Financial intermediaries are the people and institutions that stand between investors and the financial markets. They include banks, investment managers, and insurance companies. The financial crisis of 2008 has prompted much soul-searching about the risks posed by the financial sector and the proper role of finance in society.
Several books over the last few years have taken an especially critical look at these financial middlemen and whether they advance or harm the interests of investors and society as a whole. The assessment of these authors is not flattering, but their conclusions may still surprise you.
Purpose of the financial sector
The first title, “Other People’s Money: The Real Business of Finance,” published in 2015, asks what is the purpose of the financial sector and whether it is a positive or negative force in society. The author, John Kay, a British economist, believes that society benefits from the essential functions performed by the financial sector. These include: allowing savers to access the financial markets to grow their own wealth; bringing capital and credit to businesses to advance economic growth; facilitating a reliable exchange of payment; and managing risk.
These are all good things for the individual investor and society, but in practice things are not quite so straightforward. The author believes that too much of what the financial sector does promotes its own benefit at the expense of investors. Further, some things the financial sector does are not needed at all.
The explosion and financial innovation leading up to the 2008 financial crisis illustrates the point. The massive securitization of collateralized debt allowed financial institutions to package risky investments that few fully understood to the ultimate detriment of investors and the rest of the public.
Another example is the rise of algorithm-based trading that has led to trading at ever fasting rates and increased trading volumes without any apparent benefit to ordinary investors. In fact, these trends appeared to skim money from the small investor and feed the profits of the financial sector.
The author reminds us that financial intermediaries are ultimately dealing with “other people’s money” and argues that they ought to be held to a fiduciary standard. They should be held accountable to act in the best interests of the investors whose money they manage. Interestingly, the author believes that excessive regulation has contributed to this state of affairs and proposes simpler solutions.
ATM for the industry
The next title, “What They Do With Your Money: How the Financial System Fails Us and How To Fix It,” published in 2016, works a similar theme. Like the author of “Other People’s Money,” the three authors of this book agree on the essential functions of finance in society and also with the assessment that the finance sector has gone off track. Instead of focusing on the creation of wealth, they accuse the financial sector of spending more effort extracting wealth from those whose wealth they manage. They argue that the costs of financial services to the end consumer haven’t changed in over 100 years, fluctuating between 1.5 percent and 2 percent.
If true, the obvious efficiencies of information technology have not, in aggregate, reduced the costs to investors and other financial consumers. As the authors put it, the financial system is “a virtual ATM for the financial industry.”
The authors offer an insider’s look “at some of the ways in which we are led to believe that value is being delivered when it is not.” The authors challenge not only the status quo of the financial system but also conventional thinking about policy solutions, many of which have actually made matters worse. The argue for urgent reforms to better align the interests of the financial system and its middlemen with those whose money they manage.
Views of a reformer
An earlier take on the same theme is John Bogle’s book, “The Clash of the Cultures: Investment vs. Speculation,” a title we have highlighted previously. This book, published in 2012, presents a sweeping critique of the present state of our financial system and even of aspects of capitalism itself. Bogle, the founder and former CEO of The Vanguard Group, has been a central figure in financial history of the last 50 years, and he approaches this topic as a reformer not a revolutionary. He laments the increased emphasis on financial speculation encouraged by frequent trading and increasingly complex and varied investment vehicles. He ends by outlining 10 simple and practical rules for developing an investment strategy.
At the end of an election that was in many ways more personal than policy-focused, these titles should be refreshingly thought provoking about important policy decisions that will affect everyone with a bank or investment account.
Read, enjoy, and profit.
David Peartree, JD, CFP® is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, NY 14625, firstname.lastname@example.org.