In 1983, at the age of 24, I started working for an investment bank in The City of London. In those days I thought I disagreed with capitalism. Even as the banking industry swirled around me I thought that for every winner there was a loser. I now have more time for capitalism. I no longer believe that investment of spare funds by people trying to save for retirement is wrong or likely to deprive someone else of value. Indeed I can see now how capitalism is merely the free allocation of funds in a free society and that it is a more efficient way of allocating funds than some bureaucrat in Whitehall.
If I have a few thousand pounds saved which I want to invest for retirement it is acceptable to lend that money to an entrepreneur who has a plan to form a company to provide goods or a service which will make a profit. If, after a few years, I consider that my investment has grown sufficiently and I can’t see the guy making much more money or if I see that another guy has a better chance of making money then it is legitimate for me to sell my stake in the first company and buy into the second.
These are fairly standard arguments and, if one believes in freedom of the individual and of individuals to act together as groups, then they are difficult to disagree with. A whole industry has grown up to facilitate these transactions along with information services to allow me to analyse various economic and financial information.
Yes, much of the money washing around the system does belong to pension funds holding capital on behalf of rich and poor alike. From rich bankers to grieving widows.
But not all who take part in the market are equal. The people who run the companies providing the financial transactions and related services realised that they were making a lot of money and that they could make even more money by ploughing their profits back into the system and trading on their own account.
Further, an article in the Financial Times on June 7th reported that big institutional traders “are winning preferential access to deals because computers used by exchanges are programmed to accept bigger orders first when matching prices”.
So we have a market where the small invester in my initial example is at a considerable disdavantage to large pension funds and banks and as the large organisations may jump in and out of a stock several times within a day we have to ask: Is this investment or gambling?
Another fault that I see in the system is the frenzied nature of professional dealers. In 1986 a wave of deregulation swept through The City in a process known as “Big Bang”. Prior to this trading took place using a process known as open-outcry where traders use hand signals to transfer information. There was a lot of shouting and yelling and things were pretty frenetic. The process is still used by the London Metal Exchange but, after Big Bang, the London Stock Exchange replaced open-outcry by rows of traders sitting at computer screens. Technology went berserk and computers now regularly buy and sell automatically. Volumes have increased and the pace is now extraordinary. A trader will have numerous computer screens displaying graphs and figures and they will need to assimilate this information quickly and then make decisions involving huge amounts of money.
Walking around The City one has to be impressed by the fantastic granite and glass buildings with vast marble entrance halls. One has to be impressed by the frenetic pace of trading activity and by the vigour and determination of the traders but one also has to ask:
Is this any way to invest the funds you are saving for retirement?
Should the various banks be spending your pension money on the most expensive real estate in England? Should they be using your money to build luxurious head offices? Should they be rigging the pay scales of their traders to encourage them to engage in undue risk? Should they be trading in an atmosphere of hysteria?
So what’s to be done? Ban something? Many would argue that you cannot restrict such activity without restricting our fundamental freedoms. They argue that, yes, there are outrageous abuses and failings of the system but that, overall, the system functions better than any other system yet devised. As with the saying about democracy, that it is “the least worst” of all the systems of government.
I read an article recently on the risk assessment process undertaken for nuclear power stations and I recall discussing risk management with an ex-colleague who now works in the oil industry managing the movement of supertankers around the world. In both nuclear power and oil transportation the impact of a failure can be catastrophic and risk management is tasked with analysing and controlling these risks.
It seems to me that the risk management strategies in use by banks and financial institutions are mere fig leaves when compared with the very real risk management which takes place in other industries.
The British government are now making plans to require banks to ring fence their retail banking divisions keeping them at arms length from more risky investment banking. The United States had a similar law known as Glass Steagall requiring separation of high street banking and investment banking. The law was enacted to control speculation following the 1929 Wall Street Crash. However, as the American economy recovered various parts of the law were repealed until the whole thing was dismantled in 1999.
Let’s hope that the British have leaned from the American experience and that the ring fencing legislation currently being discussed will remain in force in bad times and in good.