How vested interests bar financial reform
There is an urgent need to reintegrate society with its productive side through broadening share ownership. This is the theme of a new book, “Debtonator”. (Elliott and Thompson, £9.99), by Andrew McNally, an experienced institutional investor.
In a lively account, McNally shows how equity finance benefits society, companies and individuals. Equity should form the basis of the next model of global finance. It is a mistake to view equity as just another asset class, “priced” like houses, bonds or gold. This veils the intrinsic, qualitative difference between equity and all other assets; all wealth comes from growth in an economy’s “productive assets”. Only equity finance recycles the financial returns from such assets back to society.
At present, the structure of share ownership means that the rewards go to the very few at the top of the pyramid – above all to the finance controllers. This, argues McNally, is the main engine of social inequality. Changing this is the only way to solve the problem of inequality highlighted by Thomas Piketty, rather than the left-leaning “solutions” of progressive income and wealth taxes favoured by Piketty himself.
The usual explanations of growing inequality point to factors such as liberal trade, globalisation, immigration, the impact of low-cost producers, unequal access to education, etc. Yet the most powerful engine of all, says McNally, is the unequal distribution of the rewards of growth through the concentration of equity ownership in a tiny elite.
We have to wrest ownership and control away from the few and share it among the many:
“If productive assets are the only assets that create new material wealth, then how those assets are financed is crucial…”
At present the vast majority of people are shut out of direct participation in the productive life of their countries. Yes, there are millions of SMEs. Yes, millions of people hold equities – mostly indirectly, through their pension plans and various savings schemes. But the connection with the companies in which their money is invested is weak and indirect; and a large part of the return is typically siphoned off by the financial services industry.
For firms, equity finance gives stability. It allows companies to reach their potential. It is “patient capital” without the rigid repayment schedules of bond finance or bank borrowing. It helps to align the interests of various stakeholders, notably through share ownership.
Yet the economy remains dangerously dependent on debt finance; there has been very little progress since the crisis in reducing debt ratios.
Engine of inequality
Why? Equity has many enemies, while debt has powerful supporters. These include governments, banks and central banks. By keeping interest rates consistently low, central banks have strongly favoured debt. If you know central banks are going to be buying huge quantities of bods, supporting their prices, of course individuals think it will be safer to buy them also.
Banks far prefer their corporate customers to borrow – at lending rates that give banks a juicy profit margin – rather than raise equity. The bulk of income of the investment banks come from debt – creating it, trading it, creating derivatives with it. The tax system greatly favours debt.
So individuals hold on average pitiful amounts of equity, whereas the top 1% get the lion’s share. Yet, over time, the returns to equity are massively greater than needed to compensate those holders for the risk. The deprivation of the masses of their proper share in ownership of productive assets reflects many factors, including the obsession with home ownership. Paying off the mortgage soaks up most of the savings of working-age people.
McNally advocates a multi-pronged programme to spread share ownership. We should incentivise companies to raise equity at the same time as encouraging people to invest in equity. This includes, somewhat ironically, a proposal for a government-sponsored credit scheme to facilitate share purchase by savers, as well as old chestnuts such as reducing/abolishing the tax shield for companies (where some tentative moves are being discussed with an OECD framework).
One can raise questions about this analysis: does the author take on board sufficiently people’s natural risk-aversion? Does he recognise sufficiently that while financial return to equity ownership accrues to a small minority, the wider benefits of innovation, in the Schumpeterian “gale of creative destruction” , with new products and cheaper prices, already accrue to society?
But the author is absolutely correct to stress than the real lessons of the financial crisis have yet to be learnt, let alone acted on.
This short book points the way forward.