2 janvier 2022

Is it ownership or debt?

Thomas Krantz
Advisor to the Managing Director
"One of the greatest pieces of economic wisdom is to know what you do not know": John Kenneth Galbraith

As 2022 starts, some fresh thinking is in order.

We in the financial services sector are rightly proud of the incalculable speed and variety of the products and services we sell to society.  It truly is stunning.  But it is the adjective “incalculable” that poses the question about what it is that we do.  How well do we know what we are doing, by which I mean the totality of all these contractual arrangements?  In the 2020s, an individual transaction can be very complex and written in jargon that essentially defies comprehension.  In the aggregate, on any given day, what does it all add up to?

This opinion is to help WAIFC members, and their audience, get both feet on the ground and recover a sense of the basics:   what is it that lies at the very bottom of what we do each day?

John Kenneth Galbraith taught economics at Harvard for nearly half a century; his books and textbooks were widely read and highly influential in public policy, as were his lectures.  Raised on a farm in Ontario, Canada, he trained in agricultural economics, a subject area that informed his thinking and corresponded well to his innate modesty.  Galbraith stood out in his profession for the respect his work earned as well as, literally, for his height, which was 206 cm (6 feet 9 inches). 

Financial services have evolved over the centuries with economic and technological change.  In the Western world, the Florentines of the Renaissance made their fortune largely in Italy, while the Genoese and Venetians did so in trading abroad.  Centered in Milan, the capital of Lombardy, the bankers in northern Italy were so astute that, in tribute to the transfer of credits and expertise, a main street in the City of London is indeed named Lombard Street.  As WAIFC membership demonstrates, there is geography and world-wide interaction embedded in this work, however remote from one another life is in these Covid years.

Famously in Japan, the price of rice set in Osaka was relayed across much of the archipelago in a matter of hours by smoke signals from hilltop to hilltop.  Equally renowned, the Rothschilds had their private fleet of couriers to relay information across Europe at the speed of horses, which decades later was overtaken by the firm of Reuters when telegraphs were invented – the pace then increased, and information dissemination became far broader.  Telephones later enabled two-way conversations, and that led on to the internet-based information systems we have adopted since the 1990s.  To attain yet greater speed, microwave towers were built between the markets in New York and Chicago just over a decade ago; IT systems took in the information, because human heads could not.  As any history of financial services demonstrates, there has been a constant acceleration in the speed of what is created and sent to market.

In the now distant 1970s, the first financial derivatives were being tested in the Chicago markets as the US dollar was unfixed from the price of gold, the instruments themselves adapted from the long-established commodities markets.  A decade later and with its authoritative voice, the Bank for International Settlements published the definitive book on what these “New Financial Instruments” were.  Although Messrs Black and Scholes wrote their Nobel-prize winning equation determining the value of an option in 1973, most of the participants in the Chicago markets in those early years did not have much more than a hand-held calculator, if that.  Looking back, if the value of those options could not be determined more exactly, those pioneers were indeed risking a good deal.  Perhaps that is the very definition of pioneering.  Modesty compels us to recall that we participants have gotten more than a bit too far of ourselves on occasion – from the Dutch tulip mania to the bust of the turn of the millennium, and the many crises in the centuries between and since.  As this brief look demonstrates, another constant in financial services is growing complexity.

But this is where Professor Galbraith’s writing comes in hand:  his work included the simple observation that at the bottom of it all, lost in jargon and muddied in technique, the transactions we craft are either the transfer of a form of ownership or indebtedness.  When an investor sells a put option to a buyer, there is a buyer and a seller of a right.  When an investor buys a fixed-income instrument, the issuer of that security has the obligation to meet interest and capital repayment terms.  This look back at the start of a new calendar is simply a reminder of this basic point.

By all means, inventiveness must and should continue, not only because our technology will allow it.  Hopefully, there will be gains in efficiencies, and more careful calibration of risks. 

And yet this industry can do more:  it is at the macro level where the collective work of WAIFC comes into play.  It is only by assessing and aggregating the breadth of financial businesses in each center, the sum of its diverse entities’ innumerable transactions that are either ownership or indebtedness, that one can begin to see the fuller picture.  Working with many parties, this coming into focus of the financial services industry’s output is the one of the best social contributions that WAIFC members could make.