The City Debate: In This Current Financial Environment, More Financial Regulation Is A Major Part Of The Solution

Securities & Investment Institute
Annual Debate
Mansion House, London
Wednesday, 14 January 2009

“In this current financial environment, more financial regulation is a major part of the solution”


For the motion:
Dr Vince Cable MP
Mr Alan Yarrow FSI

Against the motion:
Professor Michael Mainelli FSI
Mr David Bennett FSI
Chairman – My Lord Mayor, Ladies and Gentlemen.

Chairman:
Mr Christopher Jones-Warner FSI

Text of Professor Mainelli’s response:

[STARTS]

Tonight I am that kid who told you that Santa Claus didn’t exist. More and better regulation is a lie-for-children alongside Santa Claus, the Easter Bunny, Nessie, immaculate conception, evolutionary design and honours-on-merit.

Wikipedia’s definition of financial services regulation “is a set of beliefs and practices, often centered upon specific supernatural and moral claims about reality, the cosmos, and human nature, and often codified as prayer, ritual, and [religious] law”. Oops, that’s Wikipedia’s definition of religion. But financial services regulation is a religion. Recent regulatory failure has created apostates, the worst challenge for a religion, so the establishment is performing the classic redoubling ploy, “regulation failed because you really really didn’t believe enough in regulation. So pray harder.”

Market failure comes in three broad categories: lack of competition, information asymmetry/agency problems, and externalities. Wholesale finance certainly exhibits classic signs of lack of competition: an industry that went from a market capitalisation in the USA of 5% in 1990 to 23.5% in 2007 – a quarter of the US economy is pushing paper around? And self-evidently excessive salaries, a banking industry with 2006 profits per employee a magical 26 times higher than the average of all other industries worldwide (according to McKinsey), and a cast list of the top 10 that would be largely recognisable back in 1929: Goldman Sachs, Merrill Lynch, Lehman Brothers (oops), Morgan Stanley, Bear Stearns (oops), JP Morgan Chase, Citi … mid last year – less than 20 global investment banks, 4 auditing firms, 2 credit rating agencies, 2 actuarial firms. Frank Partnoy covers two decades of scandalous abuse of investment banking customers in nauseating detail in his 2003 book, Infectious Greed – and taxpayers pick up the cost.

When we see market failure we should first try and fix it through trust-busting or anti-monopoly laws or regulation – the 1890s in Britain, the 1900s in the USA. The religious faithful of regulation want to go much further the other way and now seek powers to create and follow mega-banks, rather than question whether size itself might be a sign of regulatory failure. Only Private Eye had the guts to call a spade a spade – “Gordon Brown promised to increase regulation to deal with collapsing financial institutions, but his biggest move so far is a massive decrease in regulation” suspending normal competition and takeover rules for Lloyds and or Santander. Yet as The Economist points out, “In a world in which big financial firms were allowed to go broke, many of these [regulatory] flaws would matter little.” [“Northern Rock: Who Regulates The Regulators?”, 29 March 2008, pages 41-42]

Regulation has caused overly-large dangerous banks. Regulation creates barriers to entry, promotes the large over the small, and reduces competitive variation. Too big to fail means too big to regulate.

Everyone has their favourite fixes (including me – changes to credit market structures, to credit rating agencies, to auditing, to accounting, to regulation, to risk management, and fundamentally, to competition). Looking back over the past two years, it is apparent that everyone has stumbled and bumbled from incident to event to problem to fix, yet almost all have failed to separate temporary fixes from permanent solutions. Permanent solutions need permanent questions, such as “how would we know when the financial system is working?”

The Credit Crunch is not amenable to quick fixes but, in today’s world of “keep-it-simple-stupid” bullet points, some high-level conclusions include:

  • too big to fail is too big to regulate – financial services is a bit special (so are pharmaceuticals, defence, electricity, air travel, shipping, water, …), but the fundamental regulatory tool in all markets is competition and we need to increase competition in financial services, not reduce it;
  • increases in regulation reduce diversity – a healthy financial services ecosystem should exhibit diversity, yet society appears to over-value presumed economies of scale in financial services;
  • less regulation is just as important as better regulation – what we have here is a failure to regulate, but more regulation is not a measure of success;
  • government intervention displaces private sector investment, as a multiple – the sooner government activity and funding of financial services returns to a minimal level, the sooner longer-term reforms can begin.

I would urge all those embarking on financial services reform to have answers to “how would you know when the financial system is working?”, i.e. what is the desired outcome. Some of those answers might be “when a 20 year old can safely enter into a financial structure for retirement” or “when we can sensibly finance a forest” – sustainable financing over 75 to 100 years, not just quickly flipped transactions. Given recent events, the financial system, if not broken, reveals itself to be incapable of dealing with the long-term. Yes, regulation must change, but moreover I would encourage research into the idea of Long Finance.

I do believe in the power of competitive markets to make the world a better place. I equally believe that markets are social tools requiring design and oversight to meet their objectives. Still you must vote against the motion, for sane discussion in the City, even from those of you who, like me, think that our industry is culpable. Human nature means that competition works, and other regulation must be limited, whatever lies for children politicians and journalists want to sell. Let’s be The City. Tell it like it is – first competition, then better regulation, but certainly not more.

[ENDS]

Result:

The opening vote was 30% in favour of the motion, 30% against the motion and 40% undecided.

The closing vote was 39% in favour of the motion and 61% against.

Yes, Michael and David won.


Supplementary information from Wikipedia:

“Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance.

From 1986 to 1995, the number of US federally insured savings and loans in the United States declined from 3,234 to 1,645. This was primarily, but not exclusively, due to unsound real estate lending.

The market share of S&Ls for single family mortgage loans went from 53% in 1975 to 30% in 1990. U.S. General Accounting Office estimated cost of the crisis to around USD $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government from 1986 to 1996. That figure does not include thrift insurance funds used before 1986 or after 1996. It also does not include state run thrift insurance funds or state bailouts.

The U.S. government ultimately appropriated 105 billion dollars to resolve the crisis. After banks repaid loans through various procedures, there was a net loss to taxpayers of 40 billion dollars by the end of 1999.”

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The City Debate: Are Economic Advancement & A Clean Environment Incompatible?

The City Debate 2007 at Mansion House, 29 January 2007

[left to right]

Chris Huhne MP (Liberal Democrats’ Shadow Environment Food and Rural Affairs Secretary), Emma Duncan (Deputy Editor, The Economist), Rt Hon Michael Portillo, Richard D North (Fellow, Insitute of Economic Affairs), Professor Michael Mainelli (Executive Chairman, Z/Yen Group)

The somewhat awkward motion was “Green and Growth Don’t Go” (together implied) though the invitation was “Are Economic Advancement and a Clean Environment Incompatible?”. The audience was over 300 people from finance.

Professor Michael Mainelli’s opening statement to engage the audience was:

Chairman – My Lord Mayor, Ladies and Gentlemen.

Anyone with a waistcoat like mine knows that Green and growth don’t go together. Tonight I am that kid who told you that Santa Claus didn’t exist. Green and growth is a lie-for-children alongside Santa Claus, the Easter Bunny, Nessie, immaculate conception, intelligent design and honours-on-merit.

Let’s face one inconvenient truth – this spinning rock we live on is currently over-run by a bunch of trumped-up naked apes who have three primate imperatives:

  1. find bright, shiny fruit;
  2. avoid snakes;
  3. if you see someone attractive, let them know in a totally satisfying way that you find them attractive.

Three simple imperatives have led to 6.5 billion of the pests monkeying with the world’s thermostat. Way up in the white ivory trees, some brainy apes don’t fulfil imperative three very often. These apes sublimate their urges by dreaming up theories. Their current brainy theory: the moist fringe of this spinning rock is getting all steamy.

Do we know that CO2 levels are rising? Yes. Is there is a credible theory of global warming? Yes. Does this imply big changes over the next century? Yes. So what’s to debate? Well, other brainy apes down on the jungle floor sublimate their urges playing trading games and inventing theories about alpha returns. Jungle-floor apes have a theory: global warming can be stopped if everyone changes their economics a little bit. However, preventing global warming requires massive changes in economics and human nature within this decade, and human nature won’t change in time.

At Mansion House we can debate with real numbers. This is the City, not Westminster.

In 2004, gross worldwide emissions were about 7bn tons of carbon. Emissions are projected to grow to 14bn tons by 2054. For long-term stability, emissions in 2054 must be at or below today’s 7bn tons, and decreasing. Green and growth fans need a 7bn ton cut from “business as usual” by 2054. Socolow at Princeton identified 15 reasonable opportunities, called “wedges”, that would each cut 1bn tons by 2054. One wedge – convert 250 million hectares to biofuels, 1/6th of the world’s cropland. Another wedge – 2 million wind turbines on 30 million hectares, a Germany of wind turbines. Remember we need at least seven of these megaprojects in the next 47 years. They’re very realistic plans. Each wedge costs more than the GDP of China.

Global GDP was $44 trillion in 2005. Stern expects people to pay $440 billion each year to prevent climate change, $125 billion in the USA, $20 billion per annum in the UK. Starting this year. And the CO2 will still exceed 500 ppm. This is incredible, by which I mean it’s not believable. I don’t want a repeat of my Westminster experience on Nuclear Electric decommissioning. “Yes Minister, that number is possible, but certainly not probable!”

The UK has 1% of world population, but emits 2.2% of greenhouse gases. The FTSE 100 alone produce 1.6% of global greenhouse gases. The average person in the UK produced as much CO2 by 6 January as the average person in the world’s poorest countries will all year. You really think this will change?

We are natural optimists in the City. We want to believe that we can do good; we can be green; the bad are punished and the good are rewarded; every story has a happy ending. We fixed the ozone layer; we handled sulphur dioxide well. But these weren’t 50-year, $22 trillion problems. You’ll point to emerging carbon markets we’d all love, but right now carbon credits are little different than the Catholic Church selling indulgences. And that leads us to human nature – sex, greed, fear and apathy.

We breed. By 2054, there will be 9.5 billion of us. Even if Britain stopped all GHG emissions, within two years China’s growth makes that effort worthless. What’s the point if Brazil, India, Russia and China just keep going?

Sure people care but CO2 is tasteless and odourless, while I must have missed seeing us stop a million children a year dying of preventable HIV and measles, 1 million of malaria, 1.5 million of diarrhoea? We are going to solve global warming, yet let 2.7 billion people live on less than $2 a day? Even Stern had to cook the discount rate to make global warming a better investment than the UN’s Millennium Development Goals.

If you believe that green and growth go together:

  • you believe that population will painlessly stop growing;
  • every Briton will pay at least $333 each year forever to prevent global warming, or perhaps $850 or more;
  • two centuries of high latitude infrastructure will be replaced, we will transform the UK’s £4 trillion housing stock – you’ve mothballed listed buildings such as this magnificent house;
  • you’ve stopped funding all oil exploration projects – what’s the point? If we burn what we already have we exceed 1,000ppm;
  • you’ve shorted most of the FTSE;
  • you’ve given up skiing and holiday in Croydon.

Our distinguished journalist will be erudite and persuasive, coming from a magazine with a readership determined to make money out of any investment fashion, a magazine that thinks invading Iraq was a good idea

After her you’ll hear from a gifted Westminster speaker who loves another excuse for them to raise taxes from us. Our speaker’s party peddles a real whopper for children – more tax is good for you and good for the country.

Human nature means that green and growth don’t go together, whatever lies for children politicians and journalists want to sell. Let’s be The City and tell it like it is. You must vote for the motion.

Thank you.

Result:

Debate This House believes that Green and Growth Don’t Go

Pre Vote

  • Yes 32
  • No 65
  • Undecided 3

Final Vote

  • Yes 41
  • No 58
  • Undecided 1

Yes, Michael and Richard won.

Additional Motions:

This House believes that the answer to climate change is technology and not restraining consumer demand

  • Yes 54
  • No 40
  • Undecided 6

This House believes that going nuclear is the answer to going green

  • Yes 57
  • No 35
  • Undecided 8

This House believes that US policy is the biggest single problem to combating climate change

  • Yes 63
  • No 36
  • Undecided 1