4 August 2010

Financial Services - A Culture Needing a Crisis - Part 2

part 2... (read Part 1 first by clicking here)
I’d have to say that I would have agreed with the view that financial markets should be left to act according to the free markets a few years ago. Ultimately buyers and sellers sort out what works and what doesn’t and how much things should cost. The trouble with the financial world is that it has become global, and it is now far removed from a single buyer and a single seller (or a borrower and a lender in the banking world). Complicated financial products were invented which enabled various high risk debts (particularly mortgage loans for low income families in America) to be packaged up (into things called Collateralized Debt Obligations – CDOs) and sold on to other banks as low risk debts.

Transparency was lacking, and also, since it was in everyone’s interests that this whole financial product edifice worked, no-one acted as the whistle-blower. To put it another way, it wasn’t in the culture to flag up a potential calamity:

  • Politicians were happy – low income families were in “their own” homes which was good for votes (and that goes right back to Bill Clinton)
  • Bankers were happy – their high risk loans had magically become low risk so they could borrow more against them as assets
  • Shareholders were happy – since bank profits increased
  • Bank employees were happy – their bonus structures (thanks to the culture – which I haven’t heard has changed) were based on profits they generated, not on the risks they generated, and after all, the taxpayer could pick up the pieces if anything went wrong (not that I think they actually thought about failure)
That’s why I don’t see any alternative other than legislating on things like bankers’ bonuses. If the culture is to reward profit and not worry too much about loss then an enforced cultural change is needed. I find it amazing that the boss of failed RBS – which has cost the taxpayer dearly – still expected a massive pension payout. As an intelligent person (presumably), one can only assume that he sees the world differently to the average man – and that’s a sign of a culture incompatible with reality. He and many others might well say that they have performed the particular task they were given well, and therefore their full rewards are due to them. The rest of us would say that they failed to see the bigger picture which they were uniquely capable of seeing and therefore they have failed.

In the meantime, the culture continues to generate complication because it looks clever, and cleverness is what counts in the banking world. RBS, for example, are currently advertising a retail product which uses “sophisticated dynamic investment techniques” to monitor an index (which itself they have invented using a combination of other indices) and which then uses various parameters to decide whether to buy long or sell short.... all presented as though that’s a good thing!

One could also highlight the culture within financial services regulation as being significant in getting us to where we are. The Treasury, the Bank of England, and the Financial Services Authority could all say that they did what was asked of them. But collectively they failed to prevent a global financial crisis, or even, apparently, to see it coming. I’m quite sure that nobody feels bad about that because they continued to meet their various targets, while continuing to receive their public sector benefits packages.

Here too, there are signs of a culture needing to change. Sadly, I don’t see the proposed reorganisation of the FSA as making any realistic change, and they will continue to regulate the easy bits rather than the bits that matter; but let’s hope I’m wrong.

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