Democratising The Financial Markets

One of President Obama's first acts has been to berate Wall Street executives for taking the sixth largest round of bonuses in history at the taxpayers' expense.

That the US President is suddenly under public pressure to do this demonstrates not only the depth of public anger but also the gulf in public knowledge about how the financial markets work. My own perception is that intensive regulation - ironically designed to protect the financial system and the general public from the kind of risks now occurring - has funneled the world's investment funds and opportunities into a cloistered environment in which only a privileged few are trusted to connect them. Enormous rewards for those few are simply a bi-product of that regulatory outcome. And it's unsurprising that those rewards should remain high as the flow of investment capital runs dry in the face of intensifying demand from cash-strapped banks and corporations.

But all the participants in the financial system must now recognise there's a new seat at the table. While governments and central banks have always been big players in the financial markets, their new role as sole marketmaker has pulled up a chair for the taxpayer. This new player demands to know how "my money" is being used, and has the benefit of increasing media attention focused on finding that out. This in turn casts each government leader in a role similar to that of an investment banking chief executive at a perpetual AGM. Voting may be over for the US President, but now the lobbying for a multitude of special resolutions begins. For Gordon Brown, more torture awaits on both fronts.

So how can governments and their leaders escape this predicament? How can they hand off their role as marketmakers, and let the taxpayer get back to running the store?

Certainly one lever they can pull, amplified recently by Niall Ferguson, is to "de-leverage" the entire system by funding yet further bank write-offs and re-writing consumer mortgages at more affordable rates (which has happened many times in the UK sub-prime mortgage sector).

But this seems to assume the financial system will remain more or less the same. And I don't believe it will. I certainly don't believe that taxpayers will ever completely turn their backs on finance again. Indeed, as emerged at WeBank, it seems we are moved to generate a new system with a new set of rules.

The attack on 'excessive' bonuses challenges the notion that matching investment capital and investment opportunities should be a rarefied activity reserved for the anointed few. Carry that challenge through and you have a set of simplified, transparent marketplaces that are substantially open to all, in a direct sense, albeit still facilitated by a skilled few in an open and transparent way. There is already a trend in this direction with individuals spread-betting and investing in contracts for differences on various plaforms. But that's still way too sophisticated to be deemed reasonably accessible to all. A process of further simplification, with increased openness and transparency, would be entirely consistent with the development of directly accessible consumer marketplaces around facilitators in travel, auctions, retail, betting, entertainment, personal finance and trade finance markets during the past decade. In those marketplaces, the role of the facilitator has been to enable consumers to seize control of their own experience and keep much more of the value that was previously retained by suppliers.

In this sense, the "democratisation" of the financial markets may be seen as very much a logical step, rather than anything terribly radical. It will be important to get the rules right - just as that has been critical to the success of many other consumer platforms already out there. But openness, fairness, transparency, and both governments' and taxpayers' determination to get out of this mess, ought to be reliable guides.

The Age of Conspicuous Thrift

When the ladies of West London first "discovered" TK Maxx some years ago, it was almost a guilty secret. And while the odd bargain might have come from there, the latest designer dress or accessory was still purchased at more or less the full retail price in the West End, Knightsbridge or Kensington.

Since Christmas, however, I've heard outright declarations that such-and-such an item was found at TKM or on Asos - where sales over the 42 weeks to 16 January '09 rose by 108%. For those who don't know, both these businesses provide "designer" labels at significantly lower prices than the primary fashion boutiques or department store concessions. And it's worth noting that Amazon.co.uk, which "endeavours to offer its customers the lowest possible prices" has opened its own clothing store featuring various fashion labels.

While the shift of clothing sales online is a remarkable enough trend in itself, that's not why I've called it out. What's especially noteworthy is the open declaration of thrift by people who used not to wear it like a badge. Thrift has become conspicuous. A lifestyle choice, not an economic one.

In December, I mentioned the "counter-Veblen effect", partly tongue-in-cheek, in the context of the Madoff affair. Economists have suggested that the effect would occur when "preferences for goods increase as their price falls, over and above the traditional supply and demand effect, due to a conspicuous thrift amongst some consumers." I mentioned it in the context of the Madoff affair, because Madoff's investors appeared to be investing as a lifestyle choice - climbing on the super-rich bandwagon - in defiance of rational economic analysis. Having been burned on that front, I speculated that they will react in the opposite direction and sport a well-worn look, partly because that would also sensibly protect the remainder of their wealth.

But you don't have to be super-rich, or even rich, to see money in lifestyle terms. Surely most of us relate to money in terms of lifestyle - what it will buy you and whether you can genuinely keep company with your friends/peers - rather than interest rates, assets/liabilities, diversification, pounds and pence. It is possible to flaunt bling, thrift or neither in all walks of life.

Nor do I consider the counter-Veblen effect to be a creature of the credit crunch itself, although that has given everyone on the planet 'permission' to be seen to focus on value at the same time.

And, I'm not talking about the sort of conspicuous consumption passed off as thrift, that might lead you to "Tear the roof off your home and replace it with solar panelling for $75,000 (£42,000), then boast about the cents you save on electricity."

Rather, conspicuous thrift reflects various established trends towards greater authenticity and individual control which have surfaced in the Web 2.0 phenomenon, for example.

Ultimately, of course, conspicuous thrift reflects pragmatism.

Taxpayers' Bung to Music Majors: Doom For Net Neutrality

Another bail out, another Quango. This time New Labour wants the taxpayer to pay for the failure of the jaded business models of the music moguls via a new rights agency to combat internet piracy, and will regulate to give them special rights to collect internet users' data.

There is no justification for this, and it is no melodramatic exaggeration to say that the direct consequence is the end of a neutral internet. Claims by content providers that they'll lose £1bn in the next 5 years are disingenuous - and it's a paltry sum given what's at stake. In its consultation on proposals to combat illicit file-sharing, BERR was told that, in spite of these "losses", online music sales are growing at 28% pa. So the industry is doing just fine, and it's no surprise that BERR received little support for its proposals. Accordingly, this focus on piracy can only be an excuse for content providers and internet service providers to lobby for a statutory right to monitor, and in due course charge for, everything we do online - whether we're "pirates" or not. BERR couldn't deliver, so now Lord Carter is to give it a try.

Apart from being another example of this government's entrenched commitment to public sector largesse, is this also some kind of parting favour to New Labour luvvies? Or is it, like the approval of Heathrow's third runway, perhaps an attempt to leave the Tories in a position where to unwind such travesties they must oppose Big Business?

Who knows, but sooner or later this particular cheque has got to bounce.

Thanks to Chris for the alert.

WeBank: New Rules for The New Economy

It was an unusually broad church that came to hear whether people will replace financial institutions at WeBank last night. More network economy than financial services.

While it was excellent to hear from platforms as diverse Zopa, Kubera Money and Midpoint & Transfer (a proposed P2P foreign exchange matching service), the panel discussion was quite revealing.

For James Gardner, Head of Innovation in a bank, the question was whether peer-to-peer finance would ever become so successful that it would make it uneconomic for banks to compete in the markets for deposits and personal loans. Having spent considerable time trying to understand how P2P platforms will scale cost effectively, he doubts that banks will lose their grip on these markets. In particular, he felt that the cost of compliance with increasing regulation will constrain growth and fee income alone won't support the investment in resources required. However, various members of the audience were keen to point out that peer-to-peer finance is the product of a very different attitude to money than people's attitude to banking. For this reason the two should not be viewed merely in competitive terms.

Indeed, Giles Andrews (MD at Zopa), said Zopa lenders were not necessarily drawing on their savings, as opposed to investment capital, in their quest for greater personal control over their returns. However, Giles did say that Zopa was gradually taking market share from banks in personal loans, having disbursed about £31m worth to date, and doubling volumes year on year. Already marginally profitable on each transaction, the business itself will reach profitability once volumes double again. On this basis, he says there is no problem with scalability.

Umair Haque of the Havas Media Lab sees P2P finance as a reflection that our established institutional rules have become ineffective, and must be re-written, in much the same way as other online marketplaces and social network services have introduced their own new rules, customs and etiquette. So we should look not so much at individual players or business models but at what set of rules is needed for social and economic recovery.

For my own part, I agree that P2P finance is not about "banking". They are on different, diverging paths. But inevitably - and particularly in the current economic enfvironment - one is drawn to the notion that banking as we have known it is doomed. James Gardner's observation that banks can't see how P2P finance could possibly scale given current institutional constraints is quite telling. Perhaps it is that mindset that has given rise to frustration and innovation amongst non-banks, from hedge funds to payment service providers to retailers and even individual people. Everyone wants to do things differently to how banks have insisted they be done. Even formal regulation has opened up more lightly-regulated territory that was previously reserved for banks, such as e-money and payment service provision - endorsing non-regulated products at the same time. In this way, one can see how the new economic rules are being written around banking, rather than by banks themselves.

Banks Bow to Pressure on PPI

Finally, the Great PPI Robbery is over. The news from various high street banks effectively concedes it was too difficult for them to sell this little-used insurance policy in a compliant manner to enough customers to make a fast buck.

It was a long overdue concession, only wrung out of them after years and years of expensive market reviews, inquiries, regulation, more inquiries, and heavy fines - culiminating in the record £7m fine imposed on Alliance & Leicester last October.

Will they capitulate on bank charges next?

Government to End Bank Charges Litigation?

With the government now such a significant shareholder in so many UK current account providers, it could save taxpayer's money and boost the (alleged) victims' finances by requiring an end to the expensive saga of bank charges litigation, and the refund of fees that the OFT alleges are excessive.

Note the finding by Mr Justice Smith (at para 415) that "information provided by the Banks suggests that in 2006 [alone] the Banks between them received £2.5 billion from Relevant Charges on an average daily unarranged overdraft balance of £0.6 billion."

Another judgment in the saga is due tomorrow morning (21 January 2009) at 10 a.m.

Update: the 21 January judgment held that only certain NatWest terms are capable of being a penalty. Whether or not they do constitute a penalty is phase two of the saga, and phase one is yet to conclude.

Phase one is held up because the banks appealed the first instance decision that both their current terms and their historic terms are capable of being assessed for fairness under the Unfair Terms in Consumer Contract Regulations. Judgment on the current terms is expected soon, whereupon the banks' appeal in relation to the historic terms will begin.

Of course, the Court of Appeal's decision on both sets of terms could go to the House of Lords, meaning several years' further delay.

Meanwhile, the lower courts won't hear cases pending the outcome of the higher court proceedings. And the Financial Services Authority is also preventing anyone getting their money back via the banks' own complaints procedures. Similarly, the Financial Ombudsman Service (where complaints to the banks utlimately go) won't process complaints until the court proceedings are over.

This is no way to treat the nation's consumers, especially when the consumers' own watchdog is involved.

If the banks won't act fairly on their own initiative, then it must be part of the government's "fiscal stimulus" package, to insist that all banks that took bail-out money immediately refund the element of bank charges which the OFT has complained are excessive.

Bleeding Edge No Place For Bleeding Hearts

You may have seen some of the bleating about Google's decision to retire some of its services that never hit the mainstream. Such whinging must be ignored, as to heed it only risks making the difficult process of innovation harder still.

Having been involved with internet start-ups since 1996, of course I subscribe to Geoffrey Moore's variation of the "Technology Adoption Life-cycle", that there's a "Chasm" between innovators/early adopters using a disruptive product, and successfully selling it to the early majority.

As an innovator or early adopter, you are out to get new stuff for free (or pay for it to be exclusive to you - thanks KM), and be ahead of the crowd. You love to show off the latest stuff and brag about how you were there at the beginning. And you definitely earn those bragging rights for putting up with the pain of participating in alpha- and beta-testing, the inevitable crashes and other technological mayhem. You understand that if you aren't protecting yourself against the failure of new technology you only have yourself to blame. Either you never let on there's a problem, or you wear the latest outage like a badge of honour. But if you whinge about it, then you aren't really an innovator or an early adopter, and you lose your bragging rights. You've become a member of the early majority - where new products with bugs or in beta-test (as opposed to new releases/upgrades) are not tolerated, and ongoing support is expected.

Similarly, if you're eager to sell your business to Google or some other behemoth in the hope that it will magically transport your "baby" across the chasm, then you're setting yourself up for intense disappointment. Even the big guys struggle to cross the chasm (which is why Microsoft waits patiently on the majority side). Until you've crossed there's still a ton of work to do, which is why they'll call one of the clauses in your sale and purchase agreement an "Earn Out".

The bleeding edge is no place for bleeding hearts.

Rant ends ;-)

OK, OK. But Absolutely No Fifth Runway

As Gordon Brown's wasteful, intrusive juggernaut grinds the blood and bones of yet another protest line into the political landscape, so the survivors must rush to the next defensive position.

But in the absence of any effective political opposition, it is wise to choose something that Gordon and his goons would be truly looney tunes to set their sights on. Something so inherently dangerous that New Labour will spontaneously combust in the attempt to achieve it. Because we all know now that as soon as the good citizens gather to defend their interests, New Labour acquires another target, and the Cavalry stays away.

Iraq turned out to be just another rut in the road for these automatons. And I'm sure they can squeeze in a fourth runway at Heathrow, if we don't mind the odd plane landing on the M4 by mistake.

But I reckon a fifth runway at Heathrow would put New Labour on collision course with the M25. Nothing could survive that.

Low Cost Government

Well, here we are in '09, the last of the Noughties: a fitting epithet for a decade of both reckless abandon and total collapse on the fiscal and financial front.

There's a lot of soul-searching going on, as well as a search for inspiration and leadership. While the US President-elect seems to have risen to the challenge, in the UK the search continues.

Bereft of vision, we look to the past, and it's a sign of the times that I was given Speeches That Changed the World for Christmas. Of course it includes Franklin D Roosevelt's First Inaugural Address, heralding the "New Deal", which has often been referred to in the news lately. It can also be read here.

While FDR's speech and the New Deal must be seen in the context of a more parlous economic situation than today's, and many of FDR's tactics are being deployed today, I was struck by one that's yet to be honoured in the UK:

"... insistence that the Federal, State, and local governments act forthwith on the demand that their cost be drastically reduced."

I mention it not just because UK civil servants were promised a 2% pay increase in a time of rising unemployment (public sector teachers will get 2.3% extra this year and next, while the Daily Mail shrieks that private schools are closing). I also raise it because New Labour might just mistake the need for fiscal stimulus as a wheeze for saddling us with more civil servants in the long term, who'll generate further cost in terms of random policy initiatives and bureaucracy to justify their existence. See the Taxpayers' Alliance "non-jobs" for examples.

Of course, hiring more public sector workers flies in the face of last September's promise to cut jobs, as reported in the Guardian:

"Separate ONS figures on public sector employment showed the number of people employed by the government fell 44,000 in the second quarter to 5.8 million, the lowest total since the second quarter of 2004. The government has pledged to cut 84,000 jobs by next April as a result of a review conducted by Sir Peter Gershon in 2005."

But as Chancellor, Gordon Brown approved a 13% increase in the public sector workforce from 5.1 in 1997 to 5.8m in 2006, according to the Institute for Fiscal Studies. So, Sir Peter's 2005 review was merely borne on the rising tide.

The IFS also says that public sector pay has caught up with private sector pay, yet about 76% of public sector workers have final salary schemes, versus 17% in the private sector. And public sector pensions are worth 25% of salary versus 20% in the private sector. With pay the same, there's no reason for that gap - if there ever really was one.

But take heart! Perhaps it's a sign the trend is about to reverse that certain people in the public sector are bizarrely receiving their Honours now - it's to reward them before they can be accused of selling out their colleagues.

On that basis, we really should have welcomed the news that, for overseeing massive public sector expansion and bail outs at the taxpayer's expense, the Permanent Secretary of HM Treasury gets a knighthood, while the captains of private sector finance get hunted out of office for their part in Brown's Boom and Bust.

The last of the Naughties?

Let's hope so.

Enjoy the year as best you can!