The financial industry

The financial industry

by Heini Lippuner*

Citizens have lost all confidence in the banks.
Even in liberal media, critical articles on the financial industry have recently been piling up. It is not just a matter of cost-cutting measures in view of shrinking margins, but also, in a more general sense, about strategic orientation, corporate culture and the role of banks within the terms of economy.
In our lessons about economics we have learned that the first sector (primary production) and the second sector (industry) are supported by the third sector, the services. The banks have long since outgrown this role; today they form a true financial industry, which operates speculative business using money from the other two sectors with only a minimal addition of their own funds.
Originally, the banks were the link between private and institutional investors on the one hand, and private, industrial and government borrowers on the other. Banks also provided an efficient payment system. The banker felt responsible for his clients and treated their money as if it were his own. Today only middle and small institutes have this understanding of their role, while the big banks form an independent industry with the goal of maximising their own profit using their depositors’ money.

The advance of American capitalism to Europe

This development started with the advance of American capitalism to Europe. In the 1980s, it could be seen how investment banks, business consultants and also some economists virtually glorified shareholder value ideas. Their slogan was short-term profit maximisation to increase exchange rates. Investment banks urged companies to make ludicrously ambitious acquisitions, disinvestments, and mergers without any industrial logic, just to get the stock market moving and thus to be able to collect huge commissions and consultation fees. Those who did not participate and who persistently pursued the long-term well-being of their companies were sneered at as “softies” by the liberal financial media.
Events on the stock exchange also changed radically with the adoption of American customs. Previously, the stock exchange had been a marketplace: buyers were – private and institutional – investors who were willing to pay a certain price for shares of a company, depending on their assessment of its future, whereas sellers of these shares were investors who were of a different view or needed liquid funds. This resulted in a fair price reflecting a company’s prospects for the future. In 1980, the average holding period for shares in Germany was approximately 10 years; in 2000 it was less than a year.

“The stock exchange has been turned into a giant casino”

Today so-called high-frequency trade sets the pace on the stock market, which has essentially been turned into a betting office. It is no longer a matter of assessing the future of a company, but of guessing how other banks are going to operate in respect of a certain security paper and then to immediately bet against or run along. These decisions are made in milliseconds by means of sophisticated computer programmes. One large bank even went so far as to want to place its computers close to the New York Stock Exchange in order to beat the more distant competition by a few milliseconds of electronic distance. So, according to Professor Chesney, the present holding period for shares is 22 seconds. This has nothing to do with corporate financing and sound investment. The stock market has been turned into a giant casino.
This casino is further driven by analysts and financial media. Analysts believe they can predict a company’s outcome for the next quarter, and the financial media first and foremost comment on deviations from this forecast. To them it is less interesting whether, for example, a company is well positioned for the future or whether it has gained market shares. Originally, analysts used to prepare neutral recommendations for sustainable financial investments for the benefit of customer service providers; today, they provide short-term profit forecasts and targeted rumours so as to ensure movement in the stock exchanges. This promotes profit by proprietary transactions and generates commission income for the banks. Contrary to the banks’ allegations that analysts are shielded by “chinese walls”, they are today also agents for traders and managers, who give daily instructions to customer support as to the purchase or sale of which titles should be promoted. The aim of these requirements is to increase the return on the bank, not the welfare of the investor.

“Erosion of ethical standards in the big banks”

In the course of time, the invasion of American neo-capitalism has brought about an erosion of ethical standards in the big banks. There is no trace left of “ownership” and “accountability” to depositors. For the cadres and the management, it remains only a matter of the absurdly high bonuses at the cost of the investors, thanks to the new incentive systems. So called “financial innovation” has daily produced new derivatives using modern IT, from a simple bond, the interest rate of which depended on the amount of annual hail damage in Switzerland, to triple-packaged American junk mortgages and related insurance. Such instruments were foisted on naive customers who were unaware that they were intended to put as much risk of losses as possible on the depositor, while the profit chances would remain with the bank.
Almost inevitably, the degeneration of the corporate culture in the big banks and the greed for more and more profit and even higher bonuses led to fraud and scandals: LIBOR agreements, manipulation of foreign exchange rates, money laundering, aiding and abetting tax fraud, etc. Only a few examples out of the endless list of offenses shall be mentioned here: The six largest banks paid fines to a total of 5.8 billion US dollars for having manipulated foreign exchange rates; HSBC, CS, ING and Standard Chartered paid 3.7 billion US dollars of fines for money laundering, JP Morgan averted the threat of being charged for deceiving investors with hypo-derivatives which, according to Attorney General Holder, should never have been legally sold, by paying 13 billion US dollars, “without acknowledging a debt” – as is the customary procedure in the US. In the same year, however, Chairman Jamie Dimon increased his salary by 74%! “Deutsche Bank” is faced with a 14 billion US dollars fine for the same offenses, and is thus existentially threatened. So as to meet their superiors’ “cross selling” requirements, Wells Fargo’s account managers registered additional products in their depositors’ folios without even telling them; the out of court settlement will cost billions.

Massive weakening of equity has no consequences for the management

The banks settle all these huge amounts from their reserves and have thus massively weakened their equity. Anyone who has invested his savings in bank shares sees their substance melting down. But only a few of the top managers were brought to account or even had to take their hat. On the contrary, Josef Ackermann, who headed “Deutsche Bank” at the time of its dubious business with hypo-derivatives and is therefore responsible for the 14 billion US dollar fine now holds the honorable post of chairman of the Bank of Cyprus. Only a few middle-ranking executives were prosecuted.
The financial crisis of 2008, when dozens of banks had to be rescued from collapse with taxpayers’s money, made clear what risk to our society is generated by the financial industry’s conduct. It is our savings they play with in their casino. Private and institutional investors’ deposits are only partly outsourced as credits to economy; a large part is lent to other banks or serves as a so-called lever for risky products, in which very little of their own money is invested. The financial authorities have tried to curb the danger of another crisis, but to date, the powerful financial lobby has managed to prevent a real reform. So nothing was done except turning a few adjustment screws, with the effect of, for instance, a gentle increase in equity or the creation of bank bonds which will be converted into equity in an emergency. Thus the banks’ highest goal – the return on equity – remains untouched, and the danger of a new crisis is not eradicated.

Arguments for a division into commercial banks and investment banks

It is high time that politicians bring themselves to finally enforce a thorough reform of the financial industry. The key element of such a reform must be the division of banks into commercial banks on the one hand and investment banks (the casino) on the other. Business banks would once again fulfill the original role as service providers for the first and second sector of the economy: they would manage assets, be the hub between savers/investors and borrowers, and operate payment transactions.
Venturesome investors could place their money with investment banks, whether in the form of investments of all kinds or as shareholders. They could speculate as much as they wanted, but they would have to be aware that neither commercial banks nor the state would help if something went wrong. If practical reasons make the separation of the exchanges impossible, certain practices such as naked sales or high-frequency trading would have to be severely restricted.
Such a separation system was introduced in the form of the Glass-Steagall Acts in the US in the aftermath of the 1933 crisis and collapsed for good in 2008 after having been gradually eroded under the pressure of the powerful US financial industry. Undoubtedly today a separation is an extremely complex task, but it must be undertaken if a renewed crisis of the world economy is to be avoided.

So far the financial industry has learned nothing from the crisis

The financial industry has forfeited trust once and for all. It has learned nothing from the crisis and is continuing on its old track with a few minor restrictions. It is going ahead with its false bonus systems, and the top management continues to collect exorbitant salaries for its miserable performance. Our politicians must act in the interest of the whole economy.
Many citizens in Europe are concerned about the social and political impact of Anglo-Saxon capitalism. Since the 1980s, Europe has taken over from the US practices that are recklessly geared to maximising short-term profit. The most recent version takes the form of the so-called “shareholder activists”: huge US investment funds such as Blackrock, which hold large share packages. They are trying to increase their own profit by imposing strategies on European companies that do not serve to secure the long-term future. We Europeans are about to abandon the principles of social market economy – meaning responsibility for society and the environment in addition to financial success – and we are already seeing the first consequences: Like in the US, the increase in income generated over the last 25 years has gone mainly to the rich. In this period, the real income of the top 10% has risen more than twice as high as that of the lower income classes.
The discussion on the free trade agreements with Canada and the US shows that opposition to the automatic takeover of American practices is forming not only in the financial sector: European consumer protection shall not be watered down by means of the more liberal US rules. In the cultural sector too, Europe is beginning to defend itself against the powerful US media groups, which are flooding our market with their shallow bulk goods. We must protect our own cultural production against this flood.

Europe needs to recollect its strengths

“Just because we have seen off communism does not mean that capitalism has won!” – Certainly American-style capitalism cannot win. Europe needs to recollect its strengths and to defend its own model of capitalism with all its might – a market economy that strives to achieve financial goals while respecting society and the environment. If our politicians will not act decicively and with determination, sooner or later a socialist “backlash” will move our political order sharply to the left.     •

*     Heini Lippuner began his professional career in the banking sector and in international wholesale. He then changed to Geigy or Ciba-Geigy, respectively. In 1986, after a variety of occupations for the company at home and abroad, he became member of the Executive Board. In 1988, he was appointed Chief Executive Officer, a position he held until the merger of Ciba with Sandoz out of which in 1996 Novartis was formed. Following that, until 2004, he was Member of the Board of Directors at Novartis; he held other board of directors mandates, inter alia at Bühler Holding AG, Winterthur-Versicherungen and Credit Suisse. 

(Translation Current Concerns)

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