the public, to please) is vitally important for innovation and de-risking long term investment for the private sector. In short, I think Vince Cable’s idea for reinvigorating industrial strategy has a lot going for it.
3. Peer-to-Peer lending – although in its early stages, I think this source of lending which cuts out the middle-man (e.g. fundingcircle.com) could solve several issues, including being an important competitor to banks. Although some teething problems will need to ironed out

We also, however, need to be pragmatic. The fact is that the technology that allows the world economy to function is largely in the hands of large corporates.  Furthermore, as Cambridge's Professor Peter Nolan points out in this article our technological progress is ultimately tied to these large corporates: “one hundred giant firms, all from the high income countries, account for over three-fifths of the total R&D expenditure among the world’s top 1,400 companies". These companies are funded through the “mainstream” financial system. As a result we cannot just rely on creating alternative forms of funding – we also need to make sure that our main system of finance can fund and steward these companies and not bring them down with its short term behaviour. John Kay's report on short-termism in the city has a good set of recommendations of how we might go about this.

 

Banking needs a re-brand as a public utility and other industries need to “speak out”

 

In my view, the rest of the economy needs to do a PR dress down of finance. This, ultimately, would be the benefit of the wider economy. The aim of such a campaign would be to disassociate a career in finance with the ‘glamour’ of the city lifestyle.  As a result we might those who are part of the academic elite might be concerned less with financial excess  and more with public service and advancing human understanding in the hi-tech, civil engineering, care or teaching professions (as well as many others). The "how" is difficult, but the following are interesting avenues:  

 

1. My blog has advocated an increase in well-being and philosophical education so people make more progressive life choices.
2. More needs to be invested in the PR of other industries when attracting young graduates (in the same way Teach First, Silicon Valley and the Civil Service Fast Stream have done).
3. Some of the change can only be a result of evening up pay levels (I still do not understand why, for instance, teachers are paid so little when they are basically responsible for the future human capital of the country). The high and low pay commissions have some interesting ideas.

It would also be nice if working in the industry is a more stable, progressive and positive place to work. But this might be more to do with the nature of work in general.

 

Be prudent - let’s not ever pretend we’ve fully understand the world (and its risks)

 

One of the mistakes of the system has been its belief that it understands the risks it is taking when investing money. I don’t want to offer any detailed solution, as this is a technical area that I have not addressed in this post. Suffice to say the system should always err on the side of caution, and we see this in the reforms included in Basel III and the Vickers reports e.g. on capital adequacy (well thought out ideas, but too boring / detailed for a blog of this nature). This will also need to be tempered so we do not create more gaps in our finance system.

Conclusion
 

Let me conclude by saying I still stand by my original assertion -  on the whole, I think the our finance system compares well to other systems. However, this does not prevent the need for reform to make sure the finance system (i) is not self-serving; (i) fully supports our wider economic system; (ii) is not a brain drain on the rest of the economy and (iv) is stable and does not succumb to the idea that we have fully mastered risk.