The upheavals in financial markets in recent days have tended to polarize arguments about who or what is to blame for the state of affairs we find ourselves in.
In one sense it is pointless pointing accusing fingers at the markets or at the people who play in those markets, because they represent an wholly unrefined element which responds to very few imperatives apart from the act of making money. Both the markets and their practitioners are programmed to follow the profits wherever they can find them, and if this means shorting the stock of a venerable British bank, regardless of the consequences to other workers, shareholders or investors, they will pile in, like sharks in a feeding frenzy when they smell blood in the water.
We are forced to recognize that market practitioners follow no rules but their own, and all the efforts of Governments and Regulators to tame those instincts are usually illusory. As soon as a new rule or regulation is created, then the practitioners will be busy finding ways to avoid it, or better still, ignore it altogether. The British Government tried to outlaw short selling after the South Sea Bubble crisis in 1720, but no-one in the market took any notice of them.
This episode did spawn one interesting observation. Because short selling was now officially prohibited, dealers could not make written records of their deals, because to do so was to leave proof of their own criminality lying around. So dealers had to trust one another to meet their obligations if called upon so to do. The system worked as long as everyone played by the rules, and out of it emerged the motto of the Stock Exchange ‘My word is my bond’. It has never ceased to amuse me that this motto, which so many generations of city practitioners have taken as a sign of high integrity and clean dealing is in fact, nothing more than a criminals’ charter!
However, in another sense, it does become valid to seek for a scapegoat for the present financial mess we are in, if only to see if there are lessons we could really learn this time.
Some commentators have claimed that the problem is down to banking greed. There can be no doubt that the short-term accounting methods forced upon the global banking sector has driven an agenda of short-term profit making, as opposed to longer-term revenue generation. But this is to see only part of the problem.
Like it or not, the banking industry has always had two faces. There is the stern, prudent profile of the traditional conservative banker, paying significant attention to a public association with all that is venerated at the heart of the financial establishment. So, banks will sponsor the opera, the major rugby internationals, Glyndebourne, etc, in an attempt to project the image they have of themselves as being part of a long-standing tradition of probity and sound practice.
However, behind this façade, is the more realistic picture of the white-socked market spiv, the sharp-suited wide-boy, on the make, on the take, and always with one eye on any opportunity to turn a profit. I used to work for an international computer company that liked to entertain its banking clients at its lavish management centre on the Cote d’Azur. One afternoon session in the seminar room was entitled ‘…Why the financial services sector gets such a bad press…’ One CEO, much refreshed from a long lunch in the sun with copious amounts of cold white Provencal wine, made the whole presentation redundant by admitting ‘…Because they know that we all screw our clients senseless…’
This is what the American criminologist Edwin Sutherland referred to when he talked about major public financial institutions engaging in ‘…public association with high codes of conduct but private derogation from the norms…’
All the time the recent clamour was on from shareholders to continue enjoying the huge profits being raked in from the sub-prime ‘market-go-round’, the banks had to deliver. As a Citibank executive recently admitted, ‘…while the music is playing, you have to get up and dance…’
All the time banks continue to be dictated to by the myth of the need to deliver ‘shareholder value’, at the expense of everything else, adequate capitalization levels, long-term capital investment programmes, risk management systems, staff training, then they will continue to look like the pure gamblers they have become as opposed to the effective financial managers they once were.
This role has not been something which the banks should have been able to adopt so easily. A significant degree of the fault lies with the supine attitude of the regulators on both sides of the Atlantic. In the US, bank and market regulation used to be relatively effective under the watchful eye of the Securities Exchange Commission and the Federal Reserve. It wasn’t terribly difficult because US law enforced a deliberate separation of financial function between retail banks and investment banks. The Glass-Steagal Act kept the two sides of the industry far apart, and refused to allow any cross-over in areas that would put the retail customer at any great risk. The SEC, in the same way reflected the concept of ‘Truth in Securities Law’ as the banking regulations amplified the ‘Truth in Banking’ standards, which had been bolted into place by the Roosevelt administration as part of the post-depression reconstruction.
Like it or not, that era of strong regulation coupled with high levels of intervention by Government enforcement agents, maintained an American economy and financial market which was able to support the US through the Second World War and enable her to emerge as the strongest economic power at the Bretton Woods conference, and to engineer the post-war reconstruction of a destroyed European economy.
In latter years, financial practitioners began to chafe at the bit, complaining that US market regulation was rendering them less competitive than their European and particularly British counterparts, and attempts were started to lobby for a reduction in regulatory supervision. At first, the era of more relaxed regulation which was ushered in by the Regan election, did not identify any marked financial failings. Following the era of Reganomic de-regulation in the US, which coincided with a long period of onward and upward movements in both securities and commodity prices, the Clinton administration was able to cement a period of financial security and profitability. However, it took the Bush administration to sow the seeds of the contemporary downward spiral in regulatory anomie. In essence already a committed de-regulator and tax cutter, George W Bush was a willing recipient of the advice poured into his ears by his financial friends, who included Kenneth Ley of Enron infamy, and who encouraged a man with a hugely limited knowledge of even the most basic principle of Economics, to tread lightly in regulatory matters.
In the UK, our own adventure with financial regulation has been equally unsatisfactory. The new regulator, with its commitment to ‘light-touch’ regulation, and the encouragement of the New Labour Government ringing in its ears, adopted a regime of ‘hands off’ as far as the markets were concerned, and as long as the money came pouring in, they were able to maintain a stance of detached interest.
Now, their Chairman has admitted that their regulatory stance was ‘regulation on the cheap’ and that the market will receive a much heavier response in future, with a far greater degree of regulatory intervention being imposed.
The only problem with this argument is to ascertain where the FSA is going to get the requisite practitioners with the relevant level of skill and knowledge from to be able to take the City on at its own grubby games. Some of their recent hires to their so-called ‘intelligence’ function leave a great deal to be desired. A career hitherto of working in refugee administration for the UN in some Central Asian Republic does not exactly provide the requisite skills needed to take on some short-selling market manipulator or insider trader.
Let us not kid ourselves any further. This market tailspin has been caused by a culmination of a host of factors, greed, lack of regulation, hubris, market conditions, investor stupidity, and a wholesale unwillingness to recognize that markets can only be driven so far before a correction becomes inevitable.
Bernard Baruch, an American economist writing in the aftermath of the Wall Street Crash said;
‘…At a time of dizzily rising prices, it behoves us to remember that two and two make four. If we had given that fact greater consideration I believe much of the present mischief could have been averted…’
It is ironic that his wise words should need to be recalled again!