How times have changed. Earlier any mention of markets automatically meant it is real and good for the people. Not anymore.
Mark Carney of BoE (while releasing the Bank’s Fair and Effective Markets Review Releases Final Report) says we need to build such markets:
Almost 350 years ago, the Great Fire destroyed the City of London and rendered 100,000 people homeless. It took half a century to rebuild. The legacy of the Great Fire endures, including such Wren masterpieces as St Paul’s and his twenty-five other steeples that survive today within the City’s precincts. But the Fire’s legacy is not limited to how the City looks, it extends to what the City does.
The blaze led Nicholas Barbon to establish the first insurance company, an innovation to fulfil a social need: the sharing of risk. Public authorities complemented private initiative.
There was a Royal Proclamation that set standards for wider roads and houses built from brick and stone instead of timber. And Parliament passed the Parish Pump Act to prevent “mischiefs that may happen by fire” by establishing fire brigades and improving water supply. So that spark in Pudding Lane ignited much more besides the Great Fire itself:
- the provision of liquidity to limit contagion;
- a recognition that clear, well-understood codes contribute to the greater good; and
- a belief that financial markets can solve real world problems.
From the coffee houses that served as meeting places for entrepreneurs and merchants; to the exchanges that supported the trading of financial claims; to a central bank that acted as lender of last resort: a rich infrastructure developed to support markets that served the UK and the world. As it grew into the world’s leading economic and trading power, the UK also became its centre of financial capitalism.
By the early 20th century, though no longer the world’s largest economy, the UK was still its hub of international finance. It held close to a half of the world’s stock of overseas investments and traded one third of all negotiable instruments.
The City has retained its pre-eminence through market innovation. From eurobonds to emerging market debt, credit derivatives and centralised clearing; the City has continually created new financial products and markets to serve the real economy. Today the City remains the leading global financial centre. The UK is the venue for 40% of foreign exchange trading volume, half of all trades in OTC interest rate derivatives, and more than two-thirds of trading in international bonds. More international banking activity is booked in London than anywhere else, and the UK is host to the world’s third largest insurance sector as well as its second largest asset management industry. UK markets matter for global commerce. But above all, our markets matter for our prosperity.
How this crisis changed things:
Though markets can be powerful drivers of prosperity, markets can go wrong. Left unattended, they are prone to instability, excess and abuse. Markets without the right standards or infrastructure are like cities without building codes, fire brigades or insurance. Poor infrastructure allowed the spark of the US subprime crisis to light a powder keg under UK markets, triggering the worst recession in our lifetimes.
Poor ‘soft’ infrastructure such as codes of conduct that too few read and too many ignored.\ Faulty ‘hard’ infrastructure like interest rate and foreign exchange benchmarks that were quite literally fixed; and Weak banks whose light capital and heavy reliance on short-term funding created a tinder box.
Central banks shared in these failings, operating a system of fire insurance whose ambiguity was anything but constructive when global markets were engulfed in flames. The Bank of England’s general approach was consistent with the attitude of FICC markets, which historically relied heavily on informal codes and understandings. That informality was well suited to an earlier age. But as markets innovated and grew, it proved wanting.
Most troubling have been the numerous incidents of misconduct that exploited such informality, undercutting public trust and threatening systemic stability. This has had direct economic consequences. Mistrust between market participants has raised borrowing costs and reduced credit availability. Falling confidence in market resilience has meant companies have held back productive investments. And uncertainty has meant people have hesitated to move job or home. These effects are not trivial, and they have reduced the dynamism of our economy in the post-crisis years.Widespread mistrust has also had deeper, indirect costs. Markets are not ends in themselves, but powerful means for prosperity and security for all. As such they need to retain the consent of society – a social licence – to be allowed to operate, innovate and grow. Repeated episodes of misconduct have called that social licence into question.
We have all been let down by these developments. And we all share responsibility for fixing them.
It is really surprising to see such reflections. For all you know, BoE and London were seen as the benchmarks for anything in finance.
What are real markets?
I believe everyone in this room would agree: we need real markets for sustainable prosperity. Not markets that collapse when there is a shock from abroad. Not markets where transactions occur in chat rooms. Not markets where no one appears accountable for anything.
Real markets are professional and open, not informal and clubby. Participants in real markets compete on merit rather than collude online. Real markets are resilient, fair and effective. They maintain their social licence. Real markets don’t just happen; they depend on the quality of market infrastructure.
Robust market infrastructure is a public good, one in constant danger of under-provision because the best markets innovate continually. This inherent risk can only be managed if all market actors, public and private, recognise their responsibilities for the system as a whole. The City has a special responsibility given London’s pre-eminent position in global markets, which is why it has already brought so many ideas and such energy to advance financial reform.
He then goes onto the various reforms underway to make financial markets real markets. It is ironical to see markets being shaped by govts and central banks of all players.
The key is humility and not let hubris set in. For years we have been told that we have arrived at a perfect real market framework which will continue to deliver prosperity to people. And then it was upto others to inch towards this kind of policy setting. And now we know how much of these ideas were not just plain wrong.