Will Hutton was interviewed on Today - the jolly slot at 0857 - about whether the 30,000 UK resident super-rich are good for the country. He talked about incentives, Scandinavia, giving back, Quaker business, Robert Owen ... but I think he missed a real trick - the one Martin Wolf points out in a recent column: the banking super-rich are there thanks to taxpayer subsidy.
In a profoundly radical column in the FT, Martin Wolf asks why the City is so rich and why banks have such a high return on their invested capital - most of the time. For the past 10 years, UK banks have returned an average of 20% on equity, year in, year out. This is huge. The usual defense is that bankers take big risks: hard cash is put up for the mere promise of more later. This is the essence of capitlalistic risk-taking. Of course it earns! - you have to compensate everyone for the roller-coaster ride.
Martin Wolf offers an alternative story. Return on capital is spectacular because banks take their bets with very little capital in reserve - it is the amount of capital base employed in lending that is low, not the returns that are spectacular - and what permits this is the fact that governments can't let banks go under. Without taxpayer protection, savers would ask for much more security when delegating their lending. This implicit or explicit taxpayer protection of the financial system creates:
- highly leveraged banks - much lending on thin capital bases
- a regulatory environment that is complex (government swaps protection for regulation) and that stops entry eroding the profits of banks (it is hard to comply)
- a structural incentive to over-extension, and with it a compensation structure that inevitably creates the super-rich
All this financed by a taxpayer's guarantee that we have seen at work in Northern Rock, but is at work every day in the calculations made by traders in risk as they assess the soundness of HSBC, Barclays or even the obscure hedge fund that everyone knows "cannot be allowed to go under, for fear of rocking the whole system."
Martin Wolf concludes with the thought that the financial system should be seen as the biggest utility around: it can operate thanks to the provisions of a social contract a bit like a water company's. "You supply water/capital, we (society) will give you the guarantees you need to do this (lender of last resort insurance/the right to the water franchise for 20 years), you promise to discharge your duties well and at reasonable cost."
But if the City is like a big water company, we should ask explicitly whether it is doing its job properly. And we should have no more truck with the argument that its salaries are needed for the proper allocation of risk and reward in the economy.
Will Hutton should have said on his interview that the City super-rich have been made so by special dispensation of the taxpayer, a dispensation whose value looks everyday more questionable.
