| Market reform: Ensuring openness and accountability |
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The final seminar in the Fabian Next Capitalism Series focused on the future stability of financial markets in the wake of the recent crisis. Led by Tom Huertas of the Financial Services Authority and John Kay of the Financial Times, and chaired by Sunder Katwala, General Secretary of the Fabian Society, the discussion centred on the issues of state and public support for financial institutions, the suitability of transparency obligations for businesses and the possibility of future sustainable growth in regulated markets. Given the general pessimism that surrounds most discussion of economic stability following the recent financial crisis, this seminar aimed to discover what, if anything, would actually change in terms of markets and financial reform and the implications of this for risk and sustainability in terms of potential future crises. The panel were asked to consider the following: firstly, what markets should look like and how they should be supported; secondly, the ways in which business transparency could be encouraged; and finally, how to ensure sustainable growth in regulated markets. Tom Huertas began by arguing that the structure and appearance of markets were highly dependent on the degree to which they were supported. He highlighted the pervasiveness of the ‘too big to fail’ philosophy and the consequences of high levels of state support for the banking sector. Specifically, he argued that market expectations of government support for banks and guaranteed ‘bail-outs’ significantly influenced the willingness of market participants to lend money to banks. Whether the bank was likely to get into trouble in the first place became a secondary concern. The ‘too big to fail’ phenomenon needed to become a thing of the past, Huertas argued, for a number of reasons. Firstly, it distorted the market and undermined market discipline; secondly, implicit or explicit guarantees were extremely expensive; and thirdly, government failure to fulfil these guarantees could cause a radical reshaping of market prices, as happened when Lehman Brothers filed for bankruptcy in 2008. We needed to find a way to resolve any future banking crisis without providing bail-outs and without destroying continuity in terms of customer accounts. Regarding transparency in financial institutions, Huertas argued that this was critically dependent on the level of support available to the borrower. Only when borrowers and lenders were truly exposed to the possibility of real loss did they demand sufficient information about a company and trends in the political and economic climates that may affect their investments. Banks were obliged to tell their customers anything that may affect their financial condition, said Huertas, but conversely there must remain very strict confidentiality in other areas, for example regarding bank activity such as mergers, which should be maintained under threat of prosecution. There were times when material information should be made available to all investors rather than a privileged minority, but a distinction had to remain between what was and what was not appropriate for public exposure. Turning to the issue of future sustainable growth, Huertas argued that this required strong and stable infrastructures such as payment clearing and settlement systems, which if not sufficiently secure had the potential to bring down the entire financial sector. He pointed out that the volume of trading in real terms had “shot through the roof” over the past two decades as the cost of trading had reduced and it had become easier. The cost of capital for market intermediaries must also be considered; the idea that a market participant engaged in proprietary trading should benefit from a ‘too big to fail’ assurance, especially when linked to the compensation that they would receive should the market fail, was a controversial one: “Heads the trader wins, tails the society loses – this is not a long-term acceptable environment”. John Kay entered the debate and turned the discussion towards the nature of markets; specifically, how to effect a reconciliation between centre-left politics and a market economy. He asked why market economies so markedly outperformed private economies in general and issued a three-fold response: firstly, that “prices as signals” proved a better method of resource allocation than planning and central direction, for which the requirements were far too large; secondly, that markets essentially constituted a “process of discovery”; and thirdly, that markets acted as a way of decentralising economic power and producing constraints on “rent-seeking” (using one’s resources to obtain an economic gain from others without reciprocating any benefits to society through wealth-creation). Kay argued that the first benefit had been over-emphasised at the expense of the other two. He highlighted the common fallacy of supposing that since markets were ‘good’, there ought to be as many of them as possible, an attitude that we needed to get away from. He went on to suggest that there had been a general confusion of pro-market policies with pro-business ones, which had combined with a strong government tendency to view the public interest in a particular industry through the eyes of established private firms operating in that sector. In the case of financial services, it was regarded as self-evident that the public interest lay in maintaining the existing corporate entities and structures which operated at the moment, whereas these were actually seriously dysfunctional and required reform. In situations like this, it was no wonder that the electorate acquiesces to and yet despises the idea of markets, as they were often equated with greed – a false assumption. The debate turned at this point to the concept of social responsibility and what could be done to ensure that financial services actively benefitted society as a whole. Both Huertas and Kay agreed that there had to be some form of cost-benefits analysis to lessen the social costs associated with market failure. Kay added that there was currently no guarantee that failure would not be subsidised by “the man on the street” and there needed to be greater clarity regarding social benefits. Financial activities do contain social benefits but these had little or no connection to their private benefits. Huertas pinpointed the example of algorithmic trading, which had contributed to the speed and overall ease of trading, but its contribution to the overall social welfare of the UK and the global economy was open to question. He added that initiatives such as stress-testing in financial institutions had added to their strength and capital adequacy. Discussion turned to the future of the market economy and the implications of past financial crises for the possibility of recovery. Kay argued that the response to previous crises, which amounted to “pumping large amounts of public money into it”, effectively, provided fuel for future ones, to the extent that he saw a larger version of the current crisis in the next five to seven years as being nearly inevitable. That there was currently no policy response in place should this happen only opened up the additional possibility of a political crisis arising from a lack of leadership. The key issue for assessment of the financial sector, said Kay, was to judge it by what it could deliver in a non-financial economy. Within the financial services sector itself, structural considerations must be paramount but this must not lead to public supervision of institutions; even if this were credible, such action would disable the idea of markets as a “process of discovery”. In closing, there was some agreement on the ability of the market to recover. This was tempered, however, by the acknowledgement of the difficulty involved in moving away from ‘too big to fail’ and the serious reprisals for the economy should this move fail. There was a strong awareness of the need to protect the average consumer by way of putting in place stable mechanisms to ensure the safety of investments. Huertas stated that “market discipline has to come from the market” and argued for the introduction of deposit guarantee schemes in the event of bank failure and protection for insurance companies to ensure customer investments were safe. The necessity for markets to operate in the public and social interests was reiterated and although it was agreed that such reform would be lengthy, to dismiss it as impossible would be a very sobering conclusion. |
Fabian Next Capitalism Series
