John Kay: Financial system ‘waiting for next crisis’

June 2, 2013 10:33 pm

Financial system ‘waiting for next crisis’

By David Oakley, Investment Correspondent

John Kay, the economist and author, will warn this week that the world is heading for another financial crisis because the economic system is geared around trading profits that create market bubbles that inevitably burst.

Almost a year after the publication of his groundbreaking review of the UK’s equity markets, the London School of Economics professor will say in a keynote speech this week that the world is “waiting for the next crisis”.

Prof Kay, who is a columnist for the Financial Times, warns: “I think the eurozone does look likely to be it [the next crisis].”The professor, who spent a year gathering material for his 40,000-word report which was published in July, says the reason for his gloom is because the financial services industry is designed around trading activity that is prone to instability.

“We have been through sequential crises, of which the prominent examples have really been the emerging market debt crisis in the mid- to late-1990s, the new economy bubble, credit expansion and bust, and the eurozone crisis.

“They’re trading crises, fundamentally, and the system is geared around trading profits, which are, in large part, money that is borrowed from the future. A crisis results from the moment at which this money has to be paid back.”

Prof Kay’s speech, which will be made at the Russell Investments’ annual pensions conference in London on Wednesday, also looks at the likely evolution of the financial services sector over the next decade and how the structure of global markets is expected to develop.

The professor says that there should be less trading in the financial system. “I’m starting to query in my mind whether the role of public equity markets isn’t just over, from the point of economic value. I don’t see the need for them any more.

“We have a kind of casino activity, which is associated in large part from what these companies actually do, and that’s OK so long as people understand the facts,” he says. “It’s rather like betting on horseracing. It doesn’t actually affect the performances of horses, or it shouldn’t.”

He will add that bubbles are created in certain asset classes as people search for momentum-driven profits. “Prices are driven to silly levels, but everyone makes a load of money in the meantime, and then you get a correction.”

Prof Kay says that he would “personally stake modest sums” on the euro collapsing.

However, one ray of light is the UK. He says the UK government has introducedreforms such as separating the retail and investment operations at the banks that should protect depositors from market crashes.

“We’ve seen some reform in the UK, like the attempt to recapture Barclays and make it a bank,” he says, while pointing out the lack of change elsewhere. “We haven’t seen it in the US, Germany or France. Only UBS has instituted reforms outside the UK. Overall, I still remain gloomy about the outlook for the economy and the financial system.”