I’m not sure if providing the source or inspiration of every book does add any useful information to the book review. But it helps me keep track of which recommendations work and which don’t. In the past, there have been some recommendations that have proven to be very wrong. These include recommendations by one of the richest men in the world today, and by one who is a maverick entrepreneur in multiple industries. But I guess no matter what the source, it’s a hit or a miss considering the sheer number of books available in the market today.

I picked up this particular book as a recommendation from one of the leading portfolio managers in India today, Raamdeo Agarwal. He heads Motilal Oswal, and I came across this book in one of his interviews.

This book closely mirrors another book that I’ve read recently – Makers and Takers. Both the books are about the same topic – the rise of finance as an industry from a supporting sector to businesses and entrepreneurs to an end-in-itself. The book traces the birth of modern finance during the 1960s when the Eurodollar market was set up as a “work-around” to the strict Regulation Q that limited the amount that American banks could give out as interest. The author talks about the early days of banking, when it was considered as a stewardship of people’s savings. Now a majority of the revenue for banks comes from trading and investment. The dropping of the Glass-Steagal Act in 1999 only served to hasten up the inevitable crash that would happen some ten years down the line, when financial institutions were up to their neck in exotic and complicated derivative instruments that ultimately resulted in the sub-prime crash.

Modern Finance is no doubt very complex, but it is ironic that this complexity was once considered as its strength. This, by no less than the doyens in the Finance field, names such as Alan Greenspan and Tim Geithner. The part about the Jackson Hole conference, where Raghuram Rajan made a fervent plea to check the excesses committed by the financial sector. Of course, he was ignored.

The excesses went on unabated and it caused the government to bail out these too-big-to-fail institutions by using tax payer money. And what’s worse, many of the executives of these financial institutions went home scot-free. After all, the financial sector does not have the same accountability that other sectors, such as airplane manufacturers may have in case of a major goof up from their side.

The book argues that part of the strong interconnectedness between the financial sector and the government is that many government officers have transitioned into high-level private sector jobs, and also the other way round. Robert Rubin, who served as the Secretary of the Treasury during Clinton’s term, was a Co-Chairman at Goldman Sachs.

The book concludes by setting out the urgent need for reform in the financial sector. The different aims of a commercial bank and an investment bank should be recognized and followed diligently. Firms that sell extremely risky or complicated products to the general public should be allowed to fail if the need arises. After all, most of the money in the financial system today is “other people’s money”. For example, “in a modern institution such as Deutsche Bank, around 3 percent of the capital at risk is the bank’s own: the other 97 per cent belongs to lenders and depositors”. Making managers more accountable, like in other industries, for their decisions will help straighten out the creases as well.

All in all, this is a good book for someone wanting to learn more about how the finance sector has changed over the years. We can already attribute at least one crisis due to this changing nature of Finance. And in absence of major reforms, there certainly will be more. As I’ve mentioned earlier in my review, the book touches the same topic as one other book that I’ve recently read. You can choose either one of these books as both provide a similar if not the same perspective towards financialization. Check out Other People’s Money here or Makers and Takers (and my review) on Amazon.

Other People's Money
John Kay
Finance, Business, Non-fiction
mobi, paperback, hardcover

Way back in college, there was a perennial debate that raged on in classes. Whether people pursuing Finance as an MBA specialization are actually doing anything to contribute to the real economy or not. One side of the debate argued that Finance MBAs do not contribute anything real to society. It is entrepreneurs and manufacturers who are the real heroes of the economy. They’re the ones who create physical assets. All Finance MBAs do is conjure  assets up out of thin air (that are likely to disappear into thin air as well), a house of cards, so to speak. The other side fought for the view that Finance is very much a rock solid constituent of the world economy. It lubricates the wheels of business, by moving capital from where it is available to where it is needed most.

No points in guessing which side of the debate this book would take. But what we would have never discussed in our debates is how the financial economy would not only contribute to the world economy in such measure, but also control the functioning of the real economy. Makers and Takers explains this phenomena in the book in detail.

The book starts with the author quoting what seems to be her favourite statistic, [Finance] represents about 7 percent of our economy but takes around 25 percent of all corporate profits, while creating only 4 percent of all jobs.

The book goes on to describe how Finance has risen in the economy in the recent few decades. The author has even coined a term for this phenomenon – calling it financialization. The author explains that a majority of this was due to the incessant lobbying by the heads of the financial sector to make the authorities go easy, and in some cases, even reverse certain laws, for their convenience. What is even more shocking is that many such lobbyists and heads of too-big-to-fail institutions later get plum government positions after they retire.

There is an interesting bit of history about Corporate America’s obsession with numbers and the gradual shift towards cost-cutting and optimization. This the author argues is partly due to the way management education (read MBA) has changed over the years. The focus, according to the author, has shifted from managerial skills to balance sheet manipulation. And that leads to questionable decisions and a lot of short-term fixes.

There is an entire chapter (and rightly so) that is devoted to the bad boys of Finance. No, I’m not talking about the investment banks (although they’re there too). I’m talking about the creations of these investment banks – derivatives. The notorious financial weapons of mass destruction. The author explains the danger inherent in giving derivatives a centre-stage in the financial market through an infamous example. In around 2011, Goldman Sachs had cornered the aluminium market and had caused its price to shoot up, much to the detriment of major aluminium consumers such as Coca Cola. This story alone is a must read for those wanting to understand how derivatives can cause an uncontrollable change in commodity prices suddenly.

The author closes the book by discussing the impact of the growing financialization on the retirement and taxation benefits of individuals, and what are the possible solutions on how “finance might be put back into the service of the real economy.”

The basic question that resonates throughout the book is – why does a sector that was meant to facilitate business now have such a stranglehold over the very businesses that it was meant to support?

What makes the book engrossing is the author’s use of real life examples to explain how the financial sector has crept slowly into the realms of the real sector. Old and reputed institutions such as Citibank, GE, Enron (reputed until it no longer was), Goldman Sachs, had a major part to contribute to this growing financialization in the American corporate economy.

There were some concepts that I did not agree with, though. The author seems to be very much against buybacks, arguing that companies should utilize this money into more meaningful endeavours such as research or investment in factories and other infrastructure. This expectation goes against the very fundamental goal of a business. According to the economist Milton Friedman, the main purpose of a business should be to maximize profits for its owners, and in the case of a publicly-traded company, the stockholders are its owners. If investments in real assets would be the most profitable investment, then a business should do so. Else, if there is no future growth in doing so, the company would do well to distribute its earnings through dividends or share buybacks. In fact, Warren Buffett was one of the strongest proponents of buybacks, and has mentioned it in his letters many a times. According to Buffett, when used correctly, buybacks are one of the most shareholder friendly ways to improve the ROE of the company.

Also, the author seems to repeat many points to a point of infatuation. I feel the editor could have done a snappier job in identifying and reducing these. However, for someone interested in the learning about how Finance has today become the biggest cog in the global economy, this book will be a very good place to start. Get this book on Amazon.

Makers and Takers - The Rise of Finance and The Fall of American Business
Rana Foroohar