Keynesian Spirits



How useful is the financial services sector?

Before the recent financial crisis ravaged the lives of tens of millions and jolted the certainties of academic economists and policymakers, regulatory bodies like Britain’s Financial Services Authority used to boost that they offered a ‘light touch’ regulation. Regulatory bodies worldwide seemed to be in a race to lower regulatory standards and openly show their faith in the invisible hand.

No longer. Adair Turner, chairman of the FSA, has taken Keynes’ words to heart (When the facts change, I change my mind. What do you do, sir?) and has taken the lead in thinking beyond the standard models and has been making strong, rather ‘radical’ policy proposals for the financial services sector. No one disagrees with the idea that a well-functioning, innovative financial sector is essential for any economy, but disagreements about safety of individual institutions and the whole system, remuneration and other issues persist. Hence, original thinking should be and is very welcome.

Below are the main points from Mr. Turner’s recent speech at Cambridge University:

1/ Taxation: While core capital requirements will be increased from 2% to 7%, they should ideally be at least double, if not treble this number.

2/ Higher pay: The trend to defer bonuses and award them in shares may have the perverse effect of actually increasing bankers’ pay in the long-term. On the other hand, we’ve already heard that bankers are using certain instruments to actually get round this problem of deferred payment.

3/ Rent extraction: A large amount of the banks’ activities essentially extract rent and do not add to social welfare:

(a) Tax management activities earn banks large fees and help firms avoid paying tax to the exchequer.

(b) Creation of obscure products that hide risks for investors and hence lead to unbearably high risks being taken not just by individual investors but by big institutional investors.

(c) Financial products offering so-called protection lead to greater volatility, which sets of another product creation cycle to allow investors to hedge risks from this increased volatility.

***

BBC’s Peston on Turner speech

John Cassidy on the usefulness of Wall Street

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