Wealth creation ?

I rambled in my October 11th posting about the disconnection between what the financial industry does, and what the real economy needs.  This wasn’t, I confess, one of my more piercingly original thoughts.  The writings of Will Hutton before the crash and John Lanchester afterwards, follow the same line.  When the Labour Party leader Ed Miliband suggested that it was important to distinguish between good capitalist enterprises, and bad ones, he was attacked for a brief period before the pause when people realised he was … er … right.  To take a simple example: it doesn’t take a genius to note that the purposes of a bank are basically threefold:

  1. To provide a safe home for deposits, and provide a reasonable return for savers – both of which they have failed to do in recent years. The banks would have collapsed without government support (read Alistair Darling’s account for the grisly details).  And they are still paying insultingly low rates of interest on deposits rates that have fallen since the Bank Of England has given them access to low cost funds (and removed their obligation to compete for real savings from real people).
  2. To offer funds to business to allow them to expand – which they have failed to do in recent years. Project Merlin was a damp squib, so that now the banks are bribed with cheap funds to lend on, with the effect mentioned above.
  3. To maintain and grow the shareholder value of the company, representing a decent investment for shareholders, which they have failed to do in recent years. Bank shares have fallen in value, and were pretty humdrum performers even before the crash.  Here’s an insight about the value of the stock market showing the true value of companies – the bank with the soundest base (HSBC) was one of the poorer performers against the adventurists.

The reasons for these failings come down to two reasons.  Most obviously, the executives have been generously paid anyway: their packages seem unconnected with these three core activities.  Secondly, there has been an alternative form of lucrative activity that seems to justify the term ‘casino capitalism’.

With this in mind, turn to yesterday’s Sunday Times business section, and weep.

  • Front page story – Royal Mail is now profitable, so it must be sold off (and if it was poorly run, of course, it would need to be sold off, too).
  • A hedge fund is shorting the stock of Ocado (who do Waitrose deliveries amongst other things) to make money when its shares fall. Exactly what value does this add to the economy ? This is a giant game of poker, with the difference that corporate reporting rules mean you can see your opponent’s hand.  It adds next to nothing to the economy.
  • The firm that owns amusement arcades, casinos and tanning companies paid £109m in dividends to an offshore company owned by the (British) founder. Which is sadder – how they make their money, or where they send it ?
  • The only noteworthy aspect of the business record of the new Chief Executive of a mining company appears to be that he sacked 12,000 striking African miners.
  • Page 3 – the characters who made money out of Comet collapsing move their attention to a company which has already undertaken one ‘pre-pack’. This is a way to declare your company insolvent, and then open up again.  The article describes this as “dumping £18m of debt”, a more elegant way of describing defaulting on your creditors than it deserves.  My wife was left unpaid for consultancy work and lost several thousand pounds on a similar scam financial restructuring recently.
  • Page 4 – the chief executive of Flybe airline explains how it is the tax system that is depressing his company results, alongside a story about the growing profits of easyJet, who I suspect pay the exact same taxes.
  • The first hospital to be privatized as part of the dynamic new way of running the NHS “appears to be in poor financial health” (page 11), rather like the hospitals that entered into public-private partnership finance deals.
  • Page 5 looks at executive rewards and notes “what appears to be lacking is a strong relationship between pay and returns to shareholders”.

I’m not sure what to do about all this, but I am sure what it shows – namely that the finance industry is not part of the solution, but part of the problem, and we should not listen to those who ask us (like the last and later disgraced chief of Barclays) to move on as ‘the time for remorse and apology is at an end’ (© Bob Diamond, 2011).

* footnote for nerds.  Economic theory was based on the idea that firms were profit maximising, because that was what their owners would want.  This motivation was an important driver in the superiority of the capitalist system – because maximising profit meant that costs would be trimmed and new markets discovered. If you’ve done “A” level Economics, you’ll even remember the diagram that shows where profit is maximised where marginal revenue = marginal cost, and which proves that competitive markets produce at the most efficient level possible.   However, in the 1940s some writers (Burnham, Berle and Means) noticed that companies were run by the managers, not the owners.  The shareholders who technically owned the company may have wished for maximum returns, but they had little or no power – they were part of millions of small holdings, or owned the company at a distance via pension funds and insurance companies.  Managers were a different class, had different interests, and were on the job all day and all week.  Why trim costs when you can get a million dollar bonus and a chauffeur driven car ?  Sad that the columnists of our major newspapers have not caught up with sixty year old insights.

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