Today, Justin Welby was announced as the new Archbishop of Canterbury. So I thought it high time to take a look at some of his sermons and writings while Bishop of Durham. Top of his recent sermon list was a speech that he recently gave to a conference of financiers in Zurich “about the issues facing the financial community as it decides whether to ‘Repair or Replace’ existing systems of control”.
Before I critique, let me say that I am very pleased that we are getting an Archbishop who thinks and speaks about finance and our economic system — surely one of the big issues of our day. He likens the current system to Humpty Dumpty of nursery rhyme fame, who fell off the wall and is now broken. Bishop Welby contends that “too much effort is going into putting Humpty back together again, and it can’t happen”; that instead we ought to put things back together differently. And he asserts that “[F]ar from being the goose that laid the golden egg, [the financial services industry] was in fact the cuckoo in the nest that pushed all the other fledgling industries out to die… The UK has one of the most concentrated and uncompetitive sectors, as regards domestic banking in Europe… [it has] socialised losses and privatised profits.” So far so true.
So here’s my problem. Seven times in his speech Bishop Welby refers to “financial services”. None of these times does he make any serious attempt to distinguish which categories of financial services he is or is not talking about. He tells us that pre-2008 “financial services… involved wild and frantic activity, often by exceptionally intelligent people, working very long hours, but they had no socially useful purpose”. This sounds like an accurate description of an important subset of financial services — e.g. trading in exotic derivatives — but not much like the teller at my building society, or the lady who sold me my home insurance. As a former oil trader, I expect Bishop Welby knows enough to make the distinction between different financial services himself. But in his speech he fails to do so. And the distinction matters.
“Financial services” is a catch-all category that covers a panoply of activities. Most people would agree that many financial activities are important to everyday life, and socially beneficial. But some financial activities are socially corrosive. We would love to stop the latter while keeping the former. However, continuing to use phrases like “financial services” without qualification or distinction, cripples our ability to separate the good financial services from the bad. Let’s have a go at drawing the distinction.
A first category of financial services helps us conduct our day-to-day lives: current accounts; savings accounts; payment systems; perhaps modest overdrafts and low-limit credit cards. Mortgages, pensions and life-insurance help us manage our finances over a lifetime. Car insurance, home insurance, travel insurance (and in the US health insurance) help us protect ourselves from bad luck in life, by pooling and sharing risk. Of course there are abuses such as excessive credit card lending, loan sharks, and the recent ‘mis-selling’ of payment protection insurance. But on the whole the above financial services are socially useful.
A second category of financial services helps support the businesses which provide employment and productive direction to our daily lives: bank loans to businesses; invoice financing; trade finance; commercial paper; vanilla corporate bond markets; early stage equity financing such as business angels and (non-levered) venture capital/private equity; underwriting of share issuances; advisory and M&A support; vanilla trading of vanilla equities; even some of the more conventional derivatives markets i.e. commodities futures — although these have come to be abused horribly. These are (or certainly can be) socially useful. (Those against the use of debt on principle, such as Paul Mills, may wish to exclude several of the above services, but would probably agree that at least the activities being financed by that debt are usually laudable.)
A third class of financial services, however, serves no such mundane goals. These constitute a giant pyramid of speculative activity undertaken primarily within large investment banks and hedge funds. This speculation involves buying financial assets that return money in the long-term (say ten years from now), but funding those purchases by borrowing money that has to be returned much sooner, perhaps the next day! This is inherently unstable, because it depends on being able to constantly renew the borrowing, which becomes impossible the moment a financial panic erupts. This speculation is then magnified by borrowing many multiples of the money that the buyer has on their own account, which is called leverage, achieved by trading on margin, and using repo and re-hypothecation. The result it to create ever more meta-money chasing a finite stock of underlying real assets — land, crops, metals, oil, businesses, peoples’ homes. This drives up prices of things that matter to you and me, and puts the system at risk of crashing down.
The purpose of this third category of financial services is to amass wealth. Now producing wealth is, all else equal, to be applauded (or else the next post would have to be lambasting business entrepreneurs). But these activities do not ‘produce’ anything. Rather they extract. They amass financial ‘wealth’. This ‘wealth’ only has value because it constitutes claims (however indirect) on some underlying real wealth produced by real human activity, in the home, or in self-employment, in business, or elsewhere in the real economy. It may sound polemical, but it is not too strong to describe this extractive kind of financial activity as parasitic. (The well-worn defence of lobbyists for these activities is that they promote ‘price discovery’ and help to ‘allocate capital efficiently’. To take those categories apart is a whole other post, but I hope such rhetoric has by now lost its power to persuade most people.)
And who is served by these financial services? Most of the benefit goes to two groups: the financiers who conduct the speculation; and a very small but extraordinarily (financially) wealthy global elite who provide the chips. A little may have trickled down to the rest of via the investments that our pension funds had in these investment banks and hedge funds. But that has been far offset by the cost of bailouts we will bear through future taxes, lost jobs, and losses to investments and pensions.
Now let me be clear. This is a not a take-no-prisoners-blanket-condemnation of every investment bank (although many of those institutions are so rotten, that attempting to separate out the socially useful activities feels like a fools game) nor of every hedge fund (which after all is another anodyne catch-all term that covers just about every possible investment activity under the sun). Rather, I am criticising a class of activities, which are mostly conducted from with those institutions. Indeed here is a big part of the problem: the socially useful activities have become enmeshed in the same institutions as the bad.
Thankfully, unlike the biblical parable in Matthew 13:24-30, we don’t have to wait until the final judgement to discern correctly the weeds among from the wheat in financial services. Yet we seem to have real trouble telling them apart, let along pulling them apart. This allows lobbyists to use a bait-and-switch. Bait: point to socially useful services like high-street banking to demonstrate that “financial services are a good and important part of our economy”. Switch: “we are also in ‘financial services’, ergo our business is a good and important part of the economy”. It’s rarely put so crudely of course. But the but the general muddying of the waters by use of the use of vague or general categories and language is very effective at confusing and defusing popular sentiment in favour of reform.
Here’s the problem. We lack sufficiently granular categories to discern good from bad among financial services. Consider an analogy. Sport is good, right? Football, rugby, tennis, athletics — fields of human cooperation and endeavour. But ‘sport’ is a very broad category. Under this banner we might also put cock-fighting, cage-fighting and other ‘blood sport’. “But that’s not the sense in which I meant sport,” you say. Quite. And neither should the parasitic type of activities finance be allowed to sneak in under the same banner of ‘financial services’ that would more helpfully be reserved for activities that serve regular people, and businesses in the real economy.
If language can be used as a tool of power, we are giving a lot of power away already. Let’s take some back. Let’s educate each other about the different categories of financial services; to distinguish the socially useful from the parasitic in our thinking and in our discussions. This doesn’t require mastery of archane technical detail. It will require some effort, but what of value doesn’t?
We need new language to reframe the debate. That’s what the Reframe Finance blog is all about.