Regulation, Demonized Bankers and Financing Systems
At the G20 and elsewhere, we’ve heard government leaders like Obama and Brown calling for more regulation to prevent financial institutions from growing too large to fail and obfuscating their responsibilities. These calls are all well and good, but they aren’t a panacea. The problem with too much regulation is that it slows down markets and hampers growth. The ‘greedy bankers’ that have been reported on so often in the press aren’t the problem—they’re only the symbol. They’ve just been following procedures in a marketplace incentivised by short-term thinking and by imbalanced approaches to risk-taking.
It’s true that markets haven’t been regulated as carefully as they could be, but there’s a reason for this: governments have always wanted wealth to be created quickly in their countries. Making the greedy banker a symbol of the financial crisis has detracted attention from the fact that the system of equity-based financing (in the UK and America) needs to stay intact.
In turn I’ll comment on the value of regulation, the demonization of the banker, and the different international approaches to financing.
Through our study of top teams and board performance, Nada and I have amassed a huge database of information about companies and their boards. Looking at this data, we’ve found that the amount of regulation hasn’t made a difference in terms of performance or quality of governance. Regulations haven’t worked to prevent the betting that quick-moving entities involve themselves in. They don’t sufficiently monitor and curtail certain type of corporate activity; despite the many recent cases of corporate largesse, no one from companies other than Tyco and Enron has gone to prison in the past decade. Government and the financial services sector have had a long-standing relationship to ensure that the financial services sector continues to make money.
Government in the UK and US can add regulations now, but they’ll just have the same system, albeit with greater regulation. I don’t think this will stop a future crisis after we’re out of this one, perhaps around 2014. People who are quick and smart in the marketplace will still be able to make money, in fact they’ll be encouraged to – the point of being a greedy banker is to create wealth quickly, doing anything to get the deal.
Have the bankers been acting irresponsibly? I don’t think it’s as bad as the media has portrayed. If we take Fred Goodwin as an example, his pension is a pittance compared to the £500 million or £1 billion bonuses others have received. It’s true that Goodwin was taking some risky positions in the marketplace, but he was also actually trying to build an infrastructure. Perhaps he can be criticized for purchasing ABN AMRO, but before that did he not use the same tactics to turn NatWest around and integrate it into RBS?
Goodwin’s villianization has been out of proportion compared to the actions of other chief executives. In the context of the failures of Lehman Brothers and others, Fred’s failures look like a breakfast bill at Harrod’s.
A responsible system starts at the source, so it’s worth taking a step back and looking at what we (in the US and the UK) have now and what the alternatives are. There are three fundamental funding systems:
There’s the equity-based financing system, which is the Anglo-American model that was created by the Dutch and the English (where people discussed business around ‘the board’ of wood with a ‘chairman’ who sat on a chair while everyone else worked on stools). In this system, quick money is created through investments and what are essentially bets. However, there are disproportionate incentives for making these bets and taking risks—success highly rewards the individual and firm, while failure gets spread across society (as we’re seeing now in the financial crisis).
On the other extreme, you have financing systems that are centralized with long-term planning (the communist system).
In the middle is the European stakeholder-based financing of the economy, in which the whole community is responsible for financing projects. Germany is a good example; for instance, their retail banks with low interest rates and laws of codetermination in which all stakeholders have a say enabled them to finance large projects.
At the moment, the quick money, equity-based financing model is under fire, and regulation won’t fix it – you can’t have long-term regulation when you want short-term profit. At the recent G20 meetings we saw Europeans with stakeholder-based financing and the Chinese with long-term planning speaking out against the Anglo-American equity-based system of financing, not wanting it to become the way of the world. At the same time we saw the greedy banker image promoted, taking attention away from the fact that regulation won’t work. What are the countries of the G20 to do? I’ll discuss this in my next post.
