Still The Masters of the Universe

by Satyajit Das

New paper economies emerged directly from the demise of the gold standard that removed restrictions on the ability to create money, especially debt. Finance inexorably displaced industry with trading and speculation becoming major activities as financial engineering replaced real engineering. In an earlier age, Heinrich Heine, the German poet, too had identified the change: “Money is the God of our time….” The rise of financiers is intimately linked to this financialisation of the global economy.

Financial innovations such as securitisation (the packaging up and sale of loans) and derivatives (effectively risk insurance) enabled banks to extend more credit. Banks could literally by increasing throughput, making more loans and selling them off to eager investors, magically increase returns to their investors. Bankers had invented a ‘money machine’.

Bank also began to trade more actively with their shareholders money, following the advice of Fear of Flying author Erica Jong: “If you don’t risk anything then you risk even more”.

All of this, of course, meant increased earnings for the bank and its star performers. As people who work in financial institutions know, it is primarily an enterprise that is run for the employees with an afterthought for shareholders.

The ability to earn high rewards only becomes a problem where the promise of a share of profits encourages excessive risk taking and a focus on short-term earnings. It also becomes a problem where the basic measure of performance is ambiguous and can be systematically manipulated. Unfortunately, ‘earnings’ proved to be the result of wildly inaccurate models, accounting tricks and risks that had not been accurately captured.

The golden age seemed to come to an end with the GFC. Initially, the world viewed the destruction of storied financial institutions in Global Financial Crisis as an entertaining blood sport.

Commentators briefly dared hope that the power and influences of finance and financiers would be reduced. Finance would revert to being a facilitator rather than the central driver of the economy.

Unfortunately, those hopes are misplaced. Low or zero interest rates, heavily managed markets, reduced competition and state underwriting of solvency has helped surviving banks prosper.

Bank risk levels have increased to and in some cases beyond pre-crisis levels. The higher levels of risk taking reflect increasing comfort in central bank support of financial institution’s liquidity and their ability and willingness to intervene to limit price risks.

Over the last 30 years, talent has increasingly been lured from productive profession into finance and the speculative economy. The rewards available mean that the brain drain into these professions is unlikely to stop. The excesses of the financial economy are also unlikely to be easily tamed.

The Masters of the Universe that survived the carnage are back to their old tricks. The ‘fight for talent’ means that bonuses and remuneration guarantees for new employees are all back in vogue.

A year after the collapse of Lehman, the near collapse of AIG and the grande mal seizure in financial markets, the Masters of the Universe are still firmly in charge. As Giuseppe di Lampedusa, author of The Leopard knew: “everything must change so that everything can stay the same.”