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Finance – Highway Robbers to Drunken Drivers

Finance – Highway Robbers to Drunken Drivers
Sony Kapoor: Financial system remains a scary mess, economies turn to public options.

Oct. 14 – TRNN The cause of the financial crisis has not been addressed, and the financial system is still not doing its job, according to the Managing Director of Re-Define, an international Think Tank promoting financial system reform, Sony Kapoor. In an interview with The Real News, Kapoor said the financial system is supposed to function like a highway, transporting money from where there’s too much and putting it to use where there is too little, facilitating investment that can generate returns.

“Finance doesn't produce things we can eat and drink. It is supposed to be a support function. And an efficient financial system is one which actually does that while maybe getting 1 or 2 per cent of the total profits at a cheap cost,” he said.

He compared the current system to a highway where the police have been asleep, and the drivers of toxic transport trucks have been being paid to drive drunk.

He said the problem of sleeping police may have been address by the Financial Stability Oversight Council established this month, which has the potential to function like a traffic manager, keeping an eye on the entire financial system.

“So that was the missing piece of the puzzle, and we do have that. And how well it's going to function remains a question of time,” he said.

However bankers’ incentives still need to be corrected so they’re no longer getting rewarded for risky conduct, or driving drunk, he said.

“So we're not asking to hang bankers, but at the very least you have much higher penalties and much lower rewards. So capping bonuses, together with much higher personal liability, can have that same effect.”

Kapoor said that safety buffers should be implemented, such as higher mandated capital-to-liability ratios, and allowing banks to go under when they risk more than the have. He said it would help if banks were prevented from being “large enough to actually cause significant collateral damage.”

Finally, he said it is imperative that the risky financial behavior, like dealing in derivatives, be separated from the regular investment activities that support the economy.

“And of these, we've only explored primarily looking at higher safety buffers. The incentive part has not been talked about. There's some lip service to bonuses, but as we saw in the news today, I think, about $144 billion of bonuses, it continues unabated. And it's our money.”

Senior Editor of The Real News, Paul Jay, raised the option of a public financial system, separate from the current private sector system, to keep liquidity in the economy and protect it from the risks caused by derivative dealing.

Kapoor said that option is increasingly being discussed and implemented more as the private sector continually fails to provide credit.

“A lot of that has become fashionable again. The United Kingdom, which is not seen to be a bastion of, you know, left-ish communism, has just set up a green investment bank. And many other countries are looking to either public institutions they already had, to revive them, to increase their size,” he said.

“Cooperative banks are suddenly back in fashion in the European Union, for example. So not just looking at the traditional shareholder model, 'cause there the incentives are very skewed for excessive risk-taking, but looking at partnerships, looking at cooperatives, looking at potential public-private mixed ownerships, etc.”

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Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Washington. As the November elections come ever closer, the question of the financial crisis and just why it happened and has anything really been done about it isn’t very much in conversation during the campaign. A lot of other issues are being talked about, of course—unemployment. But the triggering cause of the crisis, an unregulated or mostly unregulated finance sector and casino-style capitalism, as many people call it, is it still very much in play? Did the financial regulations passed in Washington last month actually do anything about it? And if not, what needs to be done? Now joining us in the studio in Washington is Sony Kapoor. He’s the managing director of Re-Define, an international finance think tank working at finding solutions. Thanks for joining us.

SONY KAPOOR, MANAGING DIRECTOR, RE-DEFINE: You’re welcome.

JAY: So you have a new book that you just put out. It’s called The Financial Crisis: Causes and Cures. So in the book you use a metaphor to I guess make it easier for people to understand how the crisis took place, which is of a highway. Just quickly describe for us how you use that.

KAPOOR: Well, the big change that happened in finance was, if you think of finance as a transport system, the financial system, which takes money from where there’s too much to where there is too little, where their returns are too low and the economy is mature to where there are opportunities for better returns, and this, in doing this, delivers prosperity and puts money where investment can generate returns, what happened over time was that finance, which used to be comprised of relatively small cars driving under the speed limit, there were a lot of policemen in the form of regulators, there were speed cameras making sure that everybody was behaving well, and the highways were well paved, changed over time.

JAY: So, in other words, a relatively regulated finance system.

KAPOOR: Absolutely, and a relatively calm, slow-moving one. And what you saw over time was a combination of technology with globalization and deregulation meant that the small institution, which were the small cars, became large trucks, and that these trucks, when they started loading up on complex, opaque products such as derivatives, you can think that it was not just trucks but it became fuel tankers or tankers with toxic chemicals. And they started driving ever faster. And the regulators fell asleep. The policemen were either fired or were asleep. And you ended up with a system where everybody was chasing each other like mad, and you had drunken drivers at the helm of these toxic trucks. And the remarkable thing about the system was not how often it crashed, but given how the situation was, how dangerous the driving that was going on was, and how little control and oversight there was, that it didn’t crash even more. And most recently, over time you also had a fog of opacity descend on the system, where through the use of tax havens, through the use of derivatives, neither of which are transparent—it’s not just that the regulators couldn’t see the trucks, but the trucks couldn’t see each other. And that’s why we got the crash that we did.

JAY: Now, part of the—just keeping the metaphor, part of the problem is that there are also highway robbers running the highways.

KAPOOR: That’s true.

JAY: And the people controlling the biggest financial institutions also to a large extent control the politicians who are supposedly regulating and passing the traffic regulations and supposedly turning the lights red and green.

KAPOOR: Absolutely.

JAY: So when you have the highway robbers controlling the highways, first of all, that’s a big piece of the problem you’re going to try to address.

KAPOOR: Yeah.

JAY: Then the second thing about the metaphor, which perhaps isn’t quite a good metaphor, is that public highways are public.

KAPOOR: Yeah.

JAY: But these financial highways actually really aren’t public. So while the whole public global economic system depends on these highways, they’re very private.

KAPOOR: Most of the world right now, most of the countries, including, for example, in Europe, are mixed economies. I mean, even in the United States you have a mix of the private and the public sector. And what it also does is it keeps discipline in the private sector, ’cause the private sector, if it’s the only game in town, can get carried away, but if there is a backstop of the public sector entity that is primarily trying to do similar things, then there is a cross-disciplinary effect.

JAY: But we haven’t seen it.

KAPOOR: We haven’t seen it.

JAY: So we had a crash.

KAPOOR: Yes.

JAY: Now we have a supposed recovery taking place, although it’s rather questionable how real this recovery is. You propose some very specific things in terms of making sure this doesn’t happen again. So let’s start with what you think needs to be done to stop this highway robber partly engineered pileup on the highway. How are you going to unravel all this?

KAPOOR: Well, sticking with the highway analogy, what you have is, in order to have a safe traffic system, you need roadworthy trucks or roadworthy vehicles. So you have annual checks on whether the brake oil is there, etc. So, similarly, regulation was primarily, supposedly, focused on looking at whether each of the institutions itself was safe. That’s what it was supposed to. But it didn’t do a very good job out of it. But what was completely missing which is important for a traffic system is also that there’s a traffic manager, there are helicopters, there are people monitoring the flow of traffic, ’cause the real danger in a traffic system doesn’t come from the truck exploding.

JAY: So did the finance reform bill that was passed here, do we have a traffic manager [inaudible]

KAPOOR: We have something like that, the Financial Stability Oversight Council that you have, FSOC, which is supposed to look at not just the individual trucks but how the trucks interact with each other, the whole financial system. So that was the missing piece of the puzzle, and we do have that. And how well it’s going to function remains a question of time.

JAY: ‘Cause the critique of that is it’s so at the level of regulation that it’s all going to depend on who are the regulators versus laws that actually prohibit, for example, derivative trading, the more risky elements of casino capitalism. Now it’s just going to be a question of, well, is that a little too much or too little, and who gets to decide that could be appointed by Dick Cheney or the next Dick Cheney. In which case, what have you got?

KAPOOR: Well, it’s very possible. Let me just finish one more thing and I’ll come back to this. So the third point that’s about a good traffic system is it’s not just enough to make sure that the traffic system—traffic is flowing smoothly and the trucks are safe, but also that the drivers are not drunk. And that is a missing part of the puzzle. And in the financial world, the analogy is you need this systemic oversight of somebody looking at the whole system. You need the supervisors looking at each of the banks. But you also need to look at the incentives of the people who are running the banks, ’cause there are no banks; there are only bankers.

JAY: How do you not get drunk on a $1 billion a year salary?

KAPOOR: Exactly. So you need things such as, for example, limits to that salary, limits to bonus caps, ’cause if I get paid to drink and drive, and especially if I collide with someone and I’m safe and the damage is done to the other folks, you know, for example, in our instance, the real economy and taxpayers, then I’ll drink and drive, and especially if someone is paying me to drink and drive, which is the equivalent of what we have with the financial system; then I’ll drive ever more recklessly.

JAY: Well, in the derivatives trading, the finance regulation bill that was passed here, if I understand it correctly—I haven’t read the whole bill, but economists are telling me that there’s loopholes in it you can drive your trucks and supertankers through. Number—the second one of the things that you suggest is the closing of the tax havens, where some people suggest as much as a third of the world economy may be going untaxed and unregulated, in places like Cayman Islands. That’s not even being talked about. Like, you cannot find a conversation in Washington about closing down tax havens.

KAPOOR: No. And the G-20 was talking about it, and they’re still talking about it, but nothing much has been done. So this is a very narrow piece of the whole puzzle that we’re talking about. And as you rightly said—.

JAY: ‘Cause even in the G-20 document, it was, like, a nudge, a hint, but nothing serious.

KAPOOR: Absolutely. I agree. So, I mean, if you again go back to the finance regulation, there are four main ways of tackling risk in the system. One, you can separate the risky part of the system from the more fundamental part which is critical for running the economy. That’s the separation of derivatives, for example, and the Volcker rule. The second possibility is you have safety buffers. You allow the system to run as it does, but you build in a lot of capital, a lot of liquidity. You allow resolution regime so you can fail a bank, just like FDIC [Federal Depository Insurance Corporation] used to. The third is you make sure that everybody has the right incentives. So we’re not asking to hang bankers, but at the very least you have much higher penalties and much lower rewards. So capping bonuses, together with much higher personal liability, can have that same effect. And the fourth possible solution is to make sure that none of the institutions is large enough to actually cause significant collateral damage. And of these, we’ve only explored primarily looking at higher safety buffers. The incentive part has not been talked about. There’s some lip service to bonuses, but as we saw in the news today, I think, about $144 billion of bonuses, it continues unabated. And it’s our money.

JAY: What about another additional or other solution? What about another highway system? What about a public highway system that says, you know, you go over here on your private highway system, and you gamble, you go do whatever you want, and if you have a big pileup and crash and you guys are all standing and—you know, that’s all your problem, because over here we have a public highway, and we’re not going to let you cause a liquidity paralysis in our economy, because we’ll have a public highway system to keep liquidity and keep loaning to small businesses and so on. I mean, in effect, is it possible to contain the private one without having a public alternative?

KAPOOR: In theory, yes. But what’s quite different in the world now is the international discussion which used to be taboo around having a public financial institution. I mean, the IMF, for example, went around discouraging developing countries which had development finance institutions for long-term financing to continue having them. Agricultural cooperatives were shut down. A lot of that has become fashionable again. The United Kingdom, which is not seen to be a bastion of, you know, leftish communism, has just set up a green investment bank. And many other countries are looking to either public institutions they already had, to revive them, to increase their size. The IMF’s size is being increased. In Europe, the European Investment Bank, the European Bank for Reconstruction and Development, all of these institutions are being used to channel some of that credit which the private sector is not delivering. And I think that what we will see in time is, especially on areas which are clearly under-served, for example the green economy, for example infrastructure, for example credit flows where a lot of jobs are created, public sector is going to step in selectively, and not just the public sector but alternative formulations. Cooperative banks are suddenly back in fashion in the European Union, for example. So not just looking at the traditional shareholder model, ’cause there the incentives are very skewed for excessive risk-taking, but looking at partnerships, looking at cooperatives, looking at potential public-private mixed ownerships, etc. So a lot of new discussions are beginning to happen. And if the private sector continues not to deliver credit to the economy and continues to be run for its own interest rather than as a service economy—. I mean, if you ever had legal services—which are a support function just like finance is—if you ever had legal services garnering 45 percent of corporate profits in the United States you would have a revolt. But this is exactly what finance was doing. Finance doesn’t produce things we can eat and drink. It is supposed to be a support function. And an efficient financial system is one which actually does that while reducing, while maybe getting 1 or 2 percent of the total profits at a cheap cost. If you were looking down from Mars and looking at planet Earth, you would not say we had an efficient financial system. In fact, it wasn’t doing its job. And where the private financial system is not doing its job, you either need to change that, or have an alternate system, or do both.

JAY: Well, anyone that’s ever had to deal with someone who’s an alcoholic, there’s a point where you really do have to do something else.

KAPOOR: I agree.

JAY: Thanks for joining us.

KAPOOR: Welcome.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

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