Tuesday, 3 July 2012

I blame the job-hoppers

The debate about what to do in response to the LIBOR scandal has predictably begun to fragment. The government continues to try and limit the scope of any inquiry to specific behaviour and nebulous culture, while Labour pushes for Leveson 2. The advertised remit will be "to examine issues of transparency, conflicts of interest and the culture and standards of the financial services industry". Meanwhile, various commentators and insiders pursue their own hobby horses. The bone-dry Terry Smith, for example, continues to advocate the breakup of retail and investment banking, though it's worth remembering that as a broker his client base would increase in size as a result of this.

As I noted the other day, culture (normative behaviour) reflects the structure and purpose of the industry, not the moral habits of the people within it. Bob Diamond's departure this morning from Barclays will not materially affect the culture. Changing the cast will make no difference if you are still putting on the same play in the same theatre, particularly if other theatres continue likewise. It bears repeating that this "culture" is industry-wide, which raises the question: how are cross-company industry norms established and maintained? More specifically, how did collusion over the LIBOR rate across multiple banks come about? In the case of the City there are two structural factors that stand out.

The first is job-hopping. Moving to another bank/brokerage/trader after a year or two is considered perfectly normal, particularly following the annual bonus round. It's no secret that banking recruiters are at their busiest in February/March for this reason. This regular movement helps establish and spread a common set of norms and values, and also spreads “innovative” financial practices (including, it would seem, fiddling the LIBOR rate). Management don't just tolerate this movement, they encourage it, hence the prevalence of head-hunting. The consequence is an incestuous industry that prides itself on being externally distinct but internally homogeneous, hence the common slang and social rituals, from the excess consumption of Bollinger to Spearmint Rhino's.

The second factor is physical proximity, which in turn facilitates the first factor. Investment banking and financial trading tend to concentrate in specific areas, with usually a single, dominant location for each jurisdiction. Deregulation and globalisation have resulted in many more country stock exchanges opening up, but large-scale financial trading has been consolidated in just a few global centres, one of which is London's square mile and its Isle of Dogs annex. In the past, this concentration reflected proximity to merchants, with the result that banking culture and merchant culture overlapped considerably (originally they were one and the same).

Since the introduction of electronic trading in the 70s, and the coincident disappearance of merchant business on the doorstep (notably in both New York and London with containerisation killing the docks), the location rationale has been driven more by the legacy of regulatory privilege (e.g. the Corporation of London) and the proximity of legal, political and commercial elites. In practical terms, financial trading could operate just as well in Guildford, but you'll find few takers for relocation. Even hedge funds, which operate at a remove from day-to-day trading, have only gone as far as Mayfair.

The continued concentration in The City, and the absence of countervailing influences from outside, has led to an inward-looking monoculture within the financial sector. This in turn has fed back to influence (or infect) industry and commerce (notably through IPOs and mergers and acquisitions) and politics (through lobbying and funding, but also indirectly via regulatory capture).

When investment banks’ customers were primarily merchants and industrialists, the bankers needed to exhibit norms that secured the latter’s confidence and custom, hence the importance of “my word is my bond” and general probity. Similarly, when retail bankers focused on small businesses and middle class depositors (before the credit card boom in the 70s), they exhibited appropriate norms: your bank manager took a keen interest in your business, and you liked the idea that your bank was run by incorruptible Quakers.

An interesting subtext of the current fretting over City culture is the snide suggestion that the recruitment of oikish barrow boys since the 80s corrupted the blameless public school ethos that had been the norm before. This ignores who did the recruiting, not to mention the long history of banking scandals over the 19th and 20th centuries. Ironically, the one "alien" input that can legitimately be fingered is the conscious importation of US practices (of which Bob Diamond is emblematic) as the old London houses sold out during the wave of consolidation post-Big Bang.

Fully separating retail and investment banking would go some way to fixing the culture (though it’s worth remembering that culturally a high-street cashier is a world away from a forex trader anyway), but ultimately the rapacity of financial traders is the result of the widespread financialisation of the modern economy. Denying access to retail deposits would only make a small difference to them (though it would make the rest of us feel much more secure), given the huge amounts of money swilling around in pensions, insurance, equity markets and sovereign wealth funds. A lot of money = a lot of transactions = more commission. This is why I am sceptical of claims that the banking omniscandal will lead to the decline of The City and by extension do damage to the UK economy.

The fundamental problem is a surplus of capital, all of it seeking a decent return. This surplus in turn reflects the imbalance in the global terms of trade over the last 30 years. I don't mean the terms of trade between individual countries, or even the (very real) imbalance in savings and consumption between developing and developed nations, but the terms of trade between the classes across all countries. I think it is widely accepted that the increase in global wealth over the period, through technological advances and productivity gains, has been disproportionately captured by the top end of the income scale. Or to put it another way, capitalists, rentiers and the supporting professions are a lot richer now than they were in the 70s. The rest of us are materially better off (because of technology), but relatively poorer in the sense that we haven't gained the full fruits of our labour and have become increasingly dependent on personal debt to maintain lifestyles.

The vast expansion in credit reflects not just the need for lower income earners to augment stagnant wages, but also an opportunity to soak up capital surplus and boost profits. As the net amount of debt at the global level is precisely zero (every debit has a matching credit), the issue is therefore one of distribution. There are many mechanisms that effect this distribution, from price inflation through wage inflation and taxation, but the one that has been on steroids since the 70s (and is now arguably out of control) is financial services.

Fixing banking therefore means fixing capitalism. An inquiry into "the culture and standards of the financial services industry" will barely scratch the surface.

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