A well-functioning financial services sector is a key part of an economy that produces goods and services that citizens need and want.
Without capital to invest in productive capacity and without the liquidity of money to allow good and services to be exchanged securely, then life would be bleak. Finance should be a little-noticed facilitator of useful work in the economy.
But a type of subversion occurred in the 1980s that deregulated financial services, and morphed the sector into a predator, feeding off the real economy, not supporting it. It is ironic that the people broadcasting this state of affairs most widely are Republican Americans.
Marco Rubio, the Republican senator for Florida, issued a report showing that the US capital markets have become too self-serving and were no longer helping non-financial business. He asserted that prioritising shareholders above all should stop, and that public policy should direct capital to more productive places — away from Wall Street, and towards Main Street.
The City of London is a far larger part of the UK’s economy than is Wall Street in the USA, and the damage on the UK’s High Street is equal to, or even greater than, the damage to the US’ Main Street.
Financial services take an inequitable share of income and wealth in the country. Their excessive fees ‘confiscate as much as 65 per cent or more of the wealth that … investors could otherwise easily earn’ (Rana Foroohar).
Financial services constrain growth. Too little of the country’s investment (household savings and credit) go into the real economy, instead it mostly goes into existing assets that give the financial services sector faster paybacks. ‘In terms of bank lending residential mortgages accounted for 65 per cent…. Credit to finance investment in non-real estate assets accounts for no more than 14 per cent of the UK total’ (Adair Turner).
And too much of the money that does get invested in companies goes into financial manipulation (especially share buybacks and increased company leverage), rather than into boosting productive capacity. Senior managers in ‘real’ companies collude with the bankers to drive share price inflation which pays out large bonuses to share option schemes.
The sequestration of investment, and the intemperate creation of credit (debt) by commercial banks drives asset inflation and high levels of indebtedness which then results in a boom and bust economy that: damages the real economy; and accelerates inequality by putting more money into the hands of the asset-rich older population in the south east of England.
There are six sets of action required to reform financial services:
- Reintroduce the post-2008 regulations, most of which have been discarded as a result of lobbying by the banking sector.
- Introduce further regulation to decrease intermediation fees and make them more transparent (to prevent widespread mis-selling) so that citizens keep a higher proportion of their savings and pension income.
- Restrict banking activities, especially the creation of complex derivatives and trading activity that add no value to the real economy.
- Substantially increase reserve and equity ratios so that the freedom for banks to create debt is severely reduced, and responsibility for determining the level of money supply is returned to government.
- Regulate against the misaligned incentives that give bankers fat bonuses for activity that creates no value in the real economy.
- Restrict the amount of debt that goes into asset inflation and debt-fuelled consumption, and, instead, legislate to direct money into productive investments in the real economy, and in particular into small and medium-sized enterprises.
Without resolute action, pensioners will increasingly discover that their pensions have been pilfered, and the UK economy will soon suffer another financial crash.
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