John Kay has embraced uncertainty and explains how we must do this to make economics relevant. Meanwhile little has changed he tells The Mint.

With the Lehman Brothers collapse and the subsequent economic carnage now belonging to a different decade, the natural question that comes to mind is, how has the banking sector culture that precipitated the crisis changed to prevent a repeat showing?

Economics academic heavyweight and trenchant critic of the financial sector, John Kay, says it hasn’t.

“The basic structures of the commercial banking sector have not changed the last 10 years. For me, the essential problem was a sector that had lost sight of its purpose and had begun trading with itself, talking to itself and judging itself by its own criteria. And that hasn’t really changed,” he says.

“They don’t know much about things that we actually need capital in the economy for. I find that rather strange.”

Kay holds up what he clearly sees as a fault line through modern finance:

“I think we have not thought through the way that the world has changed. We have this phenomenon of a vast amount of trading, within the financial community itself. What we need most of all is a financial sector that is geared to the needs of the new economy. The people who work in finance today are very different from the local bank manager who knows customers. What we have in the financial sector today is people who know mostly about finance. They know about each other. They know about the rather complex instrument they trade. They don’t know much about business. They don’t know much about property. They don’t know much about infrastructure. They don’t know much about things that we actually need capital in the economy for. I find that rather strange.”

He concedes that the sector has confessed its sins of 2008 and the waywardness within its ranks and that it accepts it isn’t trusted. However the sector’s understanding of the enormity of its cultural flaws are not, Kay believes, reflected in its actions. “The rise of the trading culture, in particular, ten years after the crash, still remains counterproductive. They’ve become aware of the issues of trust. Many of the people at the top of the institutions now talk the appropriate language and, to some extent, believe it,” he says, adding: “The truth is I think that you will hear a lot of people say we need to restore trust in the financial system, as if that was fundamentally a public relations problem. It is not a public relations problem.”

Kay emphasises that the evaporation of trust in the financial sector was a result of the way sector behaved. And that behaviour has not disappeared. “Unless that changes in a more fundamental way, the negative view that people have of finance is not going to change, nor should it,” Kay warns, adding: “Now we have a sector that in large part trades with itself and has little compunction in making profits essentially from other financial institutions and ultimately underwritten by our savings and the taxpayers.”

So how might a bank restore trust?

The conduits for trust prior to the banking Big Bang were the direct, personal relationships between banks and their customers according to Kay. The retail bank managers were “archetypal respectable citizens” known in their community, and investment banks built links with corporations. But he believes there is little chance to reinstate those relationships. “This network of trusted relationships was replaced by a much more transactional relationship culture. You were creating markets that were largely anonymous trading. You don’t have a basis for creating trust in these kinds of one-off transactional interactions.”

And the chief obstacle for banks looking to re-engage with customers – retail or corporate –could, perhaps ironically, be the nature of modern communications according to Kay: “Social media and new platforms – their whole character is that you are intermediating between people who don’t know each other and don’t have a relationship. So I think some of those relationships have simply gone forever due to the nature of technology and trading.”

This quandary of the end of personal relationships between the banks and customers and little chance of reinstating them places banks in a difficult position where they attempt to regain trust. “Trust is something that comes out of a relationship. If you don’t have a personal relationship, you don’t have a basis for producing trust. However, most people dealing with financial services want to have these personal relationships. You probably don’t if you’re just making payments with your mobile banking app, but as soon as you get to the point of wanting to invest money, what most people want to do is to have a relationship with someone they can trust,” says Kay.

“It is not a public relations problem.”

Nevertheless there are high street banks, like Metro Bank in the UK, that are devoting time and resources to cultivate relationships with customers in a bid to be considered trustworthy. And Kay thinks there is a place for that old-fashioned service even among the app gazers: “There’s no doubt that there’s a demand still for that kind of old-fashioned banking from those who want to go to branches and talk to people. A lot of people do like this kind of banking direction. One of the interesting things about Metro Bank is that it attracts young customers as well as old ones. Another example is Handelsbanken, the Swedish bank that has grown quite rapidly by offering really a very old-fashioned type of banking services.”

Clearly declaring yourself trustworthy does not make you trustworthy. But more importantly, Kay points to something the Crash demonstrated spectacularly which is that there is perhaps no longer a need to trust the bank.

“Frankly, the main reason for not worrying about trusting a bank is that you believe that the government will bail you out. So banks have gained through the Crash the popular perception that they cannot fail. Now, people will tell you that that’s not true, but if push comes to shove, I think people will think that the government will stand by banks, and in reality, they do.”

And the flip side of that is that the banks can take risks with confidence that the taxpayer will bail them out which, Kay says, is “why fundamentally the things that were wrong in 2008 have not changed”.

He is confident that there won’t be an exact repeat of the 2008 crash but expects any future crisis will be dealt with by “a mixture of public money being pushed into bailing the system out and a new raft of regulations designed to close the door after the horse has bolted once again”.

But do the central banks have the wherewithal to tackle another crisis? Kay says that is a macroeconomics issue. He insists the government will be able to stump up the liquidity as it did a decade ago: “Government can always do that”. But there is, he says a larger issue of government revenue. “What we’ve seen since 2008 is a very restrictive fiscal policy. The reason for that was to try and unwind the debts that were not really due to the crash, but due to the overspending up to 2008 when we imagined we were richer than we were.”

Kay warns against the perception held by a number of other leading economists, that the level of private debt was the central issue. “We have to be careful about understanding what is meant by private debt. Most of what we characterise as debt is banks lending money and owing money to each other, and that was the big explosion – the volume of trading within the financial sector itself. In terms of genuinely private debt in the non-financial economy, that’s mainly mortgages and that’s driven by house prices. It’s true that bullish interest rates helped push house prices up, but the private debt in the real economy was not that extraordinary.”

He suggests that the growth in house prices over the past 40 years has been fueled by increased house ownership and the fact that we’re not building houses. He is sanguine about private debt levels despite reports that they are bumping up against the levels seen just before 2008 and associated warnings from the Bank of England. I don’t think that the private debt levels are scary,” Kay says. He goes on: “What is scary is that people have become accustomed to these extraordinary low interest rates, and if interest rates were to rise, that would raise a lot of questions how well-placed people would be to service that debt?”

“You don’t have a basis for creating trust in these kinds of one-off transactional interactions.”

That leaves us with many individuals and companies on the brink of insolvency which can only survive in the current low-interest environment. So the government is unlikely to pursue measures to stem borrowing though interest rate hikes given that it could precipitate a flood of bankruptcies. “People talk about rising interest rates and a need push them up slightly, but nothing very much has happened. It’s all going on very much longer than I think anyone anticipated. So we’re stuck in an unhappy  place and it’s very difficult to know how to get out of it.”

These then are unpredictable times. There is little in the way of convincing directions for the way out of the current position. But this is territory that Kay has spent some time exploring. He wrote recently of the “radical uncertainty” as described by Frank Knight and John Maynard Keynes. They categorised uncertainty as the utterly unpredictable – the unknown-unknown as opposed to the known-unknown that can be modelled and quantified as probability. The argument from Knight and Keynes’ opponents – that all uncertainty can be addressed probabilistically – has been the dominant view but one that is “beset with glaring weaknesses” according to Kay on his website. “Recognition of that is a necessary preliminary to the rebuilding of a more relevant economic theory,” he writes.

He tells The Mint the banks have too much relied on their software in plotting their course: “In the financial sector, in particular, we’ve been too much relying on believing models that imply that we can understand what is going on and can model the future. And that, I think, is largely untrue.”

Looking for a way forward, Kay sees an early move in a return to a previous state. “One thing we need to do is go back to siloing different parts of banks,” he says. Kay sees a need to unravel the existing “financial conglomerates” which use retail banking collateral to support other kinds of trading or to cross-subsidise “activities which created the transactional culture we find now”. He says this holds for retail banking as well as the trading sector.

“You go into a bank branch now – it’s less bad than it was a few years ago – but still they will try and sell you things rather than act as financial advisors. They’re trying to sell you sophisticated products.” Kay says there is a need to take the transactional culture of intra-financial trading – and separate it or isolate it “so its disease doesn’t spread”.

He says isolating this transactional component will lead to a its winding down “because it depends on the retail deposit bank to exist”.

But how will they make profits? Kay doesn’t see the problem: “The banks I’m talking about don’t need to make profits to pay multimillion bonuses to their employees. Banking now is largely about mortgages. Most bank lending to the real economy is lending to people to buy their house. That’s not a very difficult business. It was done quite well by building society managers who frankly were people who were not quite smart enough to be bank managers.”

“Frankly, the main reason for not worrying about trusting a bank is that you believe that the government will bail you out.”


Recreating the silos, according to Kay will leave the high-risk, speculative game to the people who understand the risks and who enter the game with the knowledge to play it. Kay offers an example: “Hedge funds don’t enjoy particularly good press, but I think they are aware where risks ought to be taken. People are taking risks with either their own money or with the money of people who are relatively sophisticated and who are close to people who are running the hedge fund and know what’s going on.”

He adds: “For hedge funds of that kind to be operating and taking positions in markets is good, because the right kind of speculation can actually help stabilise the economy. Where it goes wrong is where the speculative activity comes much larger than the volume of real lending.”

Kay applauds “two big things” in Britain, as measures that are “the sort of measures we need to take to get the type of banking system that we need”.

One is ring fencing retail banking from next year, and the other is the so-called senior manager’s regime, which aims to make people at the top of the bank personally responsible for what is going on in their organisation.  However he sees there has been “a lot of pushback which reduced the effectiveness of these kind of measures”. He points to the US where a law to create some separation between retail and investment banking has been “almost completely eliminated as a result of banks pushing back”.

He finishes our interview with a less-than-positive outlook, and one that in part runs counter to his earlier assertion that the trouble with banking is not a public relations issue.

He accepts that a post financial crisis trajectory runs through mass resentment, a flurry of regulatory activity and waning public attention before the downward glide into the next crisis begins. But Kay rejects the notion that there is just passive public neglect at play after the regulatory dust settles: “It’s not that people become more complacent, but the bank lobbyists are always there,” Kay says. “When we have a crisis, ordinary people get angry and there’s a political push for politicians to do something. Politicians do something, then ordinary people get back to their normal lives. But the bank lobbyists don’t. They stay lobbying on behalf of banks to weaken government action.”

So spin happens. And Kay counsels there is another turn on the roller coaster to come: “Yes, we’re in for another rough ride, but it’s not clear where the crash will come from. We haven’t solved the problems yet.” No uncertainty there.

John Kay

John Kay is one of Britain’s leading economists. His work is centred on the relationships between economics, finance and business. His career has spanned academic work and think tanks, business …

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