Seven years after the onset of the financial crisis, John Kay recalls the events and offers an analysis of their precipitation. He proposes remedies to repair what went wrong and to install robust frameworks to prevent recurring crises, and offers convincing detail to support his arguments.
An adage from Adam Smith that we cannot entrust others with our money, since they are likely to neglect their responsibility to us for the sake of personal advantage, summarises the book’s purpose. Kay contends the crisis proves Smith’s view. The finance sector, as an intermediary, operates principally to benefit itself rather than those who use its services to process payments, provide credit and capital, and manage savings and economic risks.
When banks saw that huge riches could apparently be made by dealing on their own account and investment banking eclipsed traditional banking, activities moved from the primary to the derivative and secondary, entailing more trading and asset-backed securities with overblown rewards for investment bankers. Kay shows that these “gains” were illusory. Individual businesses could make money only at the expense of others, but this could not be true for the whole system.
The issue was not that banks, rescued by taxpayers, were “too big to fail”, but that they were too complex. A web of interbank transactions meant that any failure could bring down the whole house of cards. Lehman Brothers’ implosion ensnared institutions with direct transactions with them, alongside those with claims against Lehman’s trading partners.
Kay says: “A remarkable feature of the global financial crisis is that most people in finance seem to regard it as self-evident that government and taxpayers had an obligation to ensure that the sector continued to operate in broadly its existing form, and that this proposition won broad acceptance among politicians and the public.”
His assessment of Ireland’s banking collapse resonates. He deems the government’s bailout of insolvent banks “foolish”, a redistribution from Irish taxpayers to the spivs and speculators who took advantage of the property bubble, and a relieving of foreign lenders to Irish banks of their potential losses. He names Sean Fitzpatrick as “perhaps the most reckless of CEOs of all financial institutions”.
More regulation alone is not the answer, Kay maintains. He advocates structural reforms to counter complexity, lower costs, enhance stability and facilitate transparent information flows between borrowers and savers. Financial services should return to specialist institution structures. The subsidisation of trading activities by using the deposit base as collateral should be eliminated. Conflicts of interest that undermine loyalty and prudence to clients when the same party acts as custodian of other people’s money and trades on their own behalf would be purged. Above all, Kay advocates cultural change throughout banking. This requires more personal responsibility, with individuals held liable for their mistakes. But he backtracks somewhat by suggesting that misbehaving bankers are products of their environment, the demands of their employers and clients, and the systems within which they work.
Kay’s remedies make sense, but how do we make the changes, especially the cultural change that takes time and cannot be achieved by fiat? What if some harmful practices are too embedded to reverse? He emphasises legal repercussions but he might have delved into the personal and professional moral standards we should expect from bankers, irrespective of legal sanctions. This is fundamental. Kay might also have addressed the way bankers are recruited. Are “the brightest and the best” with their brilliant university degrees really what we need as servants of the people rather than masters of the universe?
Other People's Money by John Kay was awarded Business Book of the Year at the UCD Michael Smurfit Graduate Business School Business Journalist Awards in December 2015.
Dr Eleanor O’Higgins is on the faculty at the UCD Michael Smurfit Graduate Business School
