thank you so much for having me
let’s talk about what dominates
headlines today in terms of risks things
we worry about things we wake up with a
cold sweat in the middle of the night
thinking about climate change is one big
issue general environmental degradation
many people say for example that the
water crisis is even more serious than
global warming is another one rising
inequality not across countries but
within countries is something that we
see the numbers are very clear on that
particularly since Lehman’s crash and it
is starting to really affect our lives
in terms of the response to this rising
inequality particularly within the OECD
in that sense rising populism exactly
also is an issue that we are grappling
with increasingly particularly in Europe
and in the United States so what is if
any the common thread across most of
these problems that we grapple with what
is this elephant in the room that
connects these and my answer to this is
it’s actually the financial system the
financial system like would like to
think it is very complicated and I
remember the pre Lehman days where
anytime you talk to a banker they would
talk about finance as rocket science and
it was the best way to stop people
discussing how finance actually worked I
mean it is nothing like rocket science
perhaps a more fitting analogy sticking
with elephants is it’s been the case of
the five blind men and the elephant
where everybody beat us as retail
customers of banks or pension holders
putting money in their pension funds or
financial regulators central banks
overseeing certain aspects of the
financial system etc or as a company or
an entrepreneur trying to raise money
we all saw various parts of the elephant
somebody saw the tail and thought it was
a rope somebody felt
the leg and potted was a pillar but
frankly there wasn’t really much of an
incentive for anybody to really
understand how the financial system as a
whole worked of course that has all
changed with Lehman so where does that
leave us and what can we do to make sure
that the financial system which has been
functioning rather poorly in past few
decades and has indirectly or directly
in some cases given rise to these major
problems that we grapple with how can we
deploy it in our service that’s
basically what I’m going to try and talk
about now it is helpful to avoid jargon
it is helpful to avoid big fancy words
the financial community likes to use so
let’s try and perhaps think of finance
as a traffic system well it’s not too
different in terms of the basic function
that performs so there’s many people who
will say finances like the brain of the
economy in the sense that it is actually
the financial system which attaches
relative value to goods the value of
that house in London versus the stock in
an Indian Bank versus how much you get
paid versus how much your CEO gets paid
all of these the value description is
directly or indirectly the result of the
financial system and very importantly
indirectly as a result of these values
finance is actually responsible for
allocating resources within the economy
right in the same way that our brain
besides whether our left hand is moving
or our right leg whether I’m running or
painting the financial system channels
resources to where they ought to go and
similarly transport system is supposed
to do the same job it is supposed to get
people from where they live to where
they work it is supposed to get you from
home to school to universities it is
supposed to transport food from where it
is grown where the supplies to where the
demand is where you live where you eat
so finance is similarly expected to
take savings and money from there there
are too many from there where return
opportunities are not as attractive to
deliver that money to parts of the
economy to parts of the world where
there is a shortage of capital where the
return on that capital can actually be
significantly higher so let’s stick with
this analogy for a second now it’s not
that we had the good old days where
everything worked perfectly but what we
did have was a reasonably
well-functioning financial system in
terms of the traffic what you had was
you had cars you had trucks you had
public transport systems you had buses
you had railroads you had people walking
people on bicycles and it was pretty
well regulated the traffic system you
had a lot of speed bumps
speed limits were very strictly enforced
there were a lot of traffic cops there
were traffic cameras there were barriers
pedestrian zones where you could
couldn’t go cycle lanes and that sort of
system was you know if you look at any
of the clips from the 1970s and 80s
you see rather slow moving traffic and
you see roads that are not that
congested and you see what looks like a
rather benign looking traffic system
finance was not much different there
were banks mostly your local
neighborhood banks some were regional
there were a few big giants there were
some pension funds there were some
insurers there were some advisors some
specialists but for the most part
banking was a rather boring job finance
was nothing particularly exciting it was
well-paid but not the kind of money that
we have been seeing recently and it was
very strictly regulated you had strict
limits on what any particular
institution could do or couldn’t do you
had strict limits on how you could sell
products to retail customers you had
limits on what pension funds could
invest their money in and what
they couldn’t do you had limits and
cross-border flows of money all in all
the regulator’s were quite powerful they
kept a close watch on everything that
was going on in the financial system and
things worked reasonably well and the
fruit of those of those well-regulated
systems were very easy to see
we saw post-world War two particularly
in the 60s and the 70s onwards we saw
fantastic growth rates we saw poverty
reduction we saw great creation of new
jobs we saw falling inequality and we
saw what was generally a
well-functioning
economic system that was partly driven
by a financial system that did its job
relatively well but that started to
change it’s hard to pinpoint when but
perhaps Maggie Thatcher’s and Ronald
Reagan’s deregulation era starting in
the 80s was a good starting point so
over time these cars that were being
driven gently became SUVs the trucks
that you saw the six wheelers became the
sixteen wheelers and the thirty-two
wheelers some of them became oil tankers
and started carrying dangerous products
some oil tankers started carrying
hazardous chemicals radioactive waste
perhaps some people call these
derivative products many of which as
Warren Buffet has said and I used to
trade some of them were actually toxic
the second thing that happened was the
speed limits were slowly abolished the
traffic cops that were employed were
relatively well-paid compared to the
drivers driving these financial
institutions I’m talking about financial
regulators of course they started
getting fired or the relative
compensation fell behind so it became
more and more attractive not to be a
regulator but actually to be a banker
the other developments of course were
that the drivers started racing with
each other because speed limits have
been abolished this was one bank
competing with the other
trying to generate faster profits the
stock market’s encouraging them on the
basis of quarterly stock market returns
big bonuses were an offer so all of the
drivers could earn in theory bonuses
that were ten times their base
compensation such bonuses were simply
not available in the good old days
now this incentivized everybody to drive
even faster and crazier and remember
there are no longer driving relatively
small cars or benign trucks but they’re
driving big fuel tankers at breakneck
speeds careening down the road while the
regulator’s and the police that were
supposed to keep guard have fewer and
fewer resources the traffic cameras that
existed were spray-painted over because
one of the characteristics of derivative
products is that they’re very very
opaque and many derivative products were
traded using offshore tax havens
subsidiaries Lehman Brothers the
institution I used to work for had more
than three hundred subsidiaries and
these tax haven subsidiaries were
completely out of view for regulators so
it was Russian doll-like secrecy so it
was really not clear it became less and
less visible to regulators or to traffic
cops in the traffic system what was
actually going on no doubt no no wonder
under such a circumstance that a truck
crashed and this truck happened to be
called Lehman Brothers and it was loaded
with toxic products and at the same time
that the truck crash there was a descent
of San Francisco fog on the traffic
system so at that point the first
assumption for everybody is that hey I’m
not really sure whether this was
carrying radioactive waste
or was it sarin gas or some toxic
product but that’s out on the road
Lehman’s carcasses lying on the road and
there’s toxic fumes I don’t think I
should go driving today the second thing
was Lehman crashed while racing Goldman
morgan stanley and the second logical
thing for me to think was oh my god do
Goldman and Morgan Stanley also have
that toxic waste and will they crash too
so it made complete rational sense given
this level of uncertainty where
everybody’s logically assumed the worst
possible case for everybody to stay at
home and stop driving and of course when
finance stops working when finance stops
flowing the whole economy comes to a
standstill this is exactly what happens
in the event of a traffic jam this has
happened this is what happens whenever
there’s a big crash on the motorway and
this is what happens whenever there is a
strike but similarly that’s exactly what
happened and we need to make sure that
this doesn’t happen again so it’s not
that finance has not crashed before this
was something along the lines of the
90th financial crisis we have seen
similarly traffic crashes happen all the
time every single day a truck or a car
crashes occasionally a plane Falls and
once in a while there’s a train crash
but what has changed is within the
financial system over time the frequency
of these crashes has increased how
dangerous they are for the economy has
become far more pernicious and this has
something to do with the size of the
institution the size of these trucks the
nature of the products that they sell or
they are they’re carrying the
irresponsibility of the drivers at the
helm of it and the poor resources of
those who can enforce discipline
behavior so this cannot continue now the
question is what can be done what has
been that what is being done to help
reform the financial system in a way
that it does actually start once again
reducing inequality tackling climate
change perhaps in the same way that it
has successfully in the past tackled
problems of food shortage for example
and act in a way where crashes are less
frequent and less dangerous for society
well let’s stick with the traffic system
analogy a number of lessons can be used
from that same traffic system so the
first one is the actual nature of the
vehicles it is important you’ve
presumably all heard the words too big
to fail or systemically significant
financial institutions these are
technical words for what within the
traffic system are dangerous fast moving
trucks carrying hazardous chemicals
there are financial institutions that
are so big so powerful and trade so fast
across borders that anytime something
goes wrong with them that has
consequences across the financial system
so very tightly regulating the behavior
of these hazardous chemical trucks
called C fees or too-big-to-fail
institutions is the first sensible way
to go forward and one starting point
perhaps is to make sure that maybe the
32 wheeler trucks should be shrunk down
to the 16 wheel trucks maybe instead of
having a speed limit of 80 km/h it
should be reduced to 40 km/h maybe
instead of having the normal licensing
regime for the driver at the helm of
these institutions they should be made
to Grunder go rigorous additional tests
to make sure that they drive responsibly
perhaps rather than having these
institutions checked every year as they
are if you ever drive a car you know
that every year you have to check that
the car is Road worthy and that is the
only way you are allowed to drive
similarly for financial institutions
every year they are subject to stress
tests but maybe these tests need to be
made more stringent so that is one way
to go forward to change the nature of
the vehicles on the road to change the
nature of financial institutions that
exist to make them smaller and to make
them more different one part of the
problem has been that more and more
institutions have
come similar to each other which means
when one crashes everybody else reacts
exactly in the same way and it leads to
a huge traffic pileup the second
important lesson that can be learned
from the traffic regime is to make sure
that there is a separate bicycle lane to
expand the pedestrian zones to have a
separate lane for buses and taxis and
public transport and to make sure that
the barriers between these are not criss
crossed over again one of the
consequences of the deregulation
unleashed by touch’
and Reagan was that institutions
essentially started behaving in any way
that they wanted the same institutions
which were forbidden from at the same
time trading in derivative markets as
selling to you and I and the little
people and their savings products were
allowed to do both at the same time
which led to massive conflicts of
interest so keeping and re-enacting
these boundaries is a good disciplining
way to make sure that the traffic system
as a whole that the financial system as
a whole does its job and there isn’t a
massive conflict of interest and that
each different part of the economy gets
serviced by the kind of financial
institution that is appropriate to it
that we do not have what we saw which
was savings banks all wanted to be like
goldman sachs goldman sachs wanted to be
like a hedge fund and we ended up in a
situation where everybody suffered
let’s talk about what dominates
headlines today in terms of risks things
we worry about things we wake up with a
cold sweat in the middle of the night
thinking about climate change is one big
issue general environmental degradation
many people say for example that the
water crisis is even more serious than
global warming is another one rising
inequality not across countries but
within countries is something that we
see the numbers are very clear on that
particularly since Lehman’s crash and it
is starting to really affect our lives
in terms of the response to this rising
inequality particularly within the OECD
in that sense rising populism exactly
also is an issue that we are grappling
with increasingly particularly in Europe
and in the United States so what is if
any the common thread across most of
these problems that we grapple with what
is this elephant in the room that
connects these and my answer to this is
it’s actually the financial system the
financial system like would like to
think it is very complicated and I
remember the pre Lehman days where
anytime you talk to a banker they would
talk about finance as rocket science and
it was the best way to stop people
discussing how finance actually worked I
mean it is nothing like rocket science
perhaps a more fitting analogy sticking
with elephants is it’s been the case of
the five blind men and the elephant
where everybody beat us as retail
customers of banks or pension holders
putting money in their pension funds or
financial regulators central banks
overseeing certain aspects of the
financial system etc or as a company or
an entrepreneur trying to raise money
we all saw various parts of the elephant
somebody saw the tail and thought it was
a rope somebody felt
the leg and potted was a pillar but
frankly there wasn’t really much of an
incentive for anybody to really
understand how the financial system as a
whole worked of course that has all
changed with Lehman so where does that
leave us and what can we do to make sure
that the financial system which has been
functioning rather poorly in past few
decades and has indirectly or directly
in some cases given rise to these major
problems that we grapple with how can we
deploy it in our service that’s
basically what I’m going to try and talk
about now it is helpful to avoid jargon
it is helpful to avoid big fancy words
the financial community likes to use so
let’s try and perhaps think of finance
as a traffic system well it’s not too
different in terms of the basic function
that performs so there’s many people who
will say finances like the brain of the
economy in the sense that it is actually
the financial system which attaches
relative value to goods the value of
that house in London versus the stock in
an Indian Bank versus how much you get
paid versus how much your CEO gets paid
all of these the value description is
directly or indirectly the result of the
financial system and very importantly
indirectly as a result of these values
finance is actually responsible for
allocating resources within the economy
right in the same way that our brain
besides whether our left hand is moving
or our right leg whether I’m running or
painting the financial system channels
resources to where they ought to go and
similarly transport system is supposed
to do the same job it is supposed to get
people from where they live to where
they work it is supposed to get you from
home to school to universities it is
supposed to transport food from where it
is grown where the supplies to where the
demand is where you live where you eat
so finance is similarly expected to
take savings and money from there there
are too many from there where return
opportunities are not as attractive to
deliver that money to parts of the
economy to parts of the world where
there is a shortage of capital where the
return on that capital can actually be
significantly higher so let’s stick with
this analogy for a second now it’s not
that we had the good old days where
everything worked perfectly but what we
did have was a reasonably
well-functioning financial system in
terms of the traffic what you had was
you had cars you had trucks you had
public transport systems you had buses
you had railroads you had people walking
people on bicycles and it was pretty
well regulated the traffic system you
had a lot of speed bumps
speed limits were very strictly enforced
there were a lot of traffic cops there
were traffic cameras there were barriers
pedestrian zones where you could
couldn’t go cycle lanes and that sort of
system was you know if you look at any
of the clips from the 1970s and 80s
you see rather slow moving traffic and
you see roads that are not that
congested and you see what looks like a
rather benign looking traffic system
finance was not much different there
were banks mostly your local
neighborhood banks some were regional
there were a few big giants there were
some pension funds there were some
insurers there were some advisors some
specialists but for the most part
banking was a rather boring job finance
was nothing particularly exciting it was
well-paid but not the kind of money that
we have been seeing recently and it was
very strictly regulated you had strict
limits on what any particular
institution could do or couldn’t do you
had strict limits on how you could sell
products to retail customers you had
limits on what pension funds could
invest their money in and what
they couldn’t do you had limits and
cross-border flows of money all in all
the regulator’s were quite powerful they
kept a close watch on everything that
was going on in the financial system and
things worked reasonably well and the
fruit of those of those well-regulated
systems were very easy to see
we saw post-world War two particularly
in the 60s and the 70s onwards we saw
fantastic growth rates we saw poverty
reduction we saw great creation of new
jobs we saw falling inequality and we
saw what was generally a
well-functioning
economic system that was partly driven
by a financial system that did its job
relatively well but that started to
change it’s hard to pinpoint when but
perhaps Maggie Thatcher’s and Ronald
Reagan’s deregulation era starting in
the 80s was a good starting point so
over time these cars that were being
driven gently became SUVs the trucks
that you saw the six wheelers became the
sixteen wheelers and the thirty-two
wheelers some of them became oil tankers
and started carrying dangerous products
some oil tankers started carrying
hazardous chemicals radioactive waste
perhaps some people call these
derivative products many of which as
Warren Buffet has said and I used to
trade some of them were actually toxic
the second thing that happened was the
speed limits were slowly abolished the
traffic cops that were employed were
relatively well-paid compared to the
drivers driving these financial
institutions I’m talking about financial
regulators of course they started
getting fired or the relative
compensation fell behind so it became
more and more attractive not to be a
regulator but actually to be a banker
the other developments of course were
that the drivers started racing with
each other because speed limits have
been abolished this was one bank
competing with the other
trying to generate faster profits the
stock market’s encouraging them on the
basis of quarterly stock market returns
big bonuses were an offer so all of the
drivers could earn in theory bonuses
that were ten times their base
compensation such bonuses were simply
not available in the good old days
now this incentivized everybody to drive
even faster and crazier and remember
there are no longer driving relatively
small cars or benign trucks but they’re
driving big fuel tankers at breakneck
speeds careening down the road while the
regulator’s and the police that were
supposed to keep guard have fewer and
fewer resources the traffic cameras that
existed were spray-painted over because
one of the characteristics of derivative
products is that they’re very very
opaque and many derivative products were
traded using offshore tax havens
subsidiaries Lehman Brothers the
institution I used to work for had more
than three hundred subsidiaries and
these tax haven subsidiaries were
completely out of view for regulators so
it was Russian doll-like secrecy so it
was really not clear it became less and
less visible to regulators or to traffic
cops in the traffic system what was
actually going on no doubt no no wonder
under such a circumstance that a truck
crashed and this truck happened to be
called Lehman Brothers and it was loaded
with toxic products and at the same time
that the truck crash there was a descent
of San Francisco fog on the traffic
system so at that point the first
assumption for everybody is that hey I’m
not really sure whether this was
carrying radioactive waste
or was it sarin gas or some toxic
product but that’s out on the road
Lehman’s carcasses lying on the road and
there’s toxic fumes I don’t think I
should go driving today the second thing
was Lehman crashed while racing Goldman
morgan stanley and the second logical
thing for me to think was oh my god do
Goldman and Morgan Stanley also have
that toxic waste and will they crash too
so it made complete rational sense given
this level of uncertainty where
everybody’s logically assumed the worst
possible case for everybody to stay at
home and stop driving and of course when
finance stops working when finance stops
flowing the whole economy comes to a
standstill this is exactly what happens
in the event of a traffic jam this has
happened this is what happens whenever
there’s a big crash on the motorway and
this is what happens whenever there is a
strike but similarly that’s exactly what
happened and we need to make sure that
this doesn’t happen again so it’s not
that finance has not crashed before this
was something along the lines of the
90th financial crisis we have seen
similarly traffic crashes happen all the
time every single day a truck or a car
crashes occasionally a plane Falls and
once in a while there’s a train crash
but what has changed is within the
financial system over time the frequency
of these crashes has increased how
dangerous they are for the economy has
become far more pernicious and this has
something to do with the size of the
institution the size of these trucks the
nature of the products that they sell or
they are they’re carrying the
irresponsibility of the drivers at the
helm of it and the poor resources of
those who can enforce discipline
behavior so this cannot continue now the
question is what can be done what has
been that what is being done to help
reform the financial system in a way
that it does actually start once again
reducing inequality tackling climate
change perhaps in the same way that it
has successfully in the past tackled
problems of food shortage for example
and act in a way where crashes are less
frequent and less dangerous for society
well let’s stick with the traffic system
analogy a number of lessons can be used
from that same traffic system so the
first one is the actual nature of the
vehicles it is important you’ve
presumably all heard the words too big
to fail or systemically significant
financial institutions these are
technical words for what within the
traffic system are dangerous fast moving
trucks carrying hazardous chemicals
there are financial institutions that
are so big so powerful and trade so fast
across borders that anytime something
goes wrong with them that has
consequences across the financial system
so very tightly regulating the behavior
of these hazardous chemical trucks
called C fees or too-big-to-fail
institutions is the first sensible way
to go forward and one starting point
perhaps is to make sure that maybe the
32 wheeler trucks should be shrunk down
to the 16 wheel trucks maybe instead of
having a speed limit of 80 km/h it
should be reduced to 40 km/h maybe
instead of having the normal licensing
regime for the driver at the helm of
these institutions they should be made
to Grunder go rigorous additional tests
to make sure that they drive responsibly
perhaps rather than having these
institutions checked every year as they
are if you ever drive a car you know
that every year you have to check that
the car is Road worthy and that is the
only way you are allowed to drive
similarly for financial institutions
every year they are subject to stress
tests but maybe these tests need to be
made more stringent so that is one way
to go forward to change the nature of
the vehicles on the road to change the
nature of financial institutions that
exist to make them smaller and to make
them more different one part of the
problem has been that more and more
institutions have
come similar to each other which means
when one crashes everybody else reacts
exactly in the same way and it leads to
a huge traffic pileup the second
important lesson that can be learned
from the traffic regime is to make sure
that there is a separate bicycle lane to
expand the pedestrian zones to have a
separate lane for buses and taxis and
public transport and to make sure that
the barriers between these are not criss
crossed over again one of the
consequences of the deregulation
unleashed by touch’
and Reagan was that institutions
essentially started behaving in any way
that they wanted the same institutions
which were forbidden from at the same
time trading in derivative markets as
selling to you and I and the little
people and their savings products were
allowed to do both at the same time
which led to massive conflicts of
interest so keeping and re-enacting
these boundaries is a good disciplining
way to make sure that the traffic system
as a whole that the financial system as
a whole does its job and there isn’t a
massive conflict of interest and that
each different part of the economy gets
serviced by the kind of financial
institution that is appropriate to it
that we do not have what we saw which
was savings banks all wanted to be like
goldman sachs goldman sachs wanted to be
like a hedge fund and we ended up in a
situation where everybody suffered
Please follow and like us: