Other People's Money: The Real Business of Finance

by John Kay

Overview

The finance sector of Western economies is too large and attracts too many of the smartest college graduates. Financialization over the past three decades has created a structure that lacks resilience and supports absurd volumes of trading. The finance sector devotes too little attention to the search for new investment opportunities and the stewardship of existing ones, and far too much to secondary-market dealing in existing assets. Regulation has contributed more to the problems than the solutions.

Why? What is finance for? John Kay, with wide practical and academic experience in the world of finance, understands the operation of the financial sector better than most. He believes in good banks and effective asset managers, but good banks and effective asset managers are not what he sees.

In a dazzling and revelatory tour of the financial world as it has emerged from the wreckage of the 2008 crisis, Kay does not flinch in his criticism: we do need some of the things that Citigroup and Goldman Sachs do, but we do not need Citigroup and Goldman to do them. And many of the things done by Citigroup and Goldman do not need to be done at all. The finance sector needs to be reminded of its primary purpose: to manage other people's money for the benefit of businesses and households. It is an aberration when the some of the finest mathematical and scientific minds are tasked with devising algorithms for the sole purpose of exploiting the weakness of other algorithms for computerized trading in securities. To travel further down that road leads to ruin. A Financial Times Book of the Year, 2015
An Economist Best Book of the Year, 2015
A Bloomberg Best Book of the Year, 2015

Product Details

ISBN-13:	9781610396042
Publisher:	PublicAffairs
Publication date:	09/22/2015
Sold by:	Hachette Digital, Inc.
Format:	eBook
Pages:	352
File size:	4 MB

About the Author

John Kay is a visiting professor of economics at the London School of Economics and a fellow of St John's College, Oxford University. He is a director of several public companies and contributes a weekly column to the Financial Times. Kay is the author of nine previously published books and coauthor of The British Tax System with Mervyn King. John Kay lives in London. Follow him at @JohnKayFT and johnkay.com.

Table of Contents

Prologue The Parable of the Ox xi

Introduction: Far Too Much of a Good Thing 1

Part I Financialisation

Chapter 1 History 11

The Road to Pottersville 11

The Rise of the Trader 16

New Markets, New Businesses 23

From Crisis to Crisis 34

The Robber Barons 42

We Are the 1 Per Cent 46

Chapter 2 Risk 53

Cows, Coffee and Credit Default Swaps 53

Chasing the Dream 61

Adverse Selection and Moral Hazard 69

Chapter 3 Intermediation 77

The Role of the Middleman 77

Liquidity 84

Diversification 91

Leverage 95

Chapter 4 Profits 101

Smarter People 101

Competition 106

The Edge 108

Regulatory Arbitrage 113

I'll Be Gone, You'll Be Gone 118

How Profitable Is the Finance Sector? 126

Part II The Functions of Finance

Chapter 5 Capital Allocation 135

Physical Assets 135

Housing 140

Property and Infrastructure 145

Large Companies 150

Financing Small- and Medium-Size Enterprises 154

Chapter 6 The Deposit Channel 163

Household Wealth 163

The Payment System 170

The Activities of the Deposit Channel 177

Chapter 7 The Investment Channel 185

Managing Wealth 185

A Bias to Action 193

The Role of the Asset Manager 197

Part III Policy

Chapter 8 Regulation 205

The Origins of Financial Regulation 205

The Basel Agreements 208

Securities Regulation 213

The Regulation Industry 216

What Went Wrong 220

Chapter 9 Economic Policy 227

Maestro 227

Financial Markets and Economic Policy 234

Pensions and Inter-Generational Equity 238

Consumer Protection 245

The Economic Contribution of Finance 247

Chapter 10 Reform 255

Principles of Reform 255

Robust Systems and Complex Structures 261

Other People's Money 267

The Reform of Structure 270

Personal Responsibility 276

Chapter 11 The Future of Finance 281

Epilogue: The Emperor's Guard's New Clothes 293

Acknowledgements 295

Notes 297

Bibliography 311

Index 321

Editorial Reviews

While the gravamen of its complaint is old, Other People's Money is not merely another broadside content to denounce finance's dysfunction, but rather a masterly attempt to locate its various origins and connect them with analytical and theoretical rigor. Kay provides by way of context a panoptic overview of the history, evolution and structure of the financial system in the United States and Britain, one that is impressive in its ability to weave together a comprehensive range of material, from the mechanics of banking to the Gaussian copula, in elegant, jargon-free prose. He confidently employs many perspectives: economic, historical, legal and psychological. Call this technique a Lombard Street for the 21st century.

The New York Times Book Review - Benjamin Heller

A Financial Times’ Book of the Year, 2015
An Economist Best Book of the Year, 2015
A Bloomberg Best Book of the Year, 2015

“Other People’s Money is not merely another broadside content to denounce finance’s dysfunction, but rather a masterly attempt to locate its various origins and connect them with analytical and theoretical rigor. Kay provides by way of context a panoptic overview of the history, evolution and structure of the financial system in the United States and Britain, one that is impressive in its ability to weave together a comprehensive range of material, from the mechanics of banking to the Gaussian copula, in elegant, jargon-free prose.” —New York Times Book Review

“Mr. Kay is a brilliant writer with an ability to explain the role in the 2007-08 financial crisis of such concepts as credit default swaps, collateralized debt obligations and moral hazard… [He] is at his best in reminding us that the financial system is still fragile and in explaining that more regulation is not the answer… We can applaud his call for a cultural change that will enhance ethical standards and put the customer first.” —Wall Street Journal

“[Other People's Money] should be read by everyone concerned with preventing the next crisis...[Kay] skewers the pretensions of the finance sector and questions whether its high rewards reflect its true economic contribution. Barely a page goes by without an acute observation or pithy aphorism. ... Above all, the finance sector should be judged on the same basis as other industries; if an activity is unprofitable without taxpayer support, it should not occur. ‘Our willingness to accept uncritically the proposition that finance has a unique status has done much damage,’ the author wisely says. Let us hope those in authority will listen.” —The Economist

“Kay's insistence on stepping back, on judging finance by the humdrum standards of any other industry, with its self-serving mystique and aura of inevitability stripped away, makes Other People's Money one of the best two or three books I've read on the crash.” —Clive Crook, Bloomberg View

“This important book is simultaneously a clear primer on modern financial systems and a scathing indictment of them.” —Foreign Affairs

“An important new book.” —Robert Lenzner, TheAtlantic.com

“A challenging book that will add to ongoing discussion and debate.” —Booklist

“The theme of broken governance and accountability is echoed in economist John Kay’s Other People’s Money: The Real Business of Finance, which provides an accessible exposé of the complex and layered modern financial system and the failure of laws and regulations to protect the public. Whether his specific proposals are the best approach, policy won’t change unless many more people recognize the issues and demand better. Lack of political will remains the biggest challenge.” —Anat Admati, George G.C. Parker Professor of Finance and Economics, Stanford Graduate School of Business

“Thanks for writing this book. Only [John Kay] could have done it. This is going to be a classic.” —Frank Partnoy, Professor of Law and Finance, University of San Diego School of Law and bestselling author of Fiasco and Wait

“Kay is an admirable debunker of myths and false beliefs—he can see substantial things that others don’t.” —Nassim Nicholas Taleb, author of The Black Swan

“Kay is both a first-class economist and an excellent writer.” —Financial Times

“[O]ne of Britain’s leading economists.” —The Economist

From the Publisher

09/01/2015
Kay, a British economist, author, and visiting professor at the London School of Economics, has an interesting perspective on the world of finance in the United States, the UK, and Europe. While finance is necessary to modern societies, Kay considers how finance did, does, might, and should work. The book's first part includes the history of economics, as well as modern political, intellectual, and technological shifts. The second section tries to answer questions about the purpose and quality of modern financial activity. The third deals with structural reforms, intending to supply a blueprint for the future. Kay feels that regulation is part of the problem as is too much government involvement. He looks at financial crises in the United States, UK, and the Eurozone and feels that financial executives are using other people's money to enrich themselves and that baby boomers are profiting at the expense of future generations. Since policymakers did not restructure after the last crisis, Kay says they will get another chance after the next one. VERDICT Not for the merely curious. If words such as financialisation, demutualization, securitization, and intermediation are exciting, it's a definite read.—Bonnie A. Tollefson, Rogue Valley Manor Lib., Medford, OR

Library Journal

2015-07-15
All's not well in the counting house, nor in a capitalist system grown increasingly unequal and corrosive."We need a finance sector to manage our payments, finance our housing stock, restore our infrastructure, fund our retirement and support new business," writes British economist Kay (Obliquity: Why Our Goals Are Best Achieved Indirectly, 2010, etc.). By his account, we don't have a sector that does much of that necessary work; instead, intermediation, buying and selling abstractions rather than real things, is the new method. In fact, writes the author, lending to entities that make things, "which most people would imagine was the principal business of a bank," makes up only about 10 percent of the sector's business. The rest lies in intermediation, which is another way of saying that "the industry mostly trades with itself, talks to itself and judges itself by reference to performance criteria that it has itself generated." Take securitized mortgage loans, bundled and traded like baseball cards: there's a recipe for disaster, and in the absence of meaningful external oversight, it and other contributing factors to financial meltdown are not likely to be tamed anytime soon. Kay is no Chicken Little; his arguments are calmly made, backed by such evidence as can be teased out of the reclusive industry. In the meantime, he notes, many aspects of the financial sector, such as the lending and deposit channels, are "ripe for disruptive innovation," just as in recent years the increased use of credit and debit cards and other electronic tie-ins to bank accounts have made cash unnecessary in most daily transactions. Kay holds forth for increased regulation that is focused "more on the interests of consumers and less on the integrity of market processes"—in other words, the more vigorous application of Dodd-Frank and other regulatory regimes that Congress is now hurriedly trying to dismantle. Sobering and lucid. If you're moved to keep your money in a sock after reading this, you'd have cause.

Kirkus Reviews