Michael Roberts Blog

Is finance fit for purpose?

That was the question addressed by Yanis Varoufakis (YV) and Anastasia Nesvetailova (AN) at the next in the series of New Economics lectures organised by the British Labour Party.  Both speakers are members of Labour’s Economics Advisory Council which includes luminaries like Joseph Stiglitz and Mariana Mazzucato.

The question posed could have been answered simply.  The financial sector in the UK and elsewhere does little or nothing for the majority of people in providing loans and support for businesses and households.  From that point of view, finance is not ‘fit for purpose’ as the global financial crash proved.  Instead, the City of London and Wall Street operate to make ‘money out of money’ through ‘financial engineering’ in the world of “the casino”, as YV quoted Keynes in his address.

Our first speaker, AN, who is a professor of political economy at the City University in London and an expert in financial economics, recognised that finance is not fit for purpose in the sense that it is mostly engaged in reckless speculative activities.  But according to AN, banks are no longer the culprits; it is the non-banking sector (i.e. financial institutions that don’t take customer deposits) like investment banks, hedge funds and private equity.  They operate through opaque networks that cannot easily be regulated.  AN reckoned that regulation of banking did not work before the Great Crash.  But the revised and improved international regulations, as in Basel 3, only deal with the banks and not the large ‘shadow banking ‘sector that operates without the restraints of collateral and capital requirements.  So we now have ‘too much’ regulation of the banks to the point that they cannot operate with loans for investment and growth but still no proper regulation of the non-banking finance sector.

What’s the answer?  According to AN, what we need is ‘smart regulation’.  Apparently this meant getting ‘independent’, ‘non-ideological’ expert regulators who knew what they were doing.  However, as AN admitted, this did not look likely to emerge.  Indeed, AN seemed to suggest that as the UK’s financial sector was so important and we could not do without it, and as regulation could not work with all the forms of financing, then we would have to live with the finance sector as it is – at least until ‘smart regulators’ came along.

YV was more forthright in telling the audience that, yes, finance was more complex now, but what was needed was to separate ‘plain vanilla envelope’ banking that provided finance for homes and businesses from ‘speculative investment’ banking using derivatives and other financial ‘innovations’ to make money and which eventually caused the banking collapse.  YV’s form of regulation was to raise the capital requirements of the banks to very high levels (say, 20% of assets compared to 3-4% now) so that they could not engage in speculation and also use the law to separate off the speculative activities of banks, as the Glass-Steagall Act had done in the US (but later abolished by the likes of Larry Summers under President Clinton in 1999).  This would protect the taxpayer from future crashes.  This contrasted with AN’s view that such regulation would bring the finance sector to a halt.

AN said that finance was necessary for an economy to grow.  This comment seemed surprising: of course, finance and credit is necessary for investment – houses cannot be paid for in one go and investment projects cannot always be funded in one year.  But do banks in Britain do anything useful in this regard?  British banks have loans outstanding worth about 160% of UK GDP.  But 35% of these loans went to other financial institutions, 42.7% went to households for mortgages and another 10.1% went to commercial real estate and construction. Manufacturing received just 1.4% of the total!  UK banking’s principal activity is just leveraging up existing property assets.

I was surprised that neither Varoufakis nor Nesvatailova mentioned the work of current Bank of England deputy governor, Andy Haldane.  He has shown in various studies the unproductive nature of finance capital. Finance “could [not] be said to boost overall economic activity or productivity in the economy. They re-allocate risk in the system but do not fundamentally change its size or shape. For that reason, statisticians do not count these activities in capital markets as contributing to activity or welfare. Rightly so.” (Haldane).

The truth is that the likes of Goldman Sachs, JP Morgan, Merrill Lynch and the investment banking wings of the big banks along with the hedge funds and asset management companies offer no value whatsoever.  They are just giant betting machines sucking up the funds of households and productive sectors to make money.  The best thing would be to take them over, close them down and ‘restructure’ their wildly overpaid staff into useful work in proper banking or other industries.

But no, both speakers assumed that the task was to ‘regulate’ the finance sector to make it ‘fit for purpose’.  What we were offered by the speakers was either ‘smart regulation’ (AN), whatever that might really mean, or ‘Chinese walls’ between lending and speculation (YV), harking back to the days of Fed chief Volcker in the 1980s and more recently to the Vickers report on UK banking.

There was no mention of turning the financial sector into a service for the people, like the health service or public transport.  And there was no mention of the best and only method to achieve that – not ‘regulation’, but through public ownership and control of banking and major financial institutions. Indeed, back in 2013, when discussing what to do about the Cypriot banks that were on their knees during the debt crisis then, YV advocated taking over the banks with taxpayers money and then, once they were back on their feet, selling them off again to private investors i.e re-privatising them.

This is exactly what the British Conservative government is doing now with the partly-nationalised failed banks of RBS and Lloyds that the government was forced to take over in the bailout of 2008.  The only difference was that YV would only sell them off at a profit, while the current UK government is selling them off at a loss to the taxpayer.  But YV still opted for fixing up the banks and then putting them back into the hands of private profit.

Contrary to ‘regulation’, in this blog and elsewhere I have presented the case for a publicly-owned banking and financial system to provide a proper service for people, without speculation and without grotesque salaries and bonuses.  See my paper to the Slovenian Labour Institute and the pamphlet for the UK’s Fire Brigades Union on the banks.  That would make the finance sector ‘fit for purpose’.

But public ownership and control is still ignored even in the leftist debates of New Economics, it seems. Nevertheless, as the City of London Corporation hosted the event (!), at least we got free wine and canapés afterwards.