Putting Finance Capitalism "Back in Its Box"

So writes Philip Augar in an April 13 Financial Times (FT) op-ed. He's a former UK investment banker/broker and author of The Death of Gentlemanly Capitalism, The Greed Merchants, and most recently Chasing Alpha: How Reckless Growth and Unchecked Ambition Ruined the City's Golden Decade. More on his newest book below.

He quotes Nicolas Sarkozy, a questionable choice, at the G 20 summit saying "The all-powerful market that is always right is finished," then on departure adding "a page has been turned." For Augar, that depends on whether a "free-market" successor is constructed, something "entrenched interests in America and Britain would be well-advised to encourage if they wish to remain centre stage."

Things unraveled after Bretton Woods collapsed - the post-war monetary system of convertible currencies, fixed exchange rates, free trade, the dollar as the world's reserve currency linked to gold, and those of other nations fixed to the dollar. Absent that, Chicago School economists "persuade(d) the Reagan and Thatcher administrations to adopt laissez faire policies and deregulation." We then printed money freely, spent and lived beyond our means, and created an illusion of prosperity and wealth that led to the current crisis.

Earlier, academics and consultants embraced "free markets" and built a "coherent" business strategy on them. Regulation-freed investment bankers sold "the whole package" to CEOs. Once "derivatives theory (and securitization took hold, they) opened the door to share options and performance-based compensation (followed by) three decades in which tooth-and-claw capitalism ruled supreme." In other words, anything goes, checks and balances are out the window, let buyers beware, but look what it brought us.

"Conditions are now right for another radical rethink. The old model is busted. The big beasts of free-market economics, Britain and America, are more wounded" than most - among developed nations, that is.

So far, "governments, central banks and regulators (the few of the latter still around) are groping unconvincingly for solutions." It's high time for new ideas. Clearly the current ones don't work and must be replaced by something else. But to happen, Washington must take the lead followed by "a more effective and creative" academic response than we've seen up to now.

It "requires finance to be put back in its box." Knock it off its "commanding heights" under (Goldman Sachs) bankers like Robert Rubin, Jon Corzine and Hank Paulson, who "upheld the American tradition of Wall Street titans taking public office" and engineering disaster while there. The same thing happened in Britain with former investment bankers in high Treasury posts giving advice beneficial to themselves and companies.

In both countries, money bought influence, the way it always works. The more spent, the more other voices got crowded out, again the usual result.

Former government and Wall Street insider turned activist, Catherine Austin Fitts, recalls an Indonesian cab driver asking her: "Why do you let Goldman Sachs run your government?" Until recently, it's hard imagining that comment in America.

Surely not from mainstream academia. Instead of stimulating debate, the majority go along and are well paid for it. The few dissenters are "dismissed by economic liberals as living in the past or told that the new financial system had 'transformed risk' and raised global living standards" - despite clear proof otherwise. Markets were having a party, and nothing would was allowed to interrupt.

Finance capitalism took over at most business schools, training a young cadre of adherents. Wall Street, High Street, and hedge funds recruited academics with quantitative skills with offers of "life-changing sums in consultancy (and compensation) fees." Little wonder then that finance capitalism drew such interest and that "so much academic output" supported it.

Change is now vital lest other nations displace America and Britain with alternative models. In addition, "academics need to recapture their heritage," their integrity, their "independent thinking, and throw off the (pernicious) influence of finance." Short of that, today's financial titans may discover soon enough that "the page has indeed been turned and they are no longer on it."

Augar's new book, Chasing Alpha, attracted considerable UK attention but not in America. A financial definition calls alpha a "coefficient which measures risk-adjusted performance (of a) specific (investment to) the overall market." The higher it is, the lower the risk, the idea being to find the holy grail of high, sustained returns.

London did it for 10 years, but it's now chastened by a dark era replacing its "golden" one. How spectacular it was while it lasted, and the same is true for America and elsewhere.

The Sunday Times' David Smith expects many books on the global crisis, but Augar's "distinguishes itself by tracking the rise of the City's various components," including its prestigious High Street addresses favored by the financial community.

When Labour took office in 1997, London was booming, and it looked like the good times would last forever - buoyed by a strong pound, a supportive media, and the City's new hero class, its bankers. Real estate took off. Asset prices rose, and deregulation was the order of the day. Forgotten was the early 1990s "trials" when the insurance market was in trouble. So was Barings from the Nick Leeson scandal, and "Morgan Grenfell, one of the City's oldest and proudest names, (was) mired in a messy legal dispute."

New Labour at first was feared, yet inaugurated what Augar called "the most prosperous period in (London's) history....The (City's) hedge fund business came out of nowhere; between 2003 and 2006, more than 200 new firms and more than 600 new funds were established." Finance capitalism was on a roll with domestic and foreign-owned banks enjoying unprecedented prosperity until mid-2007 when it hit a wall. The scheme for sustainable growth couldn't last. Some officials noticed but not all.

In June 2007, new prime minister Gordon Brown congratulated London on its "global preeminence and saw it continuing thanks to 'light-touch regulation, a competitive tax environment, and flexibility." As finance minister in 2004, he told an audience of bankers: "What you have achieved for the financial services sector, we as a country now aspire to achieve for the whole of the British economy." He'll be living down that comment forever.

In contrast, Bank of England Governor Mervyn King was circumspect. He cautioned about risky financial instruments and the rise of leveraged debt. "Excessive leverage is the common theme of many (past) financial crises," he said. Are we so much cleverer than the financiers of the past?" Indeed not, and perhaps King knew something ordinary investors didn't, but wasn't letting on at the time.

Soon enough he had to as the global crisis emerged. Northern Rock was early victim enough for Britain to have its first bank run in 150 years. Others followed, big names, forcing Labour to take controlling stakes in much of Britain's banking sector. "The game was up, certainly for investment banks and many hedge funds (and unknown then) for most banks" needing government prop them up - in Britain, America, across Europe, and elsewhere.

It was big enough for Augar to produce "a useful contribution....about the biggest financial crisis for decades," a story of greed, excess, and fraud by an insider willing to take the gloss off a "busted model" and suggest something more workable in its place.