The Financial Services Industry: Only serving themselves?
John Kay’s critique of the industry, Other People’s Money, looks at the need for reform to avoid another crisis.
John Kay is an economist with both academic and corporate experience, and a columnist for the Financial Times. In his latest book, Other People’s Money (R452, Takealot.com http://www.takealot.com/other-people-s-money/PLID34890927), Kay positions himself as a critic of the current incarnation of the financial services industry, suggesting that its usefulness to society has failed to keep pace with its size and the scope of its involvement in the economy.
The financial sector serves society and the economy in (at least) four ways. The payments system enables businesses and individuals to pay and receive wages and to buy goods and services. The sector also enables effective use of savings by matching borrowers with lenders. The existence of the finance sector also enables us to manage our personal finances (across generations, if necessary), and to manage the risks associated with participation in the economy and with daily life.
Insights into the Global Financial Crisis
Kay measures the utility of financial innovations by how much they serve to advance these four functions. He argues that the financial sector has gradually mutated from serving society to largely serving itself and transacting with itself. He inevitably reaches unfavourable conclusions about the frenzied financial innovation of the last several decades, which culminated in the Global Financial Crisis (GFC) of 2007-8. Modern financial markets have increasingly become tightly coupled, complex systems (a process Kay refers to as “financialisation”), and he suggests that a catastrophic systemic failure such as the GFC was inevitable.
As a high-level explanation of the long-ago genesis of the GFC – perhaps even as a history of the development of the financial sector – Other People’s Money is unparalleled. Clear explanations and analogies make the book accessible and interesting to both professional investors and readers simply desiring a better understanding of how the world works, and an idea of how much better it could work. Kay is critical of the additional regulatory burdens imposed on the sector since the GFC. His view is that a restoration of trust in the sector and a change in its culture – neither of which can be effected by legislation – are what is required to restore the greater financial services industry to its prior role as servant of the people.
Searching for solutions
Kay does not shy away from challenging questions. For example, he returns again and again to the fact that the investment industry absorbs so many promising, technically minded graduates who, he argues, could contribute to real innovation and scientific advancement rather than developing increasingly arcane asset pricing models or structured products inside an investment bank. This line of thought presents a personal challenge to professionals working within finance who may not be experiencing the personal fulfilment that stems from engaging in a vocation, which has a clear benefit to society.
Kay argues that the four functions of the financial sector listed above may be distilled into the terms “search” (for investment ideas) and “stewardship” (of other people’s money). He argues that investment banks, insurers, and pension funds have abrogated their historical responsibilities in this area in favour of trading and administration. This leaves asset managers as the providers of the search and stewardship functions, and (perhaps) in possession of the most unambiguous mission among the various players in finance. For asset managers this is both a privileged position and a weighty obligation.
August 10, 2016
Grant van Zyl