onlinebanking

Sitting in a conference talking about living wills isn’t how you want to spend your typical day, but it did spark a whole bunch of thoughts in my mind.

The FSA issued their consultative paper 11/16 last summer.

The idea is that every bank with assets over £15 billion must produce a Recovery and Resolution Plan (RRP) by the end of this June.

The RRP = a ‘living will’.

I’m not going to delve into the depths of such matters – you can read all about it on the FSAs website - except to say that the RRP comprises a Recovery Plan and a Resolution Plan.

The Recovery Plan must include a sufficient range of material and credible options to address a range of crisis scenarios, and show how the institution would address these issues to continue operating in a stable way, avoiding capital shortfalls and pressures on liquidity.

The Resolution Plan would show how a firm would wind-down if it failed for any reason, including how it would avoid any impact to taxpayers and the public funds.

All well and good.

Or is it.

Whilst I like the idea of a living will for a zombie bank, it strikes me that we still haven’t gotten to the heart of the matter.

The question is really: what do we do with an insolvent bank that could bring down the economy of our nation?

The answer is not to let a bank become so big that it could bring down the economy of the nation.

So the real answer should actually be more to do with limitations on bank size, structure and asset base leverage, rather than getting it to open up a living will.

To me, this is what the Vickers report separating investment and retail banking, and the Volcker Rule shutting down prop trading is all about.

So the two work in tandem – a bank must shrink its size to be big enough to fail and, if it does, have a clear plan for how to deal with failure.

Yet even then, it doesn’t solve the issues.

For example, the average life of a company in the S&P500 is just 15 years today; most banks have been around for over 100 years.

The reason why banks have been around so long is down to governments regulating and maintaining them, rather than any c0mpetitive forces.

If banks weren’t protected by regulations, they would fail far more often, just as commercial firms do.

And if a large commercial firm fails – Rover, BP or Tesco – they just get acquired or shutdown. 

They don’t bring down the entire economy.

When a bank fails, it brings down the whole economy because the economy runs on finance.

Finance is the oil in commerce – no oil, no commerce.

That’s why banks aren’t allowed to fail.

It’s also why we realise the mistake when they do.

A small bank – a Northern Rock – can fail, but it won’t shake the fabric of the economy of system.,

A large bank – a Citibank or Royal Bank of Scotland – is different.

At the height of the banking crisis, UK bank liabilities were 400% of GDP: £5 trillion against GDP of £1.2 trillion – and the Royal Bank of Scotland alone had more liabilities (£1.8 trillion) than the UK’s GDP.

So now we get into the heart of the matter.

How do you deal with an insolvent bank that could break the economy?

A living will is one piece.

The separation of investment and commercial banking (Vickers) is another.

But the real test would be to go back to the trigger of this crisis: would these regulations have dealt with Lehman Brothers collapse any better?

There are two or three things that come to light in this area.

First, when Lehmans collapsed they had $400 billion of debt on their books.  That debt was linked to global credit default swap derivatives (CDS) and amplified by a factor of 20, according to Barclays Capital.

So for every $1 of debt that Lehmans were exposed to, the markets were exposed to $20 due to their AAA-rating backing derivatives traded through the OTC markets.

Hence, the real exposure of risk the markets felt on September 14^th 2008 was a $8 trillion market collapse, not a small bank folding.

Do living wills, Vickers and Volcker deal with this spaghetti of complexity that each banks’ balance sheet is linked with?

Not yet.

Second, when Lehmans collapsed the company most wrapped up in their web of debt was AIG.  AIG Financial Products in London had been trading CDS to such an extent that most of the market exposure landed on their doorstep and dragged the firm down.

However, AIG Financial Products was also a complex web of structure.

AIG was the largest insurance firm in America, trading in risks through their London office which was registered for European operations in Paris.

So three regulators were meant to track the global risks being traded by one global firm through a web of global offices.

Fail.

Do living wills, Vickers and Volcker deal with this web of globality that each banks’ balance sheet is linked with?

Not yet.

The two points made here are making it clear that the regulators need a global level playing field if their attempts to regulate the markets successfully are going to truly succeed.

But a global level playing field is also impossible, as no country can agree with another on taxation, fiscal and monetary policies.

Just look at the EU right now, and the transaction tax, if you want to see why a global level playing field is not going to work.

Sorry to be a downer Messrs Osbourne, Barnier and Bernanke but, as one speaker said yesterday, “the worst mistake regulators can make is to believe in their own rules”.

Point taken.

Things we're reading today include ...

Things we're reading today include ...

Biometrics isn’t discussed that much at banking conferences these days.

Most of the time, when I raise the topic, there’s a groan from the banking audience.

“Oh, been there, done that.”

The usual view is that biometrics doesn’t work.  It’s too flakey.  Too many false positives and false negatives, as in it doesn’t read the finger, eyeball or voice correctly.

And yet, we now have things like Siri voice recognition on the iPhone and fingerprint PC access that is commonplace.

Voice and fingerprint recognition has come a long way.

India has now identity tagged every citizen with a biometric ID, and most governments are doing the same via passport and cross-border programs.

So why are banks so reticent about biometrics for identity?

Because of the past trials or the future costs?

Probably a mixture of both.

Certainly, the idea of biometrics in banking has been around for a long time.

I was involved in rolling out iris recognition ATMs in the 1990s and engaged actively with the Japanese program of deploying palm reading ATMs in the 2000s.

At airports, I regularly pass through the fast track line with an eyeball to a screen, banks have rolled out iris recognition on smartphones and Apple has even patented a fingerprint recognition as you swipe your iPhone to unlock it.

Yet I still look for biometrics in banking and find it hard to uncover anything worthwhile.

Instead, we have passwords that can be cracked easily and so we add an extra clunky three-factor authentications with a one time password generator.

And customers don’t like it.

“It seems like an innocuous piece of kit to have inspired such annoyance, but the new HSBC ‘secure key’ has already garnered six Facebook pages plotting its demise, while Twitter is all aflutter with people explaining just why they don't want to use it. So why has the bank decided to introduce this seemingly unpopular gadget.”

No, they don’t like it one bit.

Things will change and biometrics will be deployed instead of additional tokens and devices over time.

Much of this market increase will come from large government ID and security programs, which will then ripple over into financial applications.

For example, Companies and Markets predicts that the global biometrics market will hit $12 billion by 2015, up from $5 billion in 2010, thanks to these government security programs.

The report believes fingerprints will see the major focus, although citizens don’t’ like fingerprint recognition.

The reason is that fingerprints are mucky.

Wiping your finger over a terminal touched by hundreds or thousands of others, with no cleansing or wipe in-between.

Yeuch.

That’s why the Japanese moved into palm or vein reading, as you don’t actually need to touch the terminal.

But the most intuitive of all biometrics has to be voice surely?

With mobile being so ubiquitous, voice makes sense as it’s something you can easily verify via mobile.

Voice is a proven technology and voice recognition is resilient, accurate and reliable enough to overcome accents or influenza.

With voice you don’t even realise you’re being biometrically read necessarily, and you can even use voice to detect lies.

This is why Opus Research predicts that the global number of registered voiceprints will increase from 10 million today to over 25 million in 2015, and much of this will be driven by the payments markets.

Mind you, you need to beware of voice a little bit.

After all, just checkout Siri.

Yesterday I wrote about the concept of banks being barred from betting on the bonds and equities markets.

“Own account” trading disappears and the only folks who can “speculate” are those with their own chips to play in the game: the private equity, sovereign wealth, high net wroth assets and their asset managers who back all punts with collateral and cash.

In other words, the current players who systematically internalise will leave.

Bear in mind that a systemic internaliser is defined as a market maker who regularly trade off their own book of business:

MiFID provides that a firm should be treated as a systematic internaliser if it deals with client orders in shares on an “organised, frequent and systematic basis” from its own business account.  These shares would normally be traded through an exchange or regulated market, but the investment firm is basically holding the shares themselves, waiting for the right price to match.

Some fear such trading is risky and allows banks to buck the price because the banks themselves can trade for their own benefit through such internalisation, known as prop or proprietary trading.

It is this trading that is now being targeted as being unacceptable, according to the American Volcker Rule.

The “Volcker rule”, named after Paul Volcker the former Federal Reserve chairman who proposed it, would restrict the ability of banks trading for their own benefit.

The Volcker Rule, along with others such as Vickers, could push systemic internalising out of the banking sector and, as mentioned yesterday, such that trading is purely operated through funds and asset managers who have the collateral.

So who would this impact?

We mentioned Goldman Sachs and Morgan Stanley in the USA yesterday, but the main European systematic internalisers are BNP Paribas, Citigroup, Credit Suisse, Goldman Sachs, Knight Equity Markets, Nomura, Royal Bank of Scotland N.V. (ABN AMRO as was) and UBS.

Now I know I’m pulling the chain a little here but let’s just say that all these guys trading desks, due to regulations and bonus restrictions, see mass exodus.

What is the future?

What does this mean for investment banks?

It means they purely become platform providers.

A little like the City of London describes itself as the Wimbledon of finance – we have no players, but provide the best courts to play upon – future banks will provide the infrastructure but not play.

So the world’s investment markets purely become technology oriented platforms which players plug into to play.

Kind of like  Betfair, Bet365,Ladbrokes, Paddy Power, William Hill and other online gambling and betting services, investment firms become providers of platforms but they don’t play their platforms.

The market makers and systematic internalisers become technology firms, offering the fastest execution at lowest cost with best price, and the high frequency traders in the hedge funds, private equity firms and others trade.

They may trade on their own account or on behalf of sovereign wealth funds and institutional investors, but they trade with collateral, not with depositors’ savings.

And by offering the platforms to trade effectively, the systems move everyone towards best execution.

Best execution is all about trading at fastest speeds at best price and lowest cost, with a guarantee for the likelihood of settlement.

Somehow I can see the regulators being sorely tempted to follow this line of thinking as best execution has been embodied in European and American regulations for some time.

Mind you, you don’t have to think that this is necessarily going to happen as I’ve just re-read the last write-up of the Volcker Rule in the New York Times:

When Paul Volcker called for new rules in 2009 to curb risk-taking by banks, and thus avoid making taxpayers liable in the future for the kind of reckless speculation that caused the financial crisis and resulting bailout, he outlined his proposal in a three-page letter to the president.

Last year, when the Dodd-Frank Wall Street Reform and Consumer Protection Act went to Congress, the Volcker Rule that it contained took up 10 pages.

Last week, when the proposed regulations for the Volcker Rule finally emerged for public comment, the text had swelled to 298 pages and was accompanied by more than 1,300 questions about 400 topics.

Somehow, as with all regulations, it’ll get messed up on the process, whittled down and weakened until it’s a shadow of its former self.

Ah well.

One can dream.

Things we're reading today include ...

For some time there’s been debate about whether Vickers or Volcker is the right way to go.

Should investment banks be divided from their retailing and commercial siblings by a fence, or completely separated so that one cannot poison the other?

Should banks be allowed to play in the markets off their own account, or should such risky practices be outlawed?

The debate will continue for a while and it’s clear there is a possible revolutionary outcome as, eventually, markets will decide how to behave.

This will be through a mixture of the law of unintended consequences and the law of Darwinism.

For the former, we’ve seen the impact of unintended regulatory consequences before.

When the Markets in Financial Instruments Directive (MiFID) was formulated, everyone believed it would seriously impact the systematic internaliser – the banks that trade mainly off their own account.

It did, but not in the way the regulations intended.

Instead, the regulations opened Europe’s markets to full electronic trading strategies and allowed Chi-X to decimate the traditional equities exchanges’ business.

The systematic internalisers leveraged such facilities, particularly through dark pools, and suddenly the majority of equities trading in European markets flowed through systems rather than people.

It is also why the surge in OTC Derivatives trading arose, some would say, as the human touch in banking moved from trading to creativity.

Now the regulators are trying to rewrite the rules for high frequency operations and OTC Derivatives.

We all know that means that, in the law of unintended consequences, they are again creating a new market structure that they may not foresee.

This is because the Volcker Rule – the rule introduced as part of Dodd-Frank in the USA that bans proprietary trading – means that many of the world’s leading speculators, traders and masters of the universe are already moving out of the banking network and into the investor network.

From Forbes Magazine recently: “The Volcker Rule would impact investment banking giant Goldman Sachs the most followed by Morgan Stanley. The two firms derive 48% and 27% of their total consolidated revenues from principal transactions respectively … Bank of America and JPMorgan Chase see about 9% and 8% of their total consolidated revenue come from such transactions. Citigroup will be the least hit with just 5% of its total revenue at stake.”

No wonder Goldman is seeing a mini-Exodus.

Bloomberg recently reported that Goldman Sachs lost two leaders of its biggest division.  

“Edward K. Eisler, 42, and David B. Heller, 44, are retiring from the company, where they helped lead the securities trading division since February 2008 … Eisler and Heller join about 50 Goldman Sachs partners who left the firm in the past 12 months, according to company filings, internal memos and news reports.”

What is today a mini-Exodus is likely to become a waterfall over time, as banks close down areas of business that the regulators make undesirable or untenable such as proprietary trading, along with restrictions around the level of pay rewards by curtailing bonuses.

For example, the law in the UK has changed such that “the practice of up-front cash bonuses has stopped.  The practice of guaranteed bonuses has been sharply curtailed, at least in the London market.  Bonuses now have to contain a very significant element of deferral.  At least 40% of the bonus for a significant risk taker has to be deferred for a period of at least three years.”

Increasing tax, decreasing bonus levels, a tougher job climate – over 200,000 banking jobs were taken out last year – and a general gloom over investment banking – RBS is closing its investment division – all mean that the world of capital markets is being reinvented.

The reinvention is slow at first, but will become noticeable by 2015 and notable by 2020.

What does it look like?

It’s a guess, but the future looks like one where banks no longer participate in active trading and risk.

The trading risks are taken by those who are willing to lose, and they have to have their own collateral and assets upfront in order to be able to play therefore.

That means private equity, sovereign wealth and the high net worth will be the risk takers and trading speculators.

Institutional investors, pension funds, hedge funds will also be in the game.

But banks will not be able to play.

Their inability to play will be partly due to limitations by law – Volcker, Vickers and the like – but more by the natural market selection for talent.

Real trading talent will no longer be won by the banks, due to their inability to pay and remunerate, and therefore others will hire the big guns.

Banks will be forced to focus away from trading and more toward client acquisition and satisfaction.

Banks will become hugely focused upon corporate relationship management, improving treasury returns and demonstrating real value to their clients’ CFO.

Their focal point will be to gain and retain high value relationships at the top tier of the markets, looking after their corporate client’s needs for risk management and advising them on hedging strategies for the future.

A new world where casino capitalism will only be played by those who can afford the chips.

Things we're reading today include ...

It’s Davos time, as usual.

In the last week of January, the great and the good of the world’s leadership from governments, business, academia and media all gather in Switzerland to debate the future of the world’s economies and the World Economic Forum, #WEF.

In the build-up to this year’s WEF, it seems that all the magazines, media and men are talking about capitalism, what capitalism means post-crisis and what the future of capitalism will be.

David Cameron made a speech about this last week, as did Nick Clegg and Ed Miliband, and much of the debate resonates with the speech of Amartya Sen that I attended last week.

The core of the debate is embodied in the quote by Winston Churchill that “capitalism is the worst form of economics, except for all the others that have been tried.” 

Link: TrogloPundit

True.

The debate is then what form of capitalism you want: state capitalism or liberal capitalism, dominated by making the markets completely free and open.

A wholly state run economy fails, as demonstrated by communism; whilst a wholly free market economy also fails, as demonstrated in 2008.

So there needs to be a middle ground, but how middling is that middle ground?

Somewhere between the extremes of Western and Eastern approaches to commerce.

Some believe that the West is crumbling due to over-excessive free market liberalism.

In a 2011 report, the Organisation for Economic Co-operation and Development figured that the level of income inequality in the 22 member nations it studied increased by 10% since the mid-1980s, with conditions deteriorating in 17 of them.

A recent report  by the Institute for Policy Studies, a Washington-based think tank, found that CEOs at large U.S. firms earned, on average, $10.8 million in 2010, a 28% increase from the year before, while the average worker took home $33,121, a mere 3% more. At that level, CEOs’ paychecks are 325 times bigger than their employees’. In the 1970s, CEO pay rarely topped 30 times more.

Meanwhile, the average income for an American has reduced every year for the past three years.

On the other extreme, Asian markets are rising fast and taking over, using a more state-led capitalistic approach.

“The world’s ten biggest oil-and-gas firms, measured by reserves, are all state-owned …  state-backed companies account for 80% of the value of China’s stockmarket and 62% of Russia’s.”  [The Economist]

“The ten largest economies in Asia now spend roughly $400 billion a year on research and development (R&D)—as much as America, and well ahead of Europe’s $300 billion. China’s investment leapt 28% in a year, propelling it past Japan to become the world’s second-biggest spender … America’s share of global R&D spending is falling. In the decade to 2009, it tumbled from 38% to 31%, whereas Asia’s rose from 24% to 35%. But science is not a zero-sum game.”  [The Economist]

So there is a new model rising which, according to Time Magazine, “is not so much between capitalism and another ideology but between competing forms of capitalism. The financial crisis, growing inequality and faltering economic performance in the U.S. have tarnished American ‘leave it to the markets’ capitalism, which is being challenged by ‘capitalism with Chinese characteristics’, euro­capitalism, ‘democratic development capitalism’ (India and Brazil) and even small-state entrepreneurial capitalism (Singapore, UAE and Israel). All these models favour a more significant role for the state in regulation, ownership and control of assets.”

The Economist furthers this debate, asserting that the winner is ‘state capitalism’.

Link: Ifyouhavetoaskyoudontknow

“The crisis of liberal capitalism has been rendered more serious by the rise of a potent alternative: state capitalism, which tries to meld the powers of the state with the powers of capitalism. It depends on government to pick winners and promote economic growth. But it also uses capitalist tools such as listing state-owned companies on the stockmarket and embracing globalisation.”

Examples of state capitalism include:

“The 13 biggest oil firms, which between them have a grip on more than three-quarters of the world’s oil reserves, are all state-backed including the world’s biggest natural-gas company, Russia’s Gazprom, China Mobile and Saudi Basic Industries Corporation is one of the world’s most profitable chemical companies. Russia’s Sberbank is Europe’s third-largest bank by market capitalisation. Dubai Ports is the world’s third-largest ports operator. The airline Emirates is growing at 20% a year ...  State companies make up 80% of the value of the stockmarket in China, 62% in Russia and 38% in Brazil. They accounted for one-third of the emerging world’s foreign direct investment between 2003 and 2010 and an even higher proportion of its most spectacular acquisitions, as well as a growing proportion of the very largest firms: three Chinese state-owned companies rank among the world’s ten biggest companies by revenue, against only two European ones.” [The Economist]

“State-Owned Enterprises (SOEs) make up most of the market capitalisation of China’s and Russia’s stockmarkets and account for 28 of the emerging world’s 100 biggest companies.” [The Economist]

“France owns 85% of EDF, an energy company; Japan 50% of Japan Tobacco; and Germany 32% of Deutsche Telekom. These numbers add up: across the OECD state-owned enterprises have a combined value of almost $2 trillion and employ 6m people.” [The Economist]

The Economist believes the trend for the next decade will be towards state capitalism based upon the Chinese model, albeit with caveats and issues along the way, and  concludes that “the Chinese no longer see state-directed firms as a way-station on the road to liberal capitalism; rather, they see it as a sustainable model. They think they have redesigned capitalism to make it work better, and a growing number of emerging-world leaders agree with them. The Brazilian government, which embraced privatisation in the 1990s, is now interfering with the likes of Vale and Petrobras, and compelling smaller companies to merge to form national champions. South Africa is also flirting with the model:

• Over the past 30 years China’s GDP has grown at an average rate of 9.5% a year and its international trade by 18% in volume terms. Over the past ten years its GDP has more than trebled to $11 trillion.
• China has taken over from Japan as the world’s second-biggest economy, and from America as the world’s biggest market for many consumer goods.
• The Chinese state is the biggest shareholder in the country’s 150 biggest companies.
• China’s 121 biggest SOEs saw their total assets increase from $360 billion in 2002 to $2.9 trillion in 2010 … in 2009 some 85% of China’s $1.4 trillion in bank loans went to state companies.”

But note that, unlike America where CEOs’ paychecks are 325 times bigger than their employees, state capitalism is fairer in terms of income disparities: “in 2009 the average SOE boss earned $88,000 and the highest-paid, the chairman of China Mobile, $182,000.” [The Economist]  China Mobile has 600 million customers and is one of the largest telecoms in the world.

FYI, I debated these points a couple of years ago, and concluded that the future is one where capitalism is heavily influenced by the influence of the Chinese and Islamic principles.  

Seems to be coming true?

Link: The World Is Not Enough

Postnote:

The main reading behind this blog post is inspired by two cover page stories:

• How to Save Capitalism, Time Magazine
• State Capitalism, Economist supplement

Things we're reading today include ...

Our biggest stories of the week are ...

Amartya Sen: thoughts on poverty and the global financial crisis

I attended an interesting lecture last night from an economic legend: Professor Amartya Sen of Harvard University. If you haven’t heard of him, he’s known as the Mother Teresa of economics in his native India, and has spent a lifetime...

How to create a banking strategy

Following on from my discussions of solutions versus product people and vertical alignment versus horizontal, the question came up as to how to think strategically. How can you really get inside the customer’s head? What keeps the CEO awake at...

How will the world look post-crisis?

I’ve been debating some future presentations with various folks today, and a little ray of light went off in my head. The light was triggered by a comment: “can you talk about what impact regulatory change may have on bank...

The euro will go on, and on, and on ...

Over the weekend, Standard & Poor’s downgraded nine Eurzone countries, calling into question the viability of the Eurozone for the long term. France was downgraded to a level not seen since 1975. Italy is now considered the same credit risk...

Consumers will pay for better online banking

PwC conducted research with almost 3,000 banking customers from a range of segments across markets to discover their expectations of banking in the digital age. They selected both emerging and developing markets including China, India, Mexico and the UAE, as... Eurocrash! The Musical

One of the good friends of the Financial Services Club is David Shirreff, European Business Correspondent for the Economist.   David and his compatriots Russell Sarre (music) and Ross Livingstone (direction) have come up with another timely piece of fun: Eurocrash! The Musical.

The major general news stories of the week include ...  

MPs push for Sir Fred Goodwin to lose knighthood - The Telegraph Sir Fred Goodwin, the controversial former chief executive of Royal Bank of Scotland, is to come under further pressure over his knighthood.

MPs round on Mervyn King for 'disrespect' over Bank proposals - The Telegraph Sir Mervyn King has been accused of being "disrespectful" by MPs, with members of the Treasury Select Committee complaining he gave them too little time to consider proposals for a new oversight body.

RBS attracts bidders for investment bank, raising hopes for jobs - The Telegraph EXCLUSIVE: Royal Bank of Scotland has received initial offers for all the investment banking businesses it is attempting to sell, raising hopes that many of the staff facing redundancy may be taken on by the buyers.

Barclays chief won't heed pleas for restraint on pay - The Telegraph Vince Cable has personally warned Bob Diamond, the chief executive of Barclays, that banking executives must show restraint in next month's bonus round.

The world according to Goldman Sachs - The Telegraph Ahead of the Davos summit, Goldman Sachs president Gary Cohn talks to The Sunday Telegraph about the outlook for Europe, the US economy and whether 2012 holds any rays of hope.

A Look at PayPal's 4Q2011 Financial Results - Payments News

PayPal's parent eBay announced financial results for 4Q2011. PayPal ended the quarter with 106.3 million active registered accounts, a 13% increase year over year. On average, PayPal added a million new accounts every month in 2011. PayPal revenue for the quarter increased 28% year over year driven primarily by continued

Survey Says More than Half of Retailers Testing In-Store Tablets in 2012 - Payments News In its latest custom research report, RIS News looks at retailers’ incredible interest in tablets and finds that "While only 6% of respondents report that tablets are fully deployed in their stores today, another 28% are currently testing tablets in stores and an additional 31% plan to begin testing in

UK bond trade put at risk by new US financial regulation - The Telegraph New rules designed to stop banks playing fast and loose with their customers' money could have the knock-on effect of hobbling the market in UK government debt, investors and traders have warned.

Black Friday for euro crisis - The Independent The eurozone lurched further into chaos as France was downgraded by a top credit rating agency and talks on a crucial deal to restructure Greece's unsustainable public debt burden broke down.

Central bank independence at risk from financial crisis, warns UBS - The Telegraph The potential for losses from the banking system to wipe out all or much of the capital of central banks could see the end of independence for monetary authorities, according to UBS.

If you like the Finanser, check out the books of the blog: the Complete Banker Series

The Financial Services Club is sponsored by:

For details of sponsorship email us.

I attended an interesting lecture last night from an economic legend: Professor Amartya Sen of Harvard University.

If you haven’t heard of him, he’s known as the Mother Teresa of economics in his native India, and has spent a lifetime fighting poverty with analysis rather than activism. 

Awarded the Nobel Prize in Economic Sciences in 1998, for his contributions to welfare economics and interest in the problems of society's poorest members, Sen is best known for his work on the causes of famine.

He is currently Professor of Economics and Philosophy at Harvard University, as well as being a senior fellow at the Harvard Society of Fellows, distinguished fellow of All Souls College, Oxford and a Fellow of Trinity College, Cambridge, where he previously served as Master from 1998 to 2004.

An impressive guy.

Amartya delivered his speech as part of the London Stock Exchange Group series of lectures on the future of global finance, and the evening was hosted by LSE Chairman, Chris Gibson-Smith.

Here’s a brief summary of Amartya’s sentiments (I say I think ‘sentiments’ as this is not a record of his speech and incorporates my own spin on his words).

Some people say we live in interesting times, but I think we live in baffling times.

We live in baffling, rather than interesting, times because it is very hard to get any clarity about the future. 

The only thing that is certain is, in the words of George Bernard Shaw, “the greatest of evils and the worst of crimes is poverty”.

Shaw wrote this in the Preface to his brilliant play, Major Barbara, published in 1907. 

The tragedy of poverty is, of course, obvious to all - whether in Latin America, or in Asia or Africa, or in Europe and the United States. 

The calamity of deprivation and penury can hardly be missed by those who have bothered to think about the subject, no matter whether they are themselves poor or not. 

Lives are battered, happiness stifled, creativity destroyed, freedoms eradicated by the misfortunes of poverty. 

But Bernard Shaw was not talking, on this occasion, about the hardship of poverty, or the misfortune that goes with it. 

He was commenting, in a rather unusual way, about the causation and consequences of poverty - that it is bred through evil and ends up being a crime.

If poverty is indeed an evil, not to mention “the greatest of evils” as Shaw puts it, then there must be some wickedness, or at least some culpability, behind poverty - some wrong-doing that allows such human tragedies to occur and persist. 

This raises the immediate question: who, then, are the wrong-doers?

If you look to protesters today, such as the Occupy Wall Street movement, the wrongdoers are represented by the corporate greed of capitalists and the banks.

You can just as easily take the opposite view however, and look to the Tea Party movement who see the failure being that of government and government policies.

The Tea Party align with Adam Smith, the guru of capitalism, and believe that free markets should rule.

Who is right and who is wrong?

Or is this the right question? 

In thinking about strategic issues, we cannot but go into the question of culpability and the failure of duties and obligations. 

We have to ask: how can things be done differently so that the evil of poverty is ousted? 

We have to identify the nature and genesis of the wrong-doing that is responsible for the affliction. 

That is not, however, the same as trying to identify the wrong-doers? The identification of wrong-doers is not our task and trying to identify the evil-doers is not the right strategy since the responsibility for creating an evil is very widely dispersed in the society. 

We have to see how the actions - and indeed inactions - of a great many persons together lead to this evil, and how changing our modes of actions - our policies, our institutions, our priorities - can help to eliminate poverty. 

Our focus definitely has to be on removing evil-doing, as part of our strategies and programs, rather than going on the wild-goose chase of catching the hugely dispersed collectivity of evil-doers, who may not even fully understand how their actions can be seen as part of an evil state of affairs.

In fact, we should eliminate the discussion of wrong doers completely, and focus our efforts more on how to stop poverty full stop.

This is why strategies such as closing sweatshop labour factories in poor countries, or arresting those who employ children in the making of carpets, would fail to eliminate the poverty of the victims if such action is separated from a general economic and social program. 

In the vast majority of cases the employees are there in those terrible jobs because they have very few options - none that are particularly good. 

This is because there has been a failure of the state and the society to create opportunities for decent employment, which makes it possible to recruit labour to do terrible jobs as the alternative may be unemployment and starvation. That is why exploited labourers are led to soul-destroying work today in the poorer countries, and closing down sweated-labour factories without giving the victims alternative opportunities for employment or education - the latter is extremely important in the case of child labour - is not an adequate solution to the problems and predicaments of the precarious poor. 

There is, of course, moral merit in restraining the pursuit of profit of businessmen through exploiting vulnerable and freedom-less labour, but a fuller solution can emerge only through positive opportunities of alternative employment and occupation, and that demands societal action. 

So the first action to address poverty is to expand labour opportunities and assist in education, and not to just shutdown existing sources of income.

My argument so far has been based on seeing poverty as lowness of incomes. 

Is employment with income a full solution to all problems of poverty? 

To believe that would be to underestimate vastly the complexity of poverty, particularly the nature of persistent poverty. 

By way of example, lowliness of income is the primary cause of starvation rather than the lowliness of the availability of food.

Is employment for income in order to buy food the answer to everything therefore?

No, as this misses the point of why there is persistent poverty

Strategic examination about eliminating poverty, or even reducing its burden, has to go more deeply into the nature of poverty. 

Poverty is about the inability to lead a decent, minimally acceptable life, and while low income does make it difficult to lead a life of freedom and well-being, an exclusive concentration on seeing poverty as lowness of income misses out a great many important connections.

What are the other non-income factors that contribute to poverty: a lack of education, availability of work, investment in infrastructure and more, and capitalism addresses these issues by providing an insurance.

For example, all affluent societies have addressed extreme poverty issues through public policy programs, such as the public pension, the provision of school education, the availability of healthcare and more non-market non-commercial arranged facilities.

The economics of these areas are not obvious except that an insurance system run by the state or by some other social support system, not by profit-oriented private firms, may be a necessary part of the elimination of poverty. 

Affluent societies focus upon profit maximisation and the unrestricted search for profit, but if they only relied on profit maximisation they would not function.

As a result, they balance between market mechanisms and state activities.

There is no strategic formula as to the correct balance between market mechanisms and state activities – the contrast between China and Taiwan or America and Sweden are good examples of how approaches differ – but we need to understand these balances in order to create a better world that addresses poverty with finance.

Does this mean arguing against Adam Smith’s principles for free markets?

Not really.

That view is a result of a huge misunderstanding of Adam Smith’s principles, and my position is strongly influenced by his.

Adam Smith clarified how markets work and how they can work exceedingly well.  He believes that you need a well-functioning market economy and clarity of why you want such efficient markets to be.

The task of politicians in managing the economy is then to search for two distinct objectives: first, to provide plentiful revenue to cover the basic subsistence needs of the people before the subsistence needs of the state; and second, to provide the state with enough revenue to finance public services.

The financial focus of public services is a critical part of Smith’s work and Adam Smith had an overwhelmingly clear view about support of the poor and undersupported in his market view.

Within his free market principles, he clearly defended the role of the state to fund public services, such as education and poverty relief.

Adam Smith was deeply concerned about the inequality of society and never used the word capitalism.

The word capitalism does not appear in any of his books or any other writing, and it would be hard to carve out anything in his works on market economies that were based purely upon capital.

For example, he specifically argued about protections from unlimited usury practices.

So how should we think about the wrongdoers that need rectification, and how should we address poverty?

According to Adam Smith and my own thinking, the key is increasing employment.

Increasing employment must remain a worldwide priority and China, Brazil and India are doing much better at this than America and Europe.

As employment and economic welfare rises, the state must use such employment to improve public services for good living and public welfare and, in this respect, India is not doing this as well as China and Brazil.

Finally, for the West in general and Europe in particular, the crisis of 2008 was created by the malfunctioning of market economies – the result was the state had to create support for their economies and this is the reason for rising sovereign debt.

But the cause of this malfunctioning is clearly what was thought of as lack of accountability of governments, but governments are accountable and this is what we are seeing today.

What we are seeing is that, in order to pay back their debts, governments have far more accountability.  However, they are addressing this accountability in the wrong way.

It’s hard to see how massive austerity drives, which cuts demand and growth, can therefore be supported,

Just look at Japan and learn from what happened there over the last 20 years of austerity, which is still biting.

What these governments need is fast economic growth.

Economic growth creates resources to address unemployment and poverty.

This is the key to addressing issues in Europe and the West, and it is the indiscipline of governments that has failed the markets, not the markets themselves.

Europe needs a better form of economic accountability and management of their economies, rahte than austerities which decimate human lives and economic growth.

In conclusion, I end by affirming that George Bernard Shaw was right, a hundred years ago today, to point to the connection between poverty and evil and crime.  The fact that this insight came not from an economist but from a dramatist and literary giant fits in well with my general thesis that the economics of poverty involves much more than just economics.  Human lives in society are interlinked through economic, social, political and cultural associations.  The nature, causes and consequences of poverty reflect the richness of those connections.  We have no reason to be surprised by that elementary understanding.

Amartya then took Q&A from the floor and was asked a few interesting questions.

Q: You appear to be saying that in this current crisis, it is the failure of states to regulate markets effectively that failed, rather than the markets themselves. Is this your view?

You cannot separate markets and state, and this crisis was a failure of both, but you also have to be aware of the relationship between free markets and state influence. 

For example, Adam Smith argued against usury, but was convinced to change his thoughts on interest after reading the works of Jeremy Bentham. 

The core of how markets and state should work is that free markets is the most efficient model of economic management, but free markets need states that set efficient regulations to avoid failure in order to be truly workable.

As this shows, free markets and the state are two separate entities that are interdependent.

A key question in the last crisis however is whether globalisation killed that interdependency to cause the spiral of crisis we see today.

Globalisation may have undermined national states, as government can no longer effectively regulate the free markets?

There may be some truth in this statement, and this is why the G20, G8 and other global activities – the World Bank and IMF included – are key to solving these issues this time around.

Q: Do you think the euro will survive?

No.

When the euro was created, I didn’t see why it was needed and didn’t believe it made sense.  I am a fan of Europe, don’t get me wrong there as my late wife was Italian, but to start a European integration without a fiscal foundation meant that it was never going to work.

You can see this today as many parts of the EU are not served well by a Europe that has no fiscal union.   Greece is a good example.

Now however the loss of a country would be very destabilising for this European Union.

This is why Germany is being forced to bailout Europe.

Could they retreat out of it? Yes.

Is that the right thing to do? I think so.

Fascinating stuff.

Postnote: some of Amartya’s speech is taken from a write up of an earlier presentation he made in 2007.  These words of wisdom are integrated in parts of this article to ensure more accuracy of content.