What do the people who occupy the skyscrapers of the City of London and Canary Wharf actually do?’  To an extent that defies the imagination,  they trade with each other.  Lending to non-financial business – which many people might think the principal activity of a bank – represents about 3% of the assets of British banks.  The volume of trade in foreign exchange is one hundred times the volume of world trade in goods and services.  The scale of exposures on financial derivative contracts – the esoteric bets that financial institutions make between themselves – is today around three times the value of all the assets in the world.

What is all this activity for?  And is it worth what you and I pay for it? After all, every penny that funds the remuneration packages and bonuses of those who work in wholesale financial services comes from the pockets of savers

       . Capital markets exist to facilitate capital allocation – gathering savings and directing them to productive investment.  But   the capital needs of business have changed over the last century.  The manufacturing business with its extensive and industry specific plant, buildings and machinery has given way to the ‘knowledge economy’.   Apple, Google and Microsoft are now the most valuable companies in the world and the employ very little capital.  They do not  need to own the shops, offices, computers they use in their business, and mostly they don’t.   Even capital intensive large businesses – like Exxon and Shell – are self financing. The stock market is no longer a means of putting money into companies but a means of getting it out.

       The total value of Britain’s national assets is about £7 trillion (about £120000 per head). and 60% of that is the value of our houses.  The balance is made up, in roughly equal shares, by commercial property – offices, shops, warehouses; by infrastructure assets – roads, railways, and sewers; and by business investment. Residential mortgages  represent about two-thirds of bank lending outside the financial sector . The balance is spread across lending on commercial property, business, and consumer credit (car loans and credit card debt).

       Efficient capital allocation requires effectiveness in search – looking for new investment opportunities.  And effectiveness in stewardship – ensuring that established assets are sustained and enhanced. We need to  maintain our physical assets and enhance the capabilities of our companies. These jobs are not now done well, and they are not what most people engaged in financial markets are even attempting to do.  Their focus is on rearranging claims to existing assets between themselves.

       We are neglecting new investment.  At current rates, it would take more than 200 years to replace the existing housing stock, far less cope with the needs  a growing population and smaller households. We are not building enough houses,  but we are enthusiastically bidding up the price of old ones.  Our government could borrow for fifty years to renew our crumbling infrastructure at lower interest rates than at any time in history: instead it is attempting to keep bond and share prices high through buying existing debt back  via ‘quantitative easing’ .  The changes in the nature of business I have described means that business’s need for external capital is mostly to fund the operating losses of start-ups – an activity from which banks have retreated (and were never well placed to do), Venture capital, devised for this purpose, has  morphed into private equity and became preoccupied with financial engineering for established businesses.

       With large companies no longer needing external finance, the primary role of the stock market investor is stewardship – ensuring that Britain’s businesses have effective management, well thought out strategy, and a perspective which matches the time horizons of the savers whose life cycle and retirement plans depend on them.  Instead, following a mantra of ‘shareholder value’, we have locked ourselves into a dysfunctional cycle of quarterly earnings reports, while too many executives enrich themselves at their investors’ expense. Fund managers compete to second guess each other in a pursuit of market outperformance which is necessarily futile in aggregate and unsuccessful in most individual cases.

       We need a simpler world in which unwieldy  financial conglomerates are broken into focussed institutions, and in which short chains of intermediation provide direct links between savers and the assets in which their funds are deployed.  Restore boring banks, which take our deposits and short term savings and lend them on to government and homebuyers.  Find asset managers whom we can trust to hold our savings for the long term and build knowledgeable, enduring relationships with the companies in which they invest. 

      Today’s hyperactive secondary markets meet the demands of financial market professionals , not the needs of savers.  We need intermediaries who are familiar with business, who understand the housing market and other forms of property investment, and who, like good retailers, are driven by the needs of their customers. We do not need an army of the overpaid and overbonused buying and selling from each other.