There are surprisingly few recent novels or plays about business and finance; there were far more in the nineteenth century. Events in financial markets need to be dramatic and extreme to displace the normal preoccupations of sex, drugs and rock and roll. The crisis beginning in 2007 managed that unusual feat. Robert Harris put aside the Second World War and the fall of the Roman Empire and wrote a thriller – The Fear Index – about a hedge fund in Switzerland which makes fabulous sums of money using a fiendish algorithm which eventually consumes its creators. John Lanchester’s Capital explored the mysteries of escalating London property prices and the devastation wrought on an investment banking family when the million pound bonuses stopped. At London’s National Theatre, in The Power of Yes, David Hare chronicled the crisis through interviews with participants, punctuated by interventions from a wild-eyed Professor – called Howard Davies, as it happens – who had moulded the market meltdown into a five-act Shakespearean tragedy.1
And Shakespeare indeed provided the most penetrating literary lens through which to view the great crisis of the early twenty-first century. Nicholas Hytner’s modern-dress production of Timon of Athens, in 2012, again at the National, began with our hero endowing a new art gallery, surrounded by the great and good of the city, fawning on him and hanging on his every word. When his fortunes turn, and profligate philanthropy outruns his income, Timon ends on a rubbish heap, pushing a supermarket trolley loaded with worthless trash, shunned by his former admirers.
So it was with the ‘Masters of the Universe’ on Wall Street or Lombard Street. When the World Economic Forum was held in New York shortly after 9/11, the Chairman of Lehman Brothers, Dick Fuld, hosted hundreds to dinner at the Four Seasons, with cabaret provided by Elton John. Central bankers and regulators sang along with the bankers and brokers to the chorus of ‘Crocodile Rock’. Fred Goodwin’s Royal Bank of Scotland was lionized by politicians in Edinburgh and London. The bank’s new Edinburgh HQ was opened by the Queen in 2005, with a fly-past of RAF Tornadoes. In London in 2010, Bob Diamond, then CEO of Barclay’s, bestrode the city like a colossus, posing with the Mayor at the launch of his ‘Boris bikes’, all proudly branded with the bank’s logo.
Now all three are non-persons: Fuld closeted with his lawyers; Goodwin living in obscurity, his knighthood humiliatingly removed; Diamond seeking redemption (and profit) in Africa. Nor is their experience of humiliation unique. In Zurich, after the crisis hit, a former senior UBS banker arrived at an elegant restaurant with his wife to find the other diners banging on their tables until he left for home, his tail between his legs.
In the years leading up to the collapse of 2007 it was widely believed that financiers had discovered the philosopher’s stone. Politicians and commentators could not quite understand how the riches were being created, but they were in awe of them nonetheless. Political parties, charities and arts organizations could not get enough of the investment bankers and ‘hedgies’. The top students in top universities, whatever their discipline, sent their CVs to Goldman Sachs in astonishing numbers.
Woe betide any regulator who tried to get in the way of this Midas-like wealth-creating engine. In May 2005 Tony Blair characterized the Financial Services Authority (FSA) in London, which had flexed its muscles from time to time, as ‘hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone’.2 In Washington Alan Greenspan, Chairman of the Federal Reserve Board from 1987 to 2006, stood guard against the enthusiasm of market regulators, always challenging their legitimacy in the face of the magic of the market mechanism. If willing buyers were prepared to buy triple A super-senior tranches of synthetic sub-prime CDOs (collateralized debt obligations) from willing sellers, even at infeasible risk-adjusted prices, who were the regulators to ask the reason why?
When the pendulum swung back it did so in dramatic fashion. Bankers have vanished from the Honours lists in London. They are barely respectable in New York. The worm has turned. Re-regulation is the name of the game. Capital requirements have been sharply increased. Controls on bonus payments have been imposed. Banks have been forced to abandon some of their most profitable lines of business. A spotlight has been shone on hitherto dark corners of the markets, and dubious, unethical, anti-competitive and sometimes simply illegal practices have been exposed. Fines in the billions of dollars have been levied, where, pre-crisis, the penalties for comparable offences were not even a tenth of that. New regiments of regulators have been recruited. The social utility of any kind of ‘financial engineering’ is now regularly questioned.
Financiers, lauded by the press before 2007, are now almost friendless in the media.3 If the Securities and Exchange Commission (SEC) in Washington or the Financial Conduct Authority (FCA) in London proposed that errant bankers should be required to parade naked through the streets, there would be sage leading articles in the Financial Times and Wall Street Journal hoping to see a day when such signal punishment was no longer justified.
And the re-regulators are not the most radical voices. Lurking beneath the surface of this frenzy of legislation and rulemaking are some bigger questions. Can the market monster be tamed at all? Should the state take more direct control of the allocation of capital? Has the crisis revealed that the conventional toolkit of controls is simply not up to the job and perhaps never was? Will markets always be one step ahead of the regulators, shifting their activities around the globe in search of the most congenial environment? While the global economy might seem to have benefited from the flexibility and innovation facilitated by open capital markets, does the huge cost of mopping up the mess alter the calculation? Is the game worth the candle?
The International Financial Institutions, governments and regulators have wrestled with these questions since 2008. Many major reforms have been introduced, with the best of intentions. But the overall response lacks coherence. The fundamental problem of a lack of global co-ordination has not been addressed. Monetary policy and financial regulation remain separated. There has been some, but insufficient, progress on deleveraging. There is no consensus on what led to the crisis. Was it the result of deregulation, based on a neo-liberal view of markets and an excessive reverence for the efficient market hypothesis? Or was the root cause too much government interference in markets, whether through state-backed agencies, or the moral hazard created by the existence of lender of last resort facilities which allowed the financial sector to maintain an excessively high degree of leverage, confident that the state would provide on a rainy day? So the reforms point in both directions at once: more intrusive and directive regulation, on the one hand, and half-hearted attempts to strengthen market disciplines, on the other. The interventions which contributed to market instability have not been withdrawn. Governments say they will ‘never’ bail out over-exposed banks again, and at the same time they introduce incentives to lend for house purchase which risk stoking another asset price boom. They have tightened capital rules on banks, constraining credit creation, but watched while lightly regulated non-banks have expanded.
In 2009 Paul Tucker, then a Deputy Governor of the Bank of England, argued for a new ‘Social Contract’ between the financial authorities and the markets.4 He was right that one is needed, but we are little closer to achieving that new contract today than we were then. The new equilibrium is as unstable as the old. Governments have done the easy things, and talked tough, but have ducked the most difficult questions. It is not possible to ‘control’ financial markets, if by that one means eliminating institutional failure and suppressing volatility. But it may be possible to encourage them to play a more constructive role in the service of the real economy. Before exploring the changes needed to make that happen, we should review the origins of the crisis and the changes so far implemented in response to it.