Newspaper article The Evening Standard (London, England)

Calls for Change to an Absurd System

Newspaper article The Evening Standard (London, England)

Calls for Change to an Absurd System

Article excerpt

Byline: city comment Anthony Hilton

WHEN Professor John Kay published his review of the equities markets almost two years ago, he was rigorous in his analysis of their shortcomings and how they were failing to meet the needs of business and society. He was rather less effective in coming up with suggestions as to how the problems might be solved.

Since then, however, the evidence has mounted that all is not well, that much of today's financial system is dysfunctional, and that too often it meets its own needs rather than those of its clients. Interestingly, many of those saying this are people who have spent their careers inside banking and fund management, and therefore know very clearly what they are talking about.

One is British-born but New Yorkbased fund manager Jeremy Grantham, who noticed a few years ago that the bigger the financial sector became, the slower was the overall rate of US GDP growth. Basically until 1965, the US economy expanded at about 3.5% a year. Between then and now, the financial sector has doubled in size, from around 3.5% to 7% of GDP, but the rate of growth of the economy as a whole has got ever slower. Today, taking one year with another, the US struggled to get to 3%.

It appears you can have too much of a good thing. The financialisation of an economy is subject to diminishing returns. Then there are more specific criticisms. Lord Adair Turner has shown in recent lectures how the UK banking system is the root cause of severe instability. More than three quarters of bank loans are linked to property, he says, and this creates a self-fuelling boom-and-bust cycle.

The availability of credit pushes up property prices and, as prices rise, it encourages a further round of speculative borrowing and buying pushing prices up even more and well beyond what is supportable in the long term. When the bust comes, the spiral goes into reverse and the deleveraging causes huge pain throughout the economy.

The role of banks in economic textbooks is to provide capital to entrepreneurs to build businesses. That happens very little. Today, the role of banks is to finance speculation in second-hand property. The instability that causes is harmful to the activity of the entrepreneurs. Another critic is former fund manager Paul Woolley, now at the London School of Economics. He notes that equity returns today are massively less than they were up until the 1990s. His concern is that too much of the money in the system is creamed off by intermediaries.

Fund managers do what is good for them and for the fund management business, and this is not always the same as what is good for the clients. Hugging benchmarks and momentum investing are symptoms of this. They reduce the business risk of the fund manager, but the client suffers from poor performance. …

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