OTHER PEOPLE’S MONEY: The Real Business of Finance
Author: John Kay
Publisher: PublicAffairs
Pages: 336
Price: $27.99
In an 1814 letter, Thomas Jefferson complained that the financial sector of his day was populated by “adventurers... who burthen all the interchanges of property with their swindling profits, profits which are the price of no useful industry, of theirs.” Almost exactly two centuries later, John Kay echoes the sentiment, noting that as “exchanging bits of paper cannot make profits for everyone,” it is very likely that much of finance’s profit “represents not the creation of new wealth but the sector’s appropriation of wealth created elsewhere in the economy.”
The charge is an old one that has taken on new relevance in the wake of the 2008 crisis. Yet Kay is no angry Jeffersonian agrarian, but rather an academic economist with a weekly Financial Times column and a one-time financial consultant. He is more sanguine than the typical finance basher in that he acknowledges the sector’s critical roles: as a payment system, a means of channelling savings to productive investments, an instrument to help manage personal finances across the life cycle and generations, and a marketplace for transferring and managing risk.
Nonetheless, Kay writes, a more recent process of “financialisation” has created a hypertrophied sector, its activities ever more abstract and divorced from the real economy, successful mainly at multiplying the remuneration of its members. “The tip of the tongue that laps up the cream of the commerce of a continent” was how Oliver Wendell Holmes Sr described the New York money centre of his day; Kay might rather characterise it as a gobbling maw.
Finance, Kay argues, has strayed dangerously from its core functions. And the functions themselves have been jumbled in dangerous ways (for example, with deposit-taking becoming the funding source for uncertain, long-term risk-taking). Within each function, activities have moved from the primary to the (literally and figuratively) derivative — less investing, more trading, fewer assets and more “asset-backed securities.” Meanwhile, long-term relationships have been reduced to short-term transactions. The result: instability and crisis.
While the gravamen of its complaint is old, Other People’s Money is not merely another broadside content to denounce finance’s dysfunction, but rather a masterly attempt to locate its various origins and connect them with analytical and theoretical rigor. Kay provides by way of context a panoptic overview of the history, evolution and structure of the financial system in the United States and Britain, one that is impressive in its ability to weave together a comprehensive range of material, from the mechanics of banking to the Gaussian copula, in elegant, jargon-free prose. He confidently employs many perspectives: economic, historical, legal and psychological. Call this technique a Lombard Street for the 21st century.
The last third of the book insightfully addresses reform, which, refreshingly, Kay stresses is not the same as regulation. Some of finance’s most abstruse and pernicious activity arises from regulatory arbitrage — restructuring transactions so that they move from a less favourable to a more favourable regulatory rubric. Moreover, financial regulation suffers from a faster-spinning revolving door compared with other industries, with the regulators themselves either coming from or looking forward to landing in the industry they are supposed to oversee. Kay writes like an anthropologist: The roots of finance’s dysfunction, he says, are cultural. The ethos of an old-fashioned partnership of traders risking their own capital endured even as a move toward public shareholding transferred “both these risks and these rewards from the partners... to the shareholders. In reality, it had little effect on the financial expectations of those who worked in the firms.” Reform has to mean changing the industry culture: inculcating an ethic of stewardship and faithful agency (living the rhetoric of “putting the client first”) and changing industry structure where culture clash is insuperable.
It’s a pity policy makers didn’t have this book in 2007. In 2015, it can read like an indictment of a convict already sentenced. Post-crisis, banks are more heavily capitalised, trading less and earning lower return on equity. “Large financial conglomerates were run for the primary benefit of the people who manage them — and, in the main they still are,” Kay says. But surely to a decreasing degree: At Goldman Sachs, the amount of total revenue that is set aside for employee compensation has gone from more than 50 per cent before the crisis to about 37 per cent in 2014. Still, this can feel like a change born of chastening rather than epiphany. Kay makes a strong case that change must be embraced rather than accepted grudgingly if it is to endure.
Author: John Kay
Publisher: PublicAffairs
Pages: 336
Price: $27.99
In an 1814 letter, Thomas Jefferson complained that the financial sector of his day was populated by “adventurers... who burthen all the interchanges of property with their swindling profits, profits which are the price of no useful industry, of theirs.” Almost exactly two centuries later, John Kay echoes the sentiment, noting that as “exchanging bits of paper cannot make profits for everyone,” it is very likely that much of finance’s profit “represents not the creation of new wealth but the sector’s appropriation of wealth created elsewhere in the economy.”
The charge is an old one that has taken on new relevance in the wake of the 2008 crisis. Yet Kay is no angry Jeffersonian agrarian, but rather an academic economist with a weekly Financial Times column and a one-time financial consultant. He is more sanguine than the typical finance basher in that he acknowledges the sector’s critical roles: as a payment system, a means of channelling savings to productive investments, an instrument to help manage personal finances across the life cycle and generations, and a marketplace for transferring and managing risk.
Nonetheless, Kay writes, a more recent process of “financialisation” has created a hypertrophied sector, its activities ever more abstract and divorced from the real economy, successful mainly at multiplying the remuneration of its members. “The tip of the tongue that laps up the cream of the commerce of a continent” was how Oliver Wendell Holmes Sr described the New York money centre of his day; Kay might rather characterise it as a gobbling maw.
Finance, Kay argues, has strayed dangerously from its core functions. And the functions themselves have been jumbled in dangerous ways (for example, with deposit-taking becoming the funding source for uncertain, long-term risk-taking). Within each function, activities have moved from the primary to the (literally and figuratively) derivative — less investing, more trading, fewer assets and more “asset-backed securities.” Meanwhile, long-term relationships have been reduced to short-term transactions. The result: instability and crisis.
While the gravamen of its complaint is old, Other People’s Money is not merely another broadside content to denounce finance’s dysfunction, but rather a masterly attempt to locate its various origins and connect them with analytical and theoretical rigor. Kay provides by way of context a panoptic overview of the history, evolution and structure of the financial system in the United States and Britain, one that is impressive in its ability to weave together a comprehensive range of material, from the mechanics of banking to the Gaussian copula, in elegant, jargon-free prose. He confidently employs many perspectives: economic, historical, legal and psychological. Call this technique a Lombard Street for the 21st century.
The last third of the book insightfully addresses reform, which, refreshingly, Kay stresses is not the same as regulation. Some of finance’s most abstruse and pernicious activity arises from regulatory arbitrage — restructuring transactions so that they move from a less favourable to a more favourable regulatory rubric. Moreover, financial regulation suffers from a faster-spinning revolving door compared with other industries, with the regulators themselves either coming from or looking forward to landing in the industry they are supposed to oversee. Kay writes like an anthropologist: The roots of finance’s dysfunction, he says, are cultural. The ethos of an old-fashioned partnership of traders risking their own capital endured even as a move toward public shareholding transferred “both these risks and these rewards from the partners... to the shareholders. In reality, it had little effect on the financial expectations of those who worked in the firms.” Reform has to mean changing the industry culture: inculcating an ethic of stewardship and faithful agency (living the rhetoric of “putting the client first”) and changing industry structure where culture clash is insuperable.
It’s a pity policy makers didn’t have this book in 2007. In 2015, it can read like an indictment of a convict already sentenced. Post-crisis, banks are more heavily capitalised, trading less and earning lower return on equity. “Large financial conglomerates were run for the primary benefit of the people who manage them — and, in the main they still are,” Kay says. But surely to a decreasing degree: At Goldman Sachs, the amount of total revenue that is set aside for employee compensation has gone from more than 50 per cent before the crisis to about 37 per cent in 2014. Still, this can feel like a change born of chastening rather than epiphany. Kay makes a strong case that change must be embraced rather than accepted grudgingly if it is to endure.
© 2015 The New York Times