It is time to put finance back in its box

It is time to put finance back in its box

By Philip Augar

Published: April 13 2009 20:08 | Last updated: April 13 2009 20:08

Nicolas Sarkozy arrived at the Group of 20 summit having said: “The all-powerful market that is always right is finished.” The French president left it proclaiming “a page has been turned” on the Anglo-Saxon financial model. Whether or not a page really has been turned depends on the construction of a practical successor to free-market economics, a process that entrenched interests in America and Britain would be well-advised to encourage if they wish to remain centre stage.

The ideas that defined the golden age of market capitalism were formed in the vacuum left by the collapse of the Bretton Woods system of fixed exchange rates in 1971. Over the next two decades, the Chicago School of free-market economists helped to persuade the Reagan and Thatcher administrations to adopt laisser faire policies and deregulation. Simultaneously, at Northwestern University, Professor Alfred Rappaport’s work on creating shareholder value clarified the objectives of the corporate sector.

Management consultants took hold of these ideas and converted them to a coherent strategy for business. Then investment bankers, liberated by deregulation and with an eye to the main chance, picked up the whole package and sold it hard to chief executives. Once developments in derivatives theory in the 1970s opened the door to share options and performance-based compensation for executives, there followed three decades in which tooth-and-claw capitalism ruled supreme.

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 other species. Governments, central banks and regulators are groping unconvincingly for solutions. Against this background, new ideas should be welcomed. But for this to occur there would need to be a turnround in government attitudes on either side of the Atlantic, and a more effective and creative response from the academic sector in these countries than we have seen in recent years.

A change in government thinking requires finance to be put back in its box. The industry gradually infiltrated the commanding heights of public life in America and Britain from the late 20th century onwards. Senior bankers such as Robert Rubin, Jon Corzine and Hank Paulson upheld the American tradition of Wall Street titans taking public office. In Britain, the Conservatives’ connections with the Square Mile were well established, but the City was quick to build bridges with New Labour when it was elected to office in 1997 and the incoming government was equally eager to respond. Former investment bankers appeared in full-time positions at the Treasury, the government department that worked most closely with the City, and as chancellor of the exchequer Gordon Brown appointed City grandees to the business councils that advised him.

The influence of finance over political life was reinforced by money. Wall Street bankers regularly appeared at the top of the giving lists for the political parties. In the UK, financial sector philanthropists donated to Labour and supported the government’s pet schemes, such as the Academies programme. Others lined up behind the Conservatives, whose fundraising is led by two of the City’s most prominent people, Michael Spencer, chief executive of Icap, the world’s largest inter-dealer broker, and Stanley Fink, former chief executive of Man Group, the hedge fund manager. There is no suggestion of impropriety or that this enabled the industry to buy favour, it is just that in its pomp, finance became so important and so influential that it crowded out other voices.

Similar forces were at work in the academic world, a sector that might have stimulated debate but which was conspicuous by its absence when it came to forming an effective critique of red-blooded capitalism. The few academics who suggested that markets did not always know best were dismissed by economic liberals as living in the past or told that the new financial system had “transformed risk” and raised global living standards.

Finance wrapped its tentacles around relevant parts of the academic world. Hard-pressed business schools competed for students eager to forge careers in finance after they completed their masters’ degrees. The quantitative skills of certain academics were sought by hedge funds that were prepared to pay them life-changing sums in consultancy fees. Rich alumni endowed their alma mater with benefactions to further the study of finance. The giving was well intended, and everyone has the right to pursue their career of choice, but under these circumstances it is little wonder that so much academic output was supportive of the financial system.

But now is the time for change. Unless governments in America and Britain really open themselves up to new ideas, emerging economies in Asia and mainland Europe, places where alternative economic and corporate governance models do exist, will seize the initiative and redefine the global agenda. In parallel, academics need to recapture their heritage of creative, independent thinking and throw off the influence of finance. Wall Street and the City need to be grown up about this. They might not like the prospect of losing their grip on government and exposing themselves to new ideas. But unless they do, they might just find that the page has indeed been turned and they are no longer on it.

The writer was an investment banker before turning to writing in 2000. His latest book is ‘Chasing Alpha: How reckless growth and unchecked ambition ruined the City’s golden decade’