What is wrong with the financial system and how to fix it
Ask your friends or colleagues the simple question, what is the purpose of finance? - and you may be surprised how long they pause before replying. One reason for hesitation is that this fundamental question is all too rarely asked. So says David Pitt-Watson, Executive Fellow at the London Business School and leading thinker and practitioner in responsible investment.
He himself makes a point of asking the question regularly because he believes that unless we are clear about what finance is for, it will do more harm than good. This was the theme of his lecture in the Murray Edward’s series of talks exploring Capitalism on the Edge.
Do no harm: a poor raison d’être
Pitt-Watson has a specific message for three audiences: those who teach and study economics and finance; those embarking on a career in finance, and those who simply want to understand how finance works, perhaps to influence it.
However, his definition of the role of finance is consistent to all three. Pitt-Watson remembers a gathering of senior young politicians from around the world, who fell silent when asked: “what would be your agenda for the financial services industry?” Eventually, the first to speak said they would like finance “not to collapse the world economy”.
Not doing any harm is a pretty poor raison d’être. But as Pitt-Watson points out: “Part of the reason the financial services industry is capable of so much harm is because its services are of central importance to our welfare.” In essence, these services are:
- the safe keeping of assets
- to provide an effective payment system, without which commerce could not survive
- to share risk, which allows us to buy life insurance and have a pension
- Intermediation, which transfers money from where it exists, to where it is needed.
The last of these is perhaps the most important, argues Pitt-Watson. “That is a process of enormous value. At its most simple it can be combining savings deposits and helping individuals buy homes, businesses to buy assets. It allows economies to grow. It allows social mobility.”
Collectively, these services are so important to society that finance pioneers were thought of as philanthropists. It was a minister who set up the first “people’s bank” - the Trustee Savings Bank - to serve his congregation; and two clergymen set up the first funded pension scheme.
Theory and practice
Clearly, doing finance well is valuable for society. The flip side of the coin is that doing it badly can have devastating consequences. Mohammed Yunus, an economics professor and financier in Bangladesh, won the Nobel Peace Prize for pioneering micro finance for poor people, transforming their lives. Laudable, says Pitt-Watson, and yet: “What Yunus was doing was, in theory, little different from a loan shark or from Wonga. In theory the same; in practice totally different.”
When we consider now how we are doing in practice, the picture is far from encouraging. The financial crisis of 2008 nearly brought the world’s economy to its knees. In November that year, Pitt-Watson recalls a much-publicised visit by the Queen to the London School of Economics, when leading economists seemed incapable of answering her simple question: what had happened?
Nobody, it seemed, saw it coming. Even the IMF believed that financial innovation was removing risk from banks‟ balance sheets; that large financial institutions were in a strong position, and that financial markets in developed countries were “fundamentally sound.”