Finance Watch Campaign "Change Finance!"

FINANCE WATCH CAMPAIGN "CHANGE FINANCE!"

FINANCE RULES THE WORLD. LET'S CHANGE THE RULES!

Five years after the collapse of Lehman Brothers the financial system has not been transformed: banks and derivatives markets are bigger than ever, manipulation makes for frequent headlines and productive investments seems the exception instead of the rule. Systemic risk is more a threat to society today than in September 2008.

IT'S TIME TO FLICK THE SWITCH: instead of finance writing its own rules, society needs to write them.

Only then can finance become safe and good for society. To learn more about the dangers in our financial system and what you can do about them, explore these pages and join our campaign.

WWW.FINANCE-WATCH.ORG/HOT-TOPICS/CAMPAIGN-CHANGE-FINANCE THE STATUS QUO LIFECYCLE

①

THE 2008 CRISIS AND THE GREAT RECESSION Finance takes profits, society takes losses ④ AT THE SOURCE OF THE STATUS QUO: FINANCE MAKES THE RULES STATUS QUO ② 30 years of deregulation and financialisation have put LIFECYCLE the financial industry in the ‘NEVER AGAIN’ driving seat POLITICAL REACTION An exceptional opportunity to re-regulate

5 YEARS AFTER, FUNDAMENTAL PROBLEMS REMAIN Society is not immune from another major financial crisis ③ ⑤

NEXT CRISIS CHANGE Had enough FINANCE! of the status quo? CHANGE FINANCE! WE NEED A NEW APPROACH THAT WILL MAKE CHANGE POSSIBLE

2 THE 2008 CRISIS ① AND THE GREAT RECESSION Finance takes profits, society takes losses

A largely self-regulated financial 1 system has proven over the last 30 years to be unstable.

Proportion of Countries with banking Crises, 1900—2008 Weighted by Their Share of World Income

45 The Great Depression 40 Emerging Markets, Japan 35 the Nordic countries, The first global and US (S&L) financial crisis 30 of 21st century World War I 25

20 The Panic 15

0 2008 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

1907 1929 Strong finanacial regulation Deregulation of financial services

FINANCIAL CRISES FREQUENCY AND IMPORTANCE 2 (source: Reinhart and Rogoff - 2008) Five years ago, the financial systemnearly collapsed altogether, saved only by massive public intervention. The worst financial crisis since 1929 proved that the current system is unsustainable.

(13% of EU27 GDP)

TOTAL AID TO BANKS USED BETWEEN 2008 AND 2010 IN EU27 (source: Liikanen report)

3 The ‘Great Recession’ quickly followed, stopping economic growth in Europe and beyond for years. Fiscal deterioration and bank bailouts have sent public debt soaring around the EU, burdening ordinary EU citizens for decades to come.

In April [2009], we confronted the greatest challenge to the world economy in our generation. Global output was contracting at a pace not seen since the 1930s. Trade was plummeting. Jobs were disappearing rapidly.”

G20 LEADERS’ STATEMENT, PITTSBURGH SUMMIT, SEPTEMBER 2009 3

-2

-4

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP EVOLUTION, EURO AREA (source: World Bank)

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CENTRAL GOVERNEMENT DEBT, % OF GDP, EURO AREA (source: World Bank)

Unemployment has reached record-highs, We recognise the human especially among the young. Poverty levels dimension to the crisis.” in the EU have risen and the EU’s external development aid has been slashed. G20, LEADERS’ STATEMENT, LONDON SUMMIT, APRIL 2009)

Unemployment

Youth unemployment

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

UNEMPLOYMENT AND YOUTH UNEMPLOYMENT, EURO AREA (source: Eurostat)

These social costs followed historically It is not an easy task to convince the high profits in the financial sector. electorate that the future losses must be nationalised, when the past profits €b Europe were privatised”.

40 LORENZO BINI SMAGHI, MEMBER OF THE ECB’S EXECUTIVE BOARD, 20 OCTOBER 2008

20 PROFITS OF 16 EU BANKS, AFTER TAX AND OUTSIDE EQUITY INTEREST (Source: Reserve Bank of Australia)

-10

2002 2004 2006 2008

15 Banks have since starved the real economy of credit, despite massive 6 10 injections of cheap liquidity by the ECB.

-5 2004 2005 2006 2007 2008 2009 2010 2011 2012

LOANS TO NON-FINANCIAL CORPORATIONS, ANNUAL GROWTH RATES, EURO AREA (source: ECB) THE 2008 CRISIS AND THE GREAT RECESSION Finance takes profits, society takes losses

A largely self-regulated financial 1 system has proven over the last 30 years to be unstable.

Proportion of Countries with banking Crises, 1900—2008 Weighted by Their Share of World Income

45 The Great Depression 40 Emerging Markets, Japan 35 the Nordic countries, The first global and US (S&L) financial crisis 30 of 21st century World War I 25

20 The Panic 15

0 2008 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

1907 1929 Strong finanacial regulation Deregulation of financial services

(13% of EU27 GDP)

TOTAL AID TO BANKS USED BETWEEN 2008 AND 2010 IN EU27 (source: Liikanen report)

In April [2009], we confronted the greatest challenge to the world economy in our generation. Global output was contracting at a pace not seen since the 1930s. THE STATUSTrade QUO was plummeting. LIFECYCLE Jobs were disappearing rapidly.” G20 LEADERS’ STATEMENT, PITTSBURGH SUMMIT, SEPTEMBER 2009

-2

-4

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP EVOLUTION, EURO AREA (source: World Bank)

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CENTRAL GOVERNEMENT DEBT, % OF GDP, EURO AREA (source: World Bank)

Unemployment

Youth unemployment

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

UNEMPLOYMENT AND YOUTH UNEMPLOYMENT, EURO AREA (source: Eurostat)

40 LORENZO BINI SMAGHI, MEMBER OF THE ECB’S EXECUTIVE BOARD, 20 OCTOBER 2008

20 PROFITS OF 16 EU BANKS, AFTER TAX AND OUTSIDE EQUITY INTEREST (Source: Reserve Bank of Australia)

-10

2002 2004 2006 2008

15 Banks have since starved the real economy of credit, despite massive 6 10 injections of cheap liquidity by the ECB.

-5 2004 2005 2006 2007 2008 2009 2010 2011 2012

LOANS TO NON-FINANCIAL CORPORATIONS, ANNUAL GROWTH RATES, EURO AREA (source: ECB) THE 2008 CRISIS AND THE GREAT RECESSION Finance takes profits, society takes losses

A largely self-regulated financial 1 system has proven over the last 30 years to be unstable.

Proportion of Countries with banking Crises, 1900—2008 Weighted by Their Share of World Income

45 The Great Depression 40 Emerging Markets, Japan 35 the Nordic countries, The first global and US (S&L) financial crisis 30 of 21st century World War I 25

20 The Panic 15

0 2008 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

1907 1929 Strong finanacial regulation Deregulation of financial services

(13% of EU27 GDP)

TOTAL AID TO BANKS USED BETWEEN 2008 AND 2010 IN EU27 (source: Liikanen report)

G20 LEADERS’ STATEMENT, PITTSBURGH SUMMIT, SEPTEMBER 2009

-2

-4

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP EVOLUTION, EURO AREA (source: World Bank)

0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CENTRAL GOVERNEMENT DEBT, % OF GDP, EURO AREA (source: World Bank)

Unemployment

Youth unemployment

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

UNEMPLOYMENT AND YOUTH UNEMPLOYMENT, EURO AREA (source: Eurostat)

40 LORENZO BINI SMAGHI, MEMBER OF THE ECB’S EXECUTIVE BOARD, 20 OCTOBER 2008

20 PROFITS OF 16 EU BANKS, AFTER TAX AND OUTSIDE EQUITY INTEREST (Source: Reserve Bank of Australia)

-10

2002 2004 2006 2008

15 Banks have since starved the real economy of credit, despite massive 6 10 injections of cheap liquidity by the ECB.

-5 2004 2005 2006 2007 2008 2009 2010 2011 2012

LOANS TO NON-FINANCIAL CORPORATIONS, ANNUAL GROWTH RATES, EURO AREA (source: ECB)

5 ‘NEVER AGAIN’ POLITICAL REACTION An exceptional opportunity to re-regulate ②

As panic spread through the financial system 1 from September 2008, world leaders rallied to assure the public that it would never happen again. At the Pittsburgh Summit in 2009, G20 leaders condemned the “era of irresponsibility” and promised new regulation to rein in “the excesses that led to the crisis.”

We will not allow a return to banking as usual.” (PITTSBURGH LEADERS’ STATEMENT)

“History cannot be allowed to repeat itself.” (BARACK OBAMA)

“Nothing less than a global change is required” (GORDON BROWN AND NICOLAS SARKOZY)

“We must show zero tolerance for any return to the «bad old ways» (JOSÉ MANUEL BARROSO)

An international plan of action for financial reform was drawn up, inspiring hundreds of regulatory initiatives in the years that followed. The action plan focussed on some key areas, including:

6 - Bank capital

- Financial sector pay

- Over-the-counter derivatives

- Cross-border resolution plans for banks,

- Shadow banking

- ????

- ???

But it did not question the ‘self-regulation’ principle that had guided regulators since the early 1980s. Nor did it question the core purpose, structure or size of 3 today’s financial services sector. As a result, the changes we have seen since are mainly superficial.

Leaders also needed to fix thebudget deficits that the financial crisis had blown up. As they needed the banks to help with sovereign funding, the window of opportunity for real change in the financial sector was soon closed.

EXTRACT OF DOCUMENTARY - ‘INSIDE JOB’: FORMER IMF HEAD DOMINIQUE STRAUSS-KAHN RECALLS A DINNER AT WHICH TOP BANKERS, FRIGHTENED BY THE CRISIS, BEGGED FOR MORE REGULATION TO HELP THEM CONTROL THEIR OWN GREED (source: http://www.youtube.com/watch?v=3wGSELiDx40) ‘NEVER AGAIN’ POLITICAL REACTION An exceptional opportunity to re-regulate

We will not allow a return to banking as usual.” (PITTSBURGH LEADERS’ STATEMENT)

“History cannot be allowed to repeat itself.” (BARACK OBAMA)

“Nothing less than a global change is required” (GORDON BROWN AND NICOLAS SARKOZY)

“We must show zero tolerance for any return to the «bad old ways» (JOSÉ MANUEL BARROSO)

THE2 STATUS QUO LIFECYCLE An international plan of action for financial reform was drawn up, inspiring hundreds of regulatory initiatives in the years that followed. The action plan focussed on some key areas, including:

- Bank capital

- Financial sector pay

- Over-the-counter derivatives

- Cross-border resolution plans for banks,

- Shadow banking

- ????

- ???

7 5 YEARS AFTER, FUNDAMENTAL PROBLEMS REMAIN Society is not immune from another major financial crisis 5 YEARS AFTER, FUNDAMENTAL PROBLEMS REMAIN ③ Society is not immune from another majorOfficials financial at international, crisis European and national 1 level have deployed skilled resources to produce policy documents, new standards, regulations and supervisory codes. New oversight institutions have been created. There are also signs that some of Officialsthese bodies at international, recognize the European weaknesses and ofnational ongoing 1 levelreforms. have These deployed are positiveskilled resources developments to produce that lay policythe ground documents, for the urgent new standards, deepening regulations and speeding and supervisoryup of the reform codes. process. New oversight institutions have been created. There are also signs that some of these bodies recognize the weaknesses of ongoing reforms. These are positive developments that lay the ground for the urgent deepening and speeding up of the reform process.

But has the system fundamentally changed? 2 The overwhelming answer is no.

Nearly five years after the bankruptcy of Lehman Brothers

Buttouched has theoff a system global financial fundamentally crisis, changed?we are no safer. Huge, 2 The overwhelming answer is complex and opaque banks continueno. to take enormous risks that endanger the economy.� (PROFESSOR ANAT ADMATI NY TIMES, 25 APRIL 2013) Nearly five years after the bankruptcy of Lehman Brothers touched off a global financial crisis, we are no safer. Huge, complex and opaque banks continue to take enormous risks that endanger the economy.� (PROFESSOR ANAT ADMATI, NY TIMES, 25 APRIL 2013)

3 Why do we say this? Some facts:

- The EU’s economy is more ‘financialised’ than ever, with total assets (=size) of EU financial institutions now 3 Why domore we saythan this? 350% Some of EU facts: GDP. - Bank leverage remains historically high, on average between 30x and 35x when most experts - The EU’s economy is more ‘financialised’ than ever, agree that a safe financial system should be leveraged with total assets (=size) of EU financial institutions now no more than between 15x and 20x. more than 350% of EU GDP. - Banks are still too-big-to-fail. The FSB counts 28 - Bank leverage remains historically high, on global systemically important banks on its list. average between 30x and 35x when most experts agree that a safe financial system should be leveraged - There are more derivatives traded now than before no more than between 15x and 20x. the crisis. The notional amount outstanding (=size) of the over-the-counter derivatives markets has increased - Banks are still too-big-to-fail. The Financial Stability from $596 trillion in December 2007 to $632 trillion in Board (FSB) counts 28 global systemically important December 2012, equivalent to nine times world GDP. banks on its list. - The systemic risk of EU financial institutions (SRISK, - There are more derivatives traded now than before measured as their capital shortfall in case of a new the crisis. The notional amount outstanding (=size) of financial crisis) is double what it was in September the over-the-counter derivatives markets has increased 2008. Experts at CRML estimate that the € 43 trillion from $596 trillion in December 2007 to $632 trillion in banking system in Europe is still short of € 1 trillion December 2012, equivalent to nine times world GDP. of capital. - The systemic risk of EU financial institutions (SRISK, measured as their capital shortfall in case of a new financial crisis) is double what it was in September 2008. Experts at CRML estimate that the € 43 trillion banking system in Europe is still short of € 1 trillion European ofSRISK capital. evolution

2,000

1,500

European1,000 SRISK evolution

2,000500

1,500 0 2000 2005 2008 2010

1,000 SYSTEMIC RISK MEASURE FOR EUROPEAN FINANCIAL INSTITUTIONS, IN BILLION EUROS. 500 (Source: Center for Risk Management at Lausanne (CRML), University of Lausanne. Public data, model by Jon- deau, Rockinger and Nobel Laureate Professor Robert Engle)

0 2000 2005 2008 2010

SYSTEMIC RISK MEASURE FOR EUROPEAN FINANCIAL INSTITUTIONS, IN BILLION EUROS. (Source: Center for Risk Management at Lausanne (CRML), University of Lausanne. Public data, model by Jon- deau, Rockinger and Nobel Laureate Professor Robert Engle) The only structural component of the system that has improved is the ratio of bank capital to risk-weighted assets, but the reliability of this measurement has been challenged by 4 regulators (source: FSB), warning that there areThe significantonly structural discrepancies component in ofthe the way banks calculate risk. system that has improved is the ratio of bank capital to risk-weighted assets, but the reliability of this measurement has 4 been challenged by regulators (source: FSB), warning that there are significant Overview of Progress discrepanciesin the Implementation in the way of banks the G20 calculate risk. Recommendations for Strengthening Financial Stability Report of the Financial Stability Board to G20 Leaders (5 septembre 2013) Overview of Progress in the Implementation of the G20 Both studies indicate considerable variation across Recommendations for Strengthening banks in the risk weighting of assets, even for identical Financial Stability hypothetical test portfolios. While some variation in RWAs Report of the FSB to G20 Leaders (5 septembre 2013) is natural and desirable, reflecting differences in banks’ assets composition, business models and risk preferences, Both studies indicate considerable variation across there is also material variation driven by diversity in bank banks in the risk weighting of assets, even for identical and supervisory practices that diminishes the comparability hypothetical test portfolios. While some variation in RWAs of reported regulatory capital ratios and could be harmful to is natural and desirable, reflecting differences in banks’ the international level playing field. assets composition, business models and risk preferences, there is also material variation driven by diversity in bank and supervisory practices that diminishes the comparability of reported regulatory capital ratios and could be harmful to the international level playing field.

Meanwhile, the catalogue of banking scandals never 5 seems to end: money laundering; LIBOR and other price manipulations, the London Whale and rogue trading scandals, miss-selling of swaps and insurance …

- FT UBS traderMeanwhile, Adoboli the held catalogue over of $2bn banking loss scandals never 5 seems to end: money laundering; LIBOR and other price manipulations, the London Whale and rogue trading scandals, miss-selling U.S.of swaps Bank and Legal insurance Bills … Swaps Probe Finds Banks Rigged Exceed $100 Billion - Bloomberg Rate at Expense of Retirees UBS trader Adoboli held over $2bn loss - FT - Bloomberg

U.S. Bank Legal Bills Swaps Probe Finds Banks Rigged Exceed $100 Billion - Bloomberg Rate at Expense of Retirees - Bloomberg

Serious Fraud Office to investigate Libor manipulation Barclays boss Bob Diamond - the guardian resigns amid Libor scandal - BBC NEWS business

Rale swap scandal: RBS mis-selling Serious Fraudbill mayOffice exceed to £1bn - The Telegraph investigate Libor manipulation Barclays boss Bob Diamond - The Guardian resigns amid Libor scandal - BBC NEWS business

Rale swap scandal: RBS mis-selling bill may exceed £1bn - The Telegraph 5 YEARS AFTER, FUNDAMENTAL PROBLEMS REMAIN Society is not immune from another major financial crisis

Officials at international, European and national 1 level have deployed skilled resources to produce policy documents, new standards, regulations and supervisory codes. New oversight institutions have been created. There are also signs that some of these bodies recognize the weaknesses of ongoing reforms. These are positive developments that lay the ground for the urgent deepening and speeding up of the reform process.

But has the system fundamentally changed? 2 The overwhelming answer is no.

Nearly five years after the bankruptcy of Lehman Brothers touched off a global financial crisis, we are no safer. Huge, complex and opaque banks continue to take enormous risks that endanger the economy.� (PROFESSOR ANAT ADMATI, NY TIMES, 25 APRIL 2013)

THE STATUS QUO LIFECYCLE

3 Why do we say this? Some facts:

- The EU’s economy is more ‘financialised’ than ever, with total assets (=size) of EU financial institutions now more than 350% of EU GDP.

- Bank leverage remains historically high, on average between 30x and 35x when most experts agree that a safe financial system should be leveraged no more than between 15x and 20x.

- Banks are still too-big-to-fail. The Financial Stability Board (FSB) counts 28 global systemically important banks on its list.

- There are more derivatives traded now than before the crisis. The notional amount outstanding (=size) of the over-the-counter derivatives markets has increased from $596 trillion in December 2007 to $632 trillion in December 2012, equivalent to nine times world GDP.

- The systemic risk of EU financial institutions (SRISK, measured as their capital shortfall in case of a new financial crisis) is double what it was in September 2008. Experts at CRML estimate that the € 43 trillion banking system in Europe is still short of € 1 trillion of capital.

European SRISK evolution

2,000

1,500

1,000

500

0 2000 2005 2008 2010

The only structural component of the 9 system that has improved is the ratio of bank capital to risk-weighted assets, but the reliability of this measurement has 4 been challenged by regulators (source: FSB), warning that there are significant discrepancies in the way banks calculate risk.

Overview of Progress in the Implementation of the G20 Recommendations for Strengthening Financial Stability Report of the FSB to G20 Leaders (5 septembre 2013)

Both studies indicate considerable variation across banks in the risk weighting of assets, even for identical hypothetical test portfolios. While some variation in RWAs is natural and desirable, reflecting differences in banks’ assets composition, business models and risk preferences, there is also material variation driven by diversity in bank and supervisory practices that diminishes the comparability of reported regulatory capital ratios and could be harmful to the international level playing field.

UBS trader Adoboli held over $2bn loss - FT

U.S. Bank Legal Bills Swaps Probe Finds Banks Rigged Exceed $100 Billion - Bloomberg Rate at Expense of Retirees - Bloomberg

Serious Fraud Office to investigate Libor manipulation Barclays boss Bob Diamond - The Guardian resigns amid Libor scandal - BBC NEWS business

Rale swap scandal: RBS mis-selling bill may exceed £1bn - The Telegraph 5 YEARS AFTER, FUNDAMENTAL PROBLEMS REMAIN Society is not immune from another major financial crisis

But has the system fundamentally changed? 2 The overwhelming answer is no.

3 Why do we say this? Some facts:

- The EU’s economy is more ‘financialised’ than ever, with total assets (=size) of EU financial institutions now more than 350% of EU GDP.

- Bank leverage remains historically high, on average between 30x and 35x when most experts agree that a safe financial system should be leveraged no more than between 15x and 20x.

- Banks are still too-big-to-fail. The Financial Stability Board (FSB) counts 28 global systemically important banks on its list.

European SRISK evolution

2,000

1,500

1,000

500

0 2000 2005 2008 2010

The only structural component of the system that has improved is the ratio of bank capital to risk-weighted assets, but the reliability of this measurement has 4 been challenged by regulators (source: FSB), warning that there are significant discrepancies in the way banks calculate risk.

Overview of Progress in the Implementation of the G20 Recommendations for Strengthening Financial Stability Report of the FSB to G20 Leaders (5 septembre 2013)

UBS trader Adoboli held over $2bn loss - FT

U.S. Bank Legal Bills Swaps Probe Finds Banks Rigged Exceed $100 Billion - Bloomberg Rate at Expense of Retirees - Bloomberg

Serious Fraud Office to investigate Libor manipulation Barclays boss Bob Diamond - The Guardian resigns amid Libor scandal - BBC NEWS business

Rale swap scandal: RBS mis-selling 10 bill may exceed £1bn - The Telegraph AT THE SOURCE OF THE STATUS QUO: FINANCE MAKES THE RULES ④ 30 years of deregulation and financialisation have put the financial industry in the driving seat

What is missing in the reform agenda – going back to the social purpose of the financial system and measuring the effectiveness of the current financial industry in fulfilling that purpose – is missing for a 1 very good reason: it has been left to the industry to define its own purpose and rules, and it has been assumed that such self-regulation would necessarily lead to benefits for society.

Related to this is an assumption that finance naturally serves society.

These ideas have led to market liberalisation: regulations 2 were removed or harmonised to the lowest common denominator, and the financial industry was gradually deregulated.

100

80 US

Germany Italy 60 Spain France UK

0 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

THE IMF’S ‘LIBERALISATION INDEX’ SHOWS A CLEAR TREND TOWARDS ‘FULL LIBERALISATION’ IN ALL WESTERN, DEVELOPED COUNTRIES BETWEEN THE 1980S AND THE EARLY 2000S (IMF, 2008)

Deregulation helped the financial sector to grow much 3 faster than the economic activity that supports it, a process called financialisation. For example, between 2001 and 2011, the balance sheets of European banks rose by 80% while the EU’s GDP increased by only 30%.

Financialisation brings increased power and political influence to the financial sector. 4

The balance of power between protago- nists is in fundamental disequilibrium: on the one hand the globalised world of finance dominated by a limited num- ber of large multinational actors…, on the other public authorities... who appear par- ticularly timorous each time they are called to confront the financial sector.” (PAUL GOLDSCHMIDT, FORMER DIRECTOR AT GOLDMAN SACHS, FORMER DIRECTOR AT THE EUROPEAN COMMISSION)

And as finance is assumed always to benefit society, politicians have learnt to defer to the industry for fear 5 that any ‘non-industry approved’ regulation might damage the real economy.

Government leaders are gripped by one overriding fear: that their economies will slip back into recession – or worse. The big banks play on this fear, arguing that financial reform will cause them to become unpro- fitable and make them unable to lend.” (SIMON JOHNSON, FORMER CHIEF ECONOMIST AT THE IMF).

6 Financialisation also brought new levels of complexity to the industry. Regulators have tried to keep up, but with mixed results.

Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost cer- tainly too complex. That configuration spells trouble.” (ANDREW HALDANE, DIRECTOR FOR FINANCIAL STABILITY, BANK OF ENGLAND)

Hemmed in by fears of hurting the economy and a dependence on industry expertise, policymakers are 7 recognising that the financial lobby has become too strong. As Europe’s top financial regulator said after the crisis:

We need to remember that it was many of those same lobbyists who in the past managed to convince legislators to insert clauses and provisions that contributed so much to the lax standards and mass excesses that have created the systemic risks.”

(CHARLIE MCCREEVY, EU COMMISSIONER FOR INTERNAL MARKET AND SERVICES, FEBRUARY 2009)

�Nearly all the lobbyists for financial services came from the financial industry. So let me thank Finance Watch. You understood at an early stage that lobbying must be balanced to lead to a democratic outcome. (MICHEL BARNIER, EU COMMISSIONER FOR INTERNAL MARKET AND SERVICES, MARCH 2012)

Five years after the crisis, the financial lobby continues 8 to be very successful in fighting regulation.

Related to this is an assumption that finance naturally serves society.

These ideas have led to market liberalisation: regulations 2 were removed or harmonised to the lowest common denominator, and the financial industry was gradually deregulated.

100

80 US

Germany Italy 60 Spain France UK

0 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

THE IMF’S ‘LIBERALISATION INDEX’ SHOWS A CLEAR TREND TOWARDS ‘FULL LIBERALISATION’ IN ALL WESTERN, DEVELOPED COUNTRIES BETWEEN THE 1980S AND THE EARLY 2000S (IMF, 2008)

THE STATUS QUO LIFECYCLE

Financialisation brings increased power and political influence to the financial sector. 4

And as finance is assumed always to benefit society, politicians have learnt to defer to the industry for fear 5 that any ‘non-industry approved’ regulation might damage the real economy.

6 Financialisation also brought new levels of complexity to the industry. Regulators have tried to keep up, but with mixed results.

(CHARLIE MCCREEVY, EU COMMISSIONER FOR INTERNAL MARKET AND SERVICES, FEBRUARY 2009)

Five years after the crisis, the financial lobby continues 8 to be very successful in fighting regulation.

From Washington to Berlin, banking lobbyists have blocked essential reforms at every turn.� (PROFESSOR ANAT ADMATI, NY TIMES, AUGUST 2013) AT THE SOURCE OF THE STATUS QUO: FINANCE MAKES THE RULES 30 years of deregulation and financialisation have put the financial industry in the driving seat AT THE SOURCE OF THE STATUS QUO: FINANCE MAKES THE RULES 30 years ofWhat deregulation is missing in theand reform financialisation agenda – going back to the social purpose of the financial system and have put themeasuring financial the effectiveness industry in of thethe currentdriving financial seat industry in fulfilling that purpose – is missing for a AT THE1 SOURCEvery good reason:OF THE it has STATUS been left toQUO: the industry FINANCE toWhatMAKES define is missing its THE own in RULESthepurpose reform and agenda rules, – goingand it backhas 30 years ofbeento deregulationthe assumedsocial purpose that and such of thefinancialisation self-regulation financial system would and necessarilymeasuring the lead effectiveness to benefits of forthe society.current financial have put theindustry financial in fulfilling industry that purpose in the – isdriving missing forseat a 1 Relatedvery good to reason: this is anit has assumption been left tothat the finance industry tonaturally define servesits own society. purpose and rules, and it has Whatbeen isassumed missing thatin the such reform self-regulation agenda – going would back tonecessarily the social purposelead to benefits of the financial for society. system and measuring the effectiveness of the current financial industryRelated into fulfillingthis is an that assumption purpose – isthat missing finance for a 1 verynaturally good serves reason: society. it has been left to the industry to define its own purpose and rules, and it has been assumed that such self-regulation would necessarily lead to benefits for society. These ideas have led to market liberalisation: regulations were removed or harmonised to the lowest common 2 Related to this is an assumption that finance denominator, and the financial industry was gradually naturally serves society. deregulated.

100 These ideas have led to market liberalisation: regulations 2 were removed or harmonised to the lowest common denominator, and the financial industry was gradually 80 deregulated. US Germany Italy 10060 Spain These ideas have led to market liberalisation: regulationsFrance were removed or harmonised to the lowest common UK 2 4080 denominator, and the financial industry was gradually US deregulated. Germany Italy 2060 Spain 100 France UK

40 0

801973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 US

Germany 20 THE IMF’S ‘LIBERALISATION INDEX’ SHOWS A CLEAR TREND Italy 60 TOWARDS ‘FULL LIBERALISATION’ IN ALL WESTERN, DEVELOPEDSpain COUNTRIES BETWEEN THE 1980S AND THE EARLY 2000S France 0 (IMF, 2008) UK

401973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

THE IMF’S ‘LIBERALISATION INDEX’ SHOWS A CLEAR TREND 20 TOWARDS ‘FULL LIBERALISATION’ IN ALL WESTERN, DEVELOPED COUNTRIES BETWEEN THE 1980S AND THE EARLY 2000S (IMF, 2008)

0 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

DeregulationTHE IMF’S ‘LIBERALISATION helped the financial INDEX’ SHOWSsector Ato CLEAR grow TRENDmuch 3 fasterTOWARDS than the ‘FULL economic LIBERALISATION’ activity that IN ALL supports WESTERN, it, aDEVELOPED COUNTRIES BETWEEN THE 1980S AND THE EARLY 2000S process(IMF, 2008) called financialisation. For example, between 2001 and 2011, the balance sheets of European banks rose by 80% while the EU’s GDP increased by only 30%. Deregulation helped the financial sector to grow much 3 faster than the economic activity that supports it, a process called financialisation. For example, between 2001 and 2011, the balance sheets of European banks rose by 80% while the EU’s GDP increased by only 30%.

Deregulation helped the financial sector to grow much 3 faster than theFinancialisation economic activity brings that increased supports power it, a and political process calledinfluence financialisation to the financial. For example, sector. between 4 2001 and 2011, the balance sheets of European banks rose by 80% while the EU’s GDP increased by only 30%.

The balance of power between protago- Financialisation brings increased nists is in fundamentalpower and politicaldisequilibrium: to the financial sector. influence on the one hand the globalised world4 of finance dominated by a limited num- ber of large multinational actors…, on the Theother balance public authorities... of power between who appear protago par- - niststicularly is in timorous fundamental each disequilibrium:time they are Financialisation brings increased oncalled the toone confrontpower hand the andthe globalised financial political worldsector.” influence to the financial sector. (PAULof finance GOLDSCHMIDT, dominated FORMER by a limited DIRECTOR num4 -AT GOLDMANber of large SACHS, multinational FORMER DIRECTORactors…, onAT THEthe EUROPEANother public COMMISSION) authorities... who appear par- Theticularly balance timorous of power each between time they protago are - nistscalled is to in confront fundamental the financial disequilibrium: sector.” (PAULon the GOLDSCHMIDT, one hand the FORMERglobalised DIRECTOR world AT ofGOLDMAN finance SACHS, dominated FORMER by DIRECTORa limited numAT THE- berEUROPEAN of large COMMISSION) multinational actors…, on the other public authorities... who appear par- ticularly timorous each time they are called to confront the financial sector.”

And as finance is assumed always to benefit(PAUL society, GOLDSCHMIDT, FORMER DIRECTOR AT GOLDMAN SACHS, FORMER DIRECTOR AT THE politicians have learnt to defer to the industry forEUROPEAN fear COMMISSION)5 that any ‘non-industry approved’ regulation might damage the real economy.

And as finance is assumed always to benefit society, politicians have learnt to defer to the industry for fear 5 that any ‘non-industry approved’ regulation might Government leaders are gripped by one overriding damagefear: the thatreal their economy. economies will slip back into recession – or worse. The big banks play on this fear, arguing that financial reform will cause them to become unpro- And as fitablefinance and is assumedmake them always unable to tobenefit lend.” society, politicians have learnt to defer to the industry Government leaders are gripped by onefor overriding fear 5 that any(SIMON ‘non-industry JOHNSON, approved’ FORMER CHIEF regulation ECONOMIST might AT THE IMF). fear: that their economies will slip back into recession damage– theor worse. real economy. The big banks play on this fear, arguing that financial reform will cause them to become unpro- fitable and make them unable to lend.” (SIMON JOHNSON, FORMER CHIEF ECONOMIST AT THE IMF). Government leaders are gripped by one overriding fear: that their economies will slip back into recession – or worse. The big banks play on this fear, arguing that financial reform will cause them to6 become unpro- fitable and make them unable to lend.” Financialisation also brought new levels (SIMON JOHNSON, FORMER CHIEF ECONOMIST AT THE IMF). of complexity to the industry. Regulators have tried to keep up, but with mixed results. 6 Financialisation also brought new levels of complexity to the industry. Regulators have tried to keep up, but with mixed results.

6 Financialisation also brought new levels of complexity to the industry. Regulators have tried to keep up, but with mixed results. Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost cer- tainly too complex. That configuration spells trouble.” (ANDREW HALDANE, DIRECTOR FOR FINANCIAL STABILITY, BANK OF ENGLAND) Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost cer- tainly too complex. That configuration spells trouble.” (ANDREW HALDANE, DIRECTOR FOR FINANCIAL STABILITY, BANK OF ENGLAND)

Modern finance is complex, perhaps too complex. HemmedRegulation in by fears of of modern hurting finance the economy is complex, and a almost cer- dependencetainly on too industry complex. expertise, That configuration policymakers spells are trouble.”7 recognising that the financial lobby has become too strong.(ANDREW As Europe’s HALDANE, top DIRECTOR financial FOR regulator FINANCIAL said STABILITY, BANK OF ENGLAND) after the crisis: Hemmed in by fears of hurting the economy and a dependence on industry expertise, policymakers are 7 recognising that theWe financialneed to remember lobby has that become it was many of those same too strong. As Europe’slobbyists top who financial in the pastregulator managed said to convince legislators after the crisis: to insert clauses and provisions that contributed so much to the lax standards and mass excesses that have created the Hemmed in by fearssystemic of hurting risks.” the economy and a We need to remember that it was many of those same dependence on industry(CHARLIE expertise, MCCREEVY, policymakers EU COMMISSIONER are FOR7 INTERNAL MARKET recognising that theANDlobbyists financial SERVICE whoS, lobbyinFEBRUARY the haspast become 2009)managed to convince legislators too strong. As Europe’sto insert top clauses financial and regulatorprovisions said that contributed so much to after the crisis: the lax standards and mass excesses that have created the �Nearly all the lobbyistssystemic for risks.” financial services came from the financial industry.(CHARLIE So MCCREEVY,let me thank EU FinanceCOMMISSIONER Watch. FOR INTERNAL MARKET You understood atANDWe an needSERVICE early to stage rememberS, FEBRUARY that lobbying that 2009) it was must many be of those same balanced to lead lobbyiststo a democratic who in outcome.the past managed to convince legislators to insert clauses and provisions that contributed so much to (MICHEL BARNIER, EU COMMISSIONER FOR INTERNAL MARKET �NearlyAND SERVICES, all the MARCHlobbyiststhe lax 2012) forstandards financial and services mass excesses came from that have created the the financial industry.systemic So letrisks.” me thank Finance Watch. You understood at(CHARLIE an early MCCREEVY, stage that EU lobbying COMMISSIONER must be FOR INTERNAL MARKET balanced to lead ANDto a SERVICEdemocraticS, FEBRUARY outcome. 2009) (MICHEL BARNIER, EU COMMISSIONER FOR INTERNAL MARKET AND SERVICES, MARCH 2012) �Nearly all the lobbyists for financial services came from Five years after the crisis, the financial lobby continues the financial industry. So let me thank Finance Watch. to be very 8You understoodsuccessful at an early in stage fighting that lobbying regulation. must be balanced to lead to a democratic outcome.

(MICHEL BARNIER, FromEU COMMISSIONER Washington toFOR Berlin, INTERNAL banking MARKET lobbyists have blocked AND SERVICES, MARCH 2012) Five years afteressential the crisis, reforms the financialat every turn.�lobby continues to be very 13 8 successful (PROFESSOR in ANATfighting ADMATI, regulation. NY TIMES, AUGUST 2013)

From Washington to Berlin, banking lobbyists have blocked essential reforms at every turn.� Five years after the crisis, the financial lobby continues (PROFESSOR ANAT ADMATI, NY TIMES, AUGUST 2013) 8 to be very successful in fighting regulation.

From Washington to Berlin, banking lobbyists have blocked essential reforms at every turn.� (PROFESSOR ANAT ADMATI, NY TIMES, AUGUST 2013) WE NEED A NEW APPROACH ⑤ NEXT THAT WILL MAKE CHANGE POSSIBLE CRISIS CHANGE FINANCE!

1 A clear alternative with opposite consequences:

EITHER - More of the same: the next major financial crisis could be around the corner. We know what that would mean for social and economic condi- tions, and trust in the financial sector. It could also feed euro-scepticism and political extremism.

OR - Change the rules to put society in charge. Imagine if we had a stable financial sys tem that genuinely ser- ved society’s needs, if the EU’s citizens trusted their leaders always to prioritise them ahead of the financial NEXT CRISIS CHANGE industry and private national agen- FINANCE! das, if the public started to trust and respect the financial sector again, if finance started to fulfil its potential to be one of the great tools for solving the problems of the 21st century.

Alan Greenspan famously confessed that his faith in 2 the self-regulation principle had been shaken by the global financial crisis:

Those of us who have looked to the self- interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.” (TESTIMONY TO THE HOUSE COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM, OCTOBER 2008)

14 Shock is not enough: a change of paradigm is needed. The current thinking gives too much power to the financial industry and makes politicians afraid of fundamental reform. 3 New thinking is needed for society to break free from the cycle of financial crises. In Finance Watch’s view, the new paradigm should reflect what we have learned in the crisis:

Finance does not naturally serve society. For this to happen, society must set the rules

The old paradigm was based on ideology and theory. The evidence of its impact on the real world shows its limitations: 4

- Liberalisation and deregulation in the financial industry lead to decreased efficiency, i.e. a higher cost for the same service (or higher ‘unit/cost’). This increased inefficiency has been measured for the US financial industry by Thomas Philippon of NYU. In research sponsored by Fi- nance Watch, his demonstration has recently been replicated for Europe with the same preliminary results: financial services are more expensive today than prior to the start of deregulation. Unit cost of financial intermediation in France, Germany, the UK and the US (4-years moving average) 4,0 %

3,5 %

3,0 %

2,5 %

2,0 %

1,5 %

1,0 %

France Germany UK US

0,5 %

0,0 % 1960 1970 1980 1980 2000 2006

Source: Institut des Politiques Publiques, Guillaume Bazot

- Financialisation above a certain level is detrimental to growth – this level has now been reached in all developed economies.

There comes a point where further enlargement of the financial system can reduce real growth” (CECCHETTI AND KHARROUBI)

Financial sector share un employment and growth

0.02 h

0.01

0.00

- 0.01

- 0.02

- 0.03

Five-years average GDP-per-worker growt - 0.04 -0.004 -0.002 -0.000 0.002 0.004 0.006

Five-years average financial intermediation share total employment

Source: BIS working paper, Cecchetti and Kharroubi, 2012

- Importantly, the previous two facts do not take into account negative externalities in the form of recurrent, worsening crises over the last 30 years…

A new paradigm would recognize that in the financial industry and 5 elsewhere, people act in response to social and institutional incentives and constraints. And these reflect the interests of whoever creates the rules of their environment. For example, it might be ‘rational’ for a bank executive to engage in extreme risk-taking activities in an investment bank environment that rewards such behaviour regardless of the consequences for society. The same executive would be ‘irrational’ to do this in an environment where their risk-taking were condemned and penalised. The difference lies in the rules that define that environment. WE NEED A NEW APPROACH NEXT THAT WILL MAKE CHANGE POSSIBLE CRISIS CHANGE FINANCE!

1 A clear alternative with opposite consequences:

Alan Greenspan famously confessed that his faith in 2 the self-regulation principle had been shaken by the global financial crisis:

Shock is not enough: a change of paradigm is needed. The current thinking gives too much power to the financial industry and makes politicians afraid of fundamental reform. 3 New thinking is needed for society to break free from the cycle of financial crises. In Finance Watch’s view, the new paradigm should reflect what we have learned in the crisis:

Finance does not naturally serve society. For this to happen, society must set the rules

The old paradigm was based on ideology and theory. The evidence of its impact on the real world shows its limitations: 4

3,5 %

3,0 %

2,5 %

2,0 %

1,5 %

1,0 %

France Germany UK US

0,5 %

0,0 % 1960 1970 1980 1980 2000 2006

Source: Institut des Politiques Publiques, Guillaume Bazot 15

- Financialisation above a certain level is detrimental to growth – this level has now been reached in all developed economies.

There comes a point where further enlargement of the financial system can reduce real growth” (CECCHETTI AND KHARROUBI)

Financial sector share un employment and growth

0.02 h

0.01

0.00

- 0.01

- 0.02

- 0.03

Five-years average GDP-per-worker growt - 0.04 -0.004 -0.002 -0.000 0.002 0.004 0.006

Five-years average financial intermediation share total employment

Source: BIS working paper, Cecchetti and Kharroubi, 2012

- Importantly, the previous two facts do not take into account negative externalities in the form of recurrent, worsening crises over the last 30 years…

1 A clear alternative with opposite consequences:

Alan Greenspan famously confessed that his faith in 2 the self-regulation principle had been shaken by the global financial crisis:

Finance does not naturally serve society. For this to happen, society must set the rules

The old paradigm was based on ideology and theory. The evidence of its impact on the real world shows its limitations: 4

3,5 %

3,0 %

2,5 %

2,0 %

1,5 %

1,0 %

France Germany UK US

0,5 %

0,0 % 1960 1970 1980 1980 2000 2006

Source: Institut des Politiques Publiques, Guillaume Bazot

- Financialisation above a certain level is detrimental to growth – this level has now been reached in all developed economies.

There comes a point where further enlargement of the financial system can reduce real growth” (CECCHETTI AND KHARROUBI)

Financial sector share un employment and growth

0.02 h

0.01

0.00

- 0.01

- 0.02

- 0.03

Five-years average GDP-per-worker growt - 0.04 -0.004 -0.002 -0.000 0.002 0.004 0.006

Five-years average financial intermediation share total employment

Source: BIS working paper, Cecchetti and Kharroubi, 2012

- Importantly, the previous two facts do not take into account negative externalities in the form of recurrent, worsening crises over the last 30 years…

A new paradigm would recognize that in the financial industry and 5 elsewhere, people act in response to social and institutional incentives and constraints. And these reflect the interests of whoever creates the rules of their environment. For example, it might 16 be ‘rational’ for a bank executive to engage in extreme risk-taking activities in an investment bank environment that rewards such behaviour regardless of the consequences for society. The same executive would be ‘irrational’ to do this in an environment where their risk-taking were condemned and penalised. The difference lies in the rules that define that environment. WE NEED A NEW APPROACH NEXT THAT WILL MAKE CHANGE POSSIBLE CRISIS CHANGE FINANCE!

1 A clear alternative with opposite consequences:

Alan Greenspan famously confessed that his faith in 2 the self-regulation principle had been shaken by the global financial crisis:

Finance does not naturally serve society. For this to happen, society must set the rules

The old paradigm was based on ideology and theory. The evidence of its impact on the real world shows its limitations: 4

3,5 %

3,0 %

2,5 %

2,0 %

1,5 %

1,0 %

France Germany UK US

0,5 %

0,0 % 1960 1970 1980 1980 2000 2006

Source: Institut des Politiques Publiques, Guillaume Bazot

- Financialisation above a certain level is detrimental to growth – this level has now been reached in all developed economies.

There comes a point where further enlargement of the financial system can reduce real growth” (CECCHETTI AND KHARROUBI)

Financial sector share un employment and growth

0.02 h

0.01

0.00

- 0.01

- 0.02

- 0.03

Five-years average GDP-per-worker growt - 0.04 -0.004 -0.002 -0.000 0.002 0.004 0.006

Five-years average financial intermediation share total employment

Source: BIS working paper, Cecchetti and Kharroubi, 2012

- Importantly, the previous two facts do not take into account negative externalities in the form of recurrent, worsening crises over the last 30 years…

Our key recommendations contribute to making this paradigm shift a reality: www.finance-watch.org/hot-topics/campaign-change-finance/four-demands