Dr. Eleanor O'Higgins, UCD Business, reviews John Kay's recent book

Seven years after the onset of the financial crisis, John Kay’s recent book recalls the events and offers an analysis of their precipitation. He proposes remedies to repair what went wrong, install robust frameworks to prevent recurring crises, and 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 the users of its services to process payments, provide credit and capital, and manage savings and economic risks.

When banks saw that apparent huge riches could 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. Apparent high returns on banks’ equity masked a low level of capital and very high leverage with inordinate risks, ultimately leading to default. Invidious comparisons with seemingly sensationally profitable peers encouraged contagion. Even staid institutions felt compelled to get in on the act.

The financial sector, became dominant, i.e. ‘financialisation’. Its tentacles reach into every walk of life. Thus pathology in finance will have adverse influences throughout the economy and society.

The issue was not that banks, rescued by taxpayers, were ‘too big to fail’, but 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’, and essentially a redistribution from Irish taxpayers to the spivs and speculators who took advantage of the property bubble, and relieving foreign lenders to Irish banks of their potential losses. He names Sean Fitzpatrick as ‘perhaps the most reckless of CEOs of all financial institutions’.

How does Kay’s elucidation of the dysfunctional dynamics of the finance sector underpin his reform agenda? More regulation alone is not the answer and can be counterproductive. 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. Subsidisation of trading activities by 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 trade 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, demands of their employers and clients, and the systems within which they work.

Kay’s remedies make sense, but how do we arrive there, especially the cultural change that takes time and cannot be achieved by fiat? What if some harmful practices like high frequency trading that he deplores, or shadow banking are too embedded to reverse,? In the context of cultural change and personal responsibility, he attaches importance to legal repercussions but he might have delved into the types of behaviours, 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 in terms of their brilliant university degrees really what we need as servants of the people rather than masters of the universe?