Kay, Other People’s Money

John Kay, a British economist and columnist for the Financial Times, has written a first-rate book about the path the finance industry followed from the 1970s until the crisis of 2007-2008 and the path it should follow in the wake of the bank bailouts. Other People’s Money: Masters of the Universe or Servants of the People? (Public Affairs, 2015) is not, the author is quick to point out, yet another book about the financial crisis. It is instead an exposé of financialization, in which personal relationships were replaced with an anonymous trading culture that mistakenly thought it understood risk and liquidity. And it is a call for “a finance sector to manage our payments, finance our housing stock, restore our infrastructure, fund our retirement and support new business.” Such a call is necessary because “very little of the expertise that exists in the finance industry today relates to” any of these. “The process of financial intermediation has become an end in itself.”

If this sounds familiar, I can assure you that Kay presents his case in a fresh way. In the process he offers what amounts to course on “clever” banking. For instance, he describes how banks have engaged in regulatory arbitrage, fiscal arbitrage, accounting arbitrage, and jurisdictional arbitrage.

He counters the claim that high-frequency traders contribute to market liquidity in the sense that, as a result of their activity, markets would be able to meet a sudden or exceptional demand without disruption. They problem is that they provide no capital to the market. “Speculators,” he suggests, “can help provide liquidity when they bring capital to the market and the scale of their activity is moderate relative to the activities of long-term investors. Matters are quite different when the dominant mode of market trading involves short-term speculators trading with each other. Ticket touts can serve a useful role at popular sporting events when demand may exceed supply: but when the majority of tickets are in the possession of ticket touts, the price will be volatile—determined mainly by the expectations of other ticket touts about future prices—and the needs of genuine fans ill served.”

Kay is at home with, and has opinions about, a wide range of issues that touch on finance. He claims, for example, that “probabilistic reasoning does not play a large part in our lives because the situations in which it can usefully be applied are limited. We deal with radical uncertainty [the unknown unknowns] through storytelling, by constructing narratives. … This, not the Panglossian world of ‘the Greenspan doctrine’, is the world in which business is conducted and securities are traded.”

Kay also believes that, although “transparency is a mantra in the modern world of finance, … the demand for transparency in intermediation is a sign that intermediation is working badly, not a means of making it work well. A happy motorist is one who need never look under the car bonnet. … The demand for transparency in finance is a symptom of the breakdown of trust.”

Other People’s Money is a book that many people, especially those satisfied with the status quo, will undoubtedly argue with. But it should sharpen their views, and perhaps even here and there change them.