James Tyler: The Importance of Traders and the Evils of Bankers
This is part of a series of blogposts republishing previous events of the Oxford Hayek Society and the Oxford Libertarian Society. The original blogposts were published here.
On Thursday 27 May 2010, James Tyler, Founder and Chief Executive of Tyler Capital, spoke to the Oxford Libertarian Society at Christ Church on the subject of: 'The Importance of Traders and the Evils of Bankers'.
The following is an edited transcript of Tyler's talk:
Markets and Traders
Trade and commerce are the lifeblood of wealth creation. Without specialisation and exchange, we would all starve. You have oranges, I have apples. Individually we are bored; together, we have a fruit salad.
For specialisation, exchange and commerce to work their magic, we need a common ground: a market.
At the mention of that word, some froth and foam at the mouth - the evil of markets, how the market forces this, how the market exploits that, et cetera.
But a market is just a bit of space, physical or virtual, where people willing to buy meet those willing to sell. That’s it. It has no power of its own - no influence, no horns, and no pointy tail.
But there is a fair grievance that in that sentiment. What they are trying to say is that they object to those who have power in a market. Who wields the power in a market, and where does it come from? That is a fair question to ask.
Power always comes, ultimately, from the government. The government holds the monopoly on power; the government sets the rules; and the government's arbitrary decisions can mean life or death for any businessperson taking a risk.
Money the Intermediary
Few would attack commerce between two individuals exchanging the hard-earned fruits of their labour for what they need: the apple-grower giving apples to the orange farmer for some oranges in return.
Unless, that is, the orange farmer wants pears. The apple-grower doesn't have any, but the apple-grower wants oranges. A pear farmer down the road has pears, but the pear farmer doesn't want any oranges.
The ingenuity of spontaneous order found a clever solution to this problem: an intermediate commodity called money. It wasn't imposed by a king or a taxman: it originated in the free, voluntary interaction of individuals.
Money is just a commodity like any other. Free, voluntary interaction had to choose something that was durable, portable, respected, and consistent. Free, voluntary interaction originally chose gold and silver as money, and gold remained money until governments came along and nationalised then destroyed it. Since then, money has been a fraud: we use it only because someone even more foolish is willing to use it too.
The creation of money was a fantastic innovation – a neat solution to the problem of the double coincidence of wants, or rather what to do when there wasn’t a coincidence.
The Evil Speculator
But what happens if an orange farmer wants to sell next year’s crop now?
Maybe there is a great demand for oranges and the farmer has cultivated trees to meet the demand, but the farmer doesn't want to take the risk of a craze for pears depressing the demand for oranges. A consumer of oranges may only want to buy what he can pick up and select. A grocer may not want to tie up his cash in something so far off into the future.
What is needed is someone in the middle: someone willing to guarantee a price for those oranges now, take them in the future and then sell them on when they are needed. This is where the speculator steps in and provides a vital service.
So welcome the 'evil' speculator.
How can somebody who produces nothing, does not employ physical labour, and does not reorganise the factors of production, be in any way productive in society? Off with their heads!
The key is uncertainty. Future desires and wants can never be known, so there are always highly uncertain outcomes inherent in planning for the future. The world is too complicated to simplify into predictive mathematical models or bureaucratic diktats. The risks are too great and the mistakes are too expensive.
What we need is a mechanism to attempt to put a price on future outcomes. We need to 'crowd-source' the answer to the problem of resource allocation.
And, that’s what speculation is. A speculator risks their own shirt to take on risks that others do not want. They speculate that they will find another buyer at a future point in time, and charge a fee for their service of risk-taking.
This is not 'making money from nothing'. Speculators provide a service to the world by smoothing out the jagged pointy edges. If things go wrong, they will have to pay the price personally.
Speculation is important because of the signals that it emits. If prices rise, it signals a shortage which stimulates extra production to satiate demand. If the speculator successfully sells short some shares, the falling price will send out a signal that not all is well with that company.
Are Markets Efficient?
Some contend that markets are not efficient: they make mistakes and misallocate resources. This isn't true.
Markets work in waves and ripples and patterns, not aggregates, averages and efficiencies. Early adopters get rewarded the most; late arrivers are penalised. The crowd sometimes gets carried away, and prices rise too much or fall in an unwarranted way, but by and large, when not unduly influenced by power, markets are a remarkably efficient way of making myriad mind-numbing decisions that all hang together.
Markets are smart in a way that a regulator can never be. Traders in a market can make mistakes, but the mistakes made by crowds are much smaller than those created when the government tries to solve a problem.
The great unsung heroes of stock markets are the short-sellers. Selling short is the process of selling something that you do not own, in order to profit from a fall in prices, then buying it back at a lower price.
Short-selling is a dangerous game. You are hated by everyone - governments, regulators, corporate bosses, virtually everyone. You are always at risk of being targeted for a ’short squeeze’. But short-selling is vital for two reasons.
Firstly, buyers need a seller to buy from.
If you want to buy some shares, who will sell them to you? It’s usually not an investment fund, or a pensioner, or your mate. It is more than likely that the person you bought them from will not own them, but will scrabble around for the rest of the day trying to find them a penny cheaper. Can you be bothered to do that?
Banning short=selling stops the market working – meaning that movements are likely to be bigger - and, crucially, the falls larger.
Secondly, short-sellers are the policemen of the markets – a much better (and more fearsome) regulator than the Financial Services Authority.
Without short-sellers, Enron and WorldCom would have got away with their fraud for a lot longer. It is a tragedy that the short-sellers of banks were not bigger and better armed during the run-up to the Recession. Short-sellers were there, but they were just too small in face of the great money/banking juggernaut carelessly careening away. Stronger short selling might have seen off the sub-prime fiasco earlier and with less pain.
As a society, we should desperately be encouraging short-sellers in situations like this. Big business needs to respect the short-seller: it keeps them honest. When prices are rising in a rampant fashion, usually no good comes of this. This is when we need the short-seller to tame the wild beast.
Booms and Busts
Speculators do a much better job of sifting through the morass of conflicting signals to fish out the price for the best allocation of resources in a way that Sir Humphrey, sitting in an ivory tower in Whitehall, could only dream about.
Traders and speculators are vital for a productive and fully-functioning capitalist economy. In a pure and free economy, they are a force for efficiency and part of the crowd-sourced resource allocation system.
But unfortunately, we do not have free markets.
The Recession has shown us that markets, especially financial markets, are anything but pure. Markets are distorted by power, and we should turn your swivel gun onto the source of that power.
The one thing you should know about busts is that you can’t stop the pain at that point: it’s too late; the damage has already been done.
The boom may have felt good at the time, but those tequila slammers at 2am always seem like fun compared to the feeling in the morning. Trying to alleviate the hangover by more of the same is the action of an alcoholic.
Similarly, it’s the boom when assets are wildly misallocated, and that’s where we should focus.
How the Government Lets the Bankers Get Away with It
The Recession started with the government, was promoted by government agencies, and was taken to dizzying heights by a banking system fuelled with masses of cheap money, produced by central banks that panicked after the previous cheap money bubble popped in 2001.
The bankers perceived an inexhaustible supply of cash that could be lent at a profit to people who had no chance of paying it back. The Mexican strawberry picker was given a $750,000 loan to buy a house he could never afford to repay. A cleaner could run a buy-to-let portfolio of 4 houses, with zero down payment.
Banks are not run by kind, old, bespectacled men, carefully lending money to young families to give them their first break. Remember It’s a Wonderful Life with Jimmy Stewart and the friendly banker looking after good old townsfolk? Scrub it from your mind. Banks are vast hedge funds with vast trading floors of speculators.
Banks are licensed by the government. I cannot start up a bank and neither can you, unless you go through the various hoops, fires, and barriers erected in front of you. You need mountains of capital. The government and the bankers make it difficult to join their club.
Banks also operate under a specially-loosened set of accounting rules.
Normally, companies are required by accounting rules and law to make sure that they provide for their liabilities as they fall due. If you order a load of gear on credit, you have to show that you have the ability to pay for it – and pretty rapidly. Companies are expected to make their creditors ‘whole’.
Look at the accounts of Vodafone and in their balance sheet they have to provide for ‘current liabilities’ and ‘long-term liabilities’, but not so for a bank. Banks get away with a broad ‘liabilities’ section with no attempt at sorting near-term risks from long-term assets. It doesn’t matter whether they owe money tomorrow or are due to cover it in 5 years' time.
Banks thrive on red tape, loopholes, fuzzy wording and obfuscation. For instance, 75% of people in this country believe that when they place their hard-earned money in a current account, it remains their money.
It most emphatically does not. You hand your money over, and you get a promise. I say 'promise', but the bank goes to great lengths to hide this fact. You are given a statement, which shows your money proudly sitting there, waiting for you – all safe and sound.
Except it’s not. It is being lent out to Dubai World, or passed onto the trading floor, and being pushed into Alphabetti Spaghetti Derivative Hooplas, funnelled into their massive casino operation.
Even though you might spend it tomorrow, the bank will not have your money. If you want it, they have to get it from somebody else’s account, or go onto the money markets and borrow it.
A bank is an operation designed to make profits from money that is not their own.
When you put your Tesco’s money into a bank, you are investing in a hedge fund, except that you don’t get any of the profits. If it all goes wrong, as it did in 2008, then the taxpayer pays for all the losses.
Even in the good times, the taxpayer insures deposits, explicitly or implicitly, leaving the banks free to gamble away. Does this seem like free-market capitalism to you?
Banks operate with privilege and monopoly rights, with taxpayer backing. And we can add a final potion into the mix: incentive and liability.
The sub-prime crisis cost Wall Street and the City trillions, or rather it is costing taxpayers that much. If I lose money, I remortgage my house; otherwise I don’t come back.
When Goldman Sachs put all its eggs in the AIG basket, they should have received a bloody nose – at the very least. Yet Uncle Sam paid them out 100 cents on the dollar.
A trader called Howie Hubler recorded the single biggest loss ever at a bank. He cost Morgan Stanley over 10 billion dollars, but he got to keep the 24 million dollar bonus he earned the year before. Dick Fuld at Lehman faced some devastatingly-hard questions from some horrible congressmen, but still he retired a very rich man.
It was the taxpayer who paid the price. Private profits and socialised losses – emphatically not free-market competition.
What Should We Do?
I don’t mean that we should round these guys up and shoot them, or even take their bonuses back – they signed contracts, and we respect the rule of law and contracts. It’s the basis of our freedom and we risk tyranny if we selectively choose to violate these rights.
We have to recognise that bank traders get a free option. You can bet it all on red or black: win, you get a bonus; lose, you may lose your job – but then probably use your reputation and experience to walk into another one.
The system is wrong, and something must be done about it.
When dealing with a crisis, we have to remember that the damage is dealt before we are aware of it. In the sub-prime crisis, it was done in those happy days of 110% mortgages, up-front discounted rates, and more freshly-printed money than you know what to do with. We were killing our economy with cheap money.
When gravity asserted itself, and the inevitable bust came we faced a simple choice: take the pain, or hide it.
In 1982, 100 Keynesian economists wrote a letter to the times saying that the government’s economic policies were suicidal - at the exact moment that the real economy started to grow. Time and again, history shows us that if we take our medicine early, we get through the illness quicker.
Or we could take the Japanese/Keynesian approach, and hide it with fiscal aggregate kabalah nonsense - and lose twenty years in the process.
But banks, what should we do with them?
Banks should not speculate with your beer money – unless you understand this and you explicitly sign it off.
Banks should be audited as strictly and as thoroughly as normal companies are – no favours.
Banks should legally have to provide for liabilities as they fall due – as every other company should.
Banks should offer accounts that are 100% reserved - where your money is kept safe, not used to speculate, and where it remains your property.
Speculation should be undertaken by hedge funds and specialist trading groups, not by deposit-taking institutions, or by the likes of Barclays, that can borrow money from the Bank of England at 0.5% and walk over to the craps table.
Anybody, or company, that offers fiduciary advice should face 100% liability in case it goes wrong.
Any person paid more than a certain amount by a bank should be liable when things go wrong.