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Value(s) by Mark Carney: Chapter 14: Values in Companies: Key Takeaways / Analysis / Citations

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Chapter 14: Values in Companies

Key Takeaways

Carney starts out with the history of companies as a concept and asks what is the purpose of companies? It is not simply to make a profit, but rather to create value which is only partly quantified in the form of profit. For Carney, purpose requires balancing dynamism, fairness(?), solidarity (with employees and community), sustainability (across generations) and responsibility.

As John Kay put it…“Profit is no more the purpose of business than breathing is the purpose of living.” And while you need to make a profit to operate just as you need to breath, it is not the purpose of business.

Who owns the company? Shareholders do not own the companies to which they hold stock, Carney argues.

Wedgwood as the Model of a Modern Major Capitalist:

  • What is the company for? Carney suggests it’s more than profits. Josiah Wedgwood is the example of a capitalist that made life better for customers by democratizing.
  • He was born as the industrial revolution was taking off.
  • He tracked 5,000 changes in experimentation to understand how to make the perfect pottery.
  • He was an abolitionist icon (ie. against slavery).
  • He built a town with amenities to support his growing factory.
  • He was an ardent economic nationalist, admits Ricardian Carney.

Five things that change us in a crisis;

1)      Triggers a revaluation of what we value…

2)      Triggers a shift in what we value…

3)      Triggers an improvement in reporting…

4) Triggers cause resilience…

5) Triggers embed responsibility…

1st for Carney, a crisis triggers a reevaluation of what we value. In prior chapters, Carney showed that the crisis was caused partly by:

·         the underpricing in risk and the lack of supervising and off-loading responsibility to the wisdom of the market in Chapter 7’s breakdown of the Financial Crisis;

·         the years of undervaluing resilience, with states failing to protect citizens despite ample warnings in Chapter 9’s breakdown during Covid;

·         the tragedy of the commons where we aren’t pricing pollution as the producers problem (externality)

2nd for Carney, a crisis changes our appraisal of value and values. Who benefits from these shifts? Shareholder, stakeholders are disrupted through change….

The Covid crisis caused:

·         a reappraisal of value and values

·         a reset by companies

·         a social reset by countries

·         accelerated move to e-commerce,

·         accelerated shift to e-learning

·         accelerated shift to e-health

·         a reorientation of supply chains from ‘just-in-time’ to ‘just-in-case’

·         greater consumer caution

·         widespread financial restructuring (sees a stretched)

3rd for Carney, crises are a catalyst for new reporting of systematic risk.

·         1929 Wall Street Crash (crazy speculation by everyday people using loan money) + Roosevelt’s New Deal = creation of the Securities and Exchange Commission to protect the investors and  efficient markets. The SEC then also triggered the creation in 1936 of GAAP (generally accepted accounting principles) which became the global standard to ensure financial data could be reliably counted on.

·         2008 Financial Crisis = reporting for OTC derivatives, reduce the influence of shadow banking, new rules for securitization, accounting standards such as IFRS 9 was developed. IRFS includes what the expected losses are which provides more clarity.

·         The Climate Crisis, Carney is (hoping?) to bring about TCFD for consistent, standardized disclosures on climate-related financial risk.

4th for Carney, crises increased resilience, they make us tougher. Global banks have a buffer 10x the size prior. Trading has been reduced 1/2, interbank leading is declined 1/3rd and cloistering of divisions within banks, with deep separation aims to prevent a systematic collapse.

Again, Carney argues the Climate Crisis has a valid target of net-zero. ¾ of the world’s coal reserves…

5th for Carney, embedding responsibility. Having purpose, Carney suggests might have prevented the financial crisis. In the aftermath, regulations, rules and compensation provide the teeth for a better future.

The Firm As A Series of Contracts versus A Purpose-Driven Entity at the Heart of an Ecosystem:

Carney goes through the history of company formation. The coordination of employees, investors, suppliers, buyers. He notes that corporations are indeed people both legally and in reality. For Carney, the company is not the sum of a bunch of contracts, however.

Shareholder & Purpose:

East India Company (the 1st publicly traded company in the UK) was incorporated with the purpose of protecting a monopoly in Asia. The concept of the shareholder was buy shares of a company with the agreement that that capital would be used to advance the purpose of the firm, a larger goal. But during the industrial revolution, in 1844, the UK government passed a law that allowed firms to be incorporated without an express purpose and it made registration much easier. By the 19th century, the focus on public purpose shifted to private purpose.

Shareholder Primacy:

Ford Motor Company challenged the idea further when in 1916, there was a $112 million surplus on their balance sheet. Shareholders wanted a dividend but Henry Ford wanted to direct those profits into creating more innovation and to democratize cars for more people. The Michigan Supreme Court sided with shareholders but the amount doled out was much smaller through managerial discretion. This case Dodge v. Ford is central to the idea that shareholders own the company to which they hold shares. The UK Companies Act in 2006 and the Delaware Supreme Court in 2015 re-asserted that the purpose of ‘directors must make stockholder welfare their sole end.’ So, in the UK and the US, it is to maximize shareholder value. But there is disagreement, Wachtell, Lipton, Rosen & Katz LLP (WLRK) says shareholder primacy is not exactly what is going on….

Carney shows through legal examples in Canada and France that shareholder aren’t even owners of the company and thus the maxim of maximizing shareholder value is flawed. It is true that shareholders do get paid after everyone else: creditors, bond holders, employees, suppliers and governments via taxation both in the UK and the US. But employees cannot diversify their risk to a company as Martin Wolf has argued so shareholders may not really be taking the most risk, aren’t really owners and certainly a poor shareholder who put their life-savings in it is taking more risk than Warren Buffett in the owning of a given share of any company. Shareholders do not have much downside risk either. So, for Carney shareholder primacy is flawed.

The Agency Problem:

The separation of ownership of shareholders and control via the management which have their own self-interest (perks, pet projects, empire building) mixed in with meeting shareholder interests, triggered the Milton Friedman doctrine that:

a)    an executive is an employee of the owners of the business;

b)    the executive is responsible for maximizing shareholder value;

c)    shareholders (probably want) profits therefore that is the value in question;

d)    as long as the firm conforms to rules of society in terms of customs and law, they are good.

Carney sees Friedman’s ideas as useful but deeply flawed. Shareholder primacy is problematic and the proof is that Friedman gives himself an out in two ways:

1)    saying that money making should conform to customers and laws of their day. As Carney has shown, values are subject to their time therefore, Friedman has an out when there is disembodiment between the market and shareholder. Friedman claims any charity to employees is merely window-dressing. But Carney has shown in this book that there are times where there is deep corrosion in financial markets.

2)    saying that shareholders have primacy is flawed because shareholders merely have a ownership of the shares in a limited legal way. There is strain in how the wealthy treat the poor for example.

Companies have Command and Control Dynamics so Models from an Economist is a Matter of Degrees:

For Coase in The Nature of the Firm, the firm is defined by costs difference of providing goods and services through the market. Transactions in the market hold the costs of gathering information, bargaining and enforcement. These transactions bear costs that the firm saves but the expense is the span of control, complexity and diseconomies of scale. The activities performed more efficiently in a Command and Control system within the firm with the rest completed through the market.

Stakeholder Value:

Carney argues that instead of Shareholder Value there ought to be Stakeholder Value, which also happens to be the latest trend in business school literature. Profit is essential but it is not the only thing. Many CEOs reject the notion that there is a single purpose to a firm. For Carney, a successful firm must deliver a balance of competing interests amongst stakeholders (which Carney neglects to define), but this is analogue to the individual who pursues the good life. Competitive advantage, for Carney includes, having an attractive purpose as Chapter 15 will show.

Other Thoughts from Chapter 14:

·         For a better tomorrow, we need companies that are motivated by profit and empowered through purpose;

·         Profit and purpose are both necessary and re-enforce each other;

·         Firms should embed purpose in what they do;

·         Corporate purpose reduces risks, inspires employees, provides guidance in uncertainty and attracts and drives innovation;

·         Non-financial metrics should matter even if they are notoriously hard to measure;

·         The challenge falls with turning a purpose into practice (actions, outputs);

·         Maximizing shareholder value (short-term) is not the sole aim of corporations, full stop;

·         Environmental, Social and Governance (ESG) can contribute to profits and also purpose;

·         The make-up of boards and their focus on purpose is critical;

·         Board-level reforms need to include purpose-oriented reform;

·         Patagonia, Unilever have institutionalized purpose;

·         B Corp certification reward companies that meet social and environmental metrics;

·         Danone is a company that embraces a enterprise a mission designation;

·         Executive level compensation needs to be connected to ESG factors and needs to be re-configured to align incentives that are longer term;

·         Companies need to consider future generations;

·         Companies should be engaged in improving communities;

·         Reporting is Key: two-way flow of information between stakeholders, shareholders and companies;

·         Good and bad ideas need to be tested and then good ideas scaled, and bad thrown away;

·         There is more and more evidence that suggest that companies that perform well on ESG also tend to have better financial performance, 63% report a positive co-variation, increased ESG leads to increased financial performance, Chapter 15 will address the counter-arguments.  

·         Employees who know their employers purpose also have better financial performance;

·         Patagonia give 1% of its revenue and they get 9000 applicants per post as a result….;

Previous Chapter
Next Chapter
Introduction: Humanity Distilled Chapter 1 Objective Value
 Chapter 2 Subjective Value Chapter 3 Money & Gold
 Chapter 4 Magna Carta  Chapter 5 Future of Money
 Chapter 6 Market Society Chapter 7 Financial Crisis
 Chapter 8 Safer FinanceChapter 9 Covid Crisis
 Chapter 10 Covid Recovery Chapter 11 Climate Crisis
 Chapter 12 Climate Horizon Chapter 13 Your Values
 Chapter 14 Values in Companies Chapter 15 ESG
  

Analysis Part 3 Chapter 14

Ø  Chapter’s message in a nutshell: You get more with honey then you do with vinegar, be nice and have better outcomes in good and bad times.

Ø  The Covid crisis has accelerated a shift, but for how long? What is the reasonable band-width for which human’s recalibrate? Carney seems to be have a view that change is more permanent than might be believed by myself or others.

Ø  “During the [Covid] crisis, we have acted as interdependent communities not independent individuals, with the values of economic dynamism and efficiency, joined by those of solidarity, fairness, responsibility and compassion.” (386, Value(s). This is not quite what is happening or happened or has it? Hard to measure? Are media stories representative of reality? How does Carney know from publications, statistical research or the people he hangs out with? People aren’t, pre-determined. There is speculation and sales in his statement; persuasive as it is.  

Ø  If Carney is so certain of the benefits of a crisis, then logically should triggering a crisis not be an aim of effecting change? From 9/11 to detonating a nuclear weapon in the Antarctic, causing a crisis is perhaps a logically implication of his breakdown of how the financial crisis has progressed financial technology forward. Carney seems to imply that all the Dodd-Frank legislation was a major success, whatever has been implemented deserves a thumbs up, however the process of providing new safe-guards was very contentious and as Obama points out in my blog post, it wasn’t always that great.

Ø  An inverted view might be that the financial crisis brought on regulations that are a mixed bag of efficacy and punishment. Instead of weeding out the incompetent, regulations have caused a retrenchment of those most passionate about finance.

Ø  Perhaps this will be addressed in Chapter 15, but how do you really objectively measure ESG performance? If the measures are game-able, they will be gamed, just a fun fact of human nature. Humans are cunning. Get used to it.

Ø  Carney took the Patagonia “9,000” applications example in two funny ways. 1) that Patagonia didn’t plant this story as a PR stunt, 2) that Patagonia has those high number of applicants because of their purpose (single causation is flawed thinking or perhaps Carney is simply trying to persuade).

Ø  Senator Elizabeth Warren’s 2018 proposed Accountable Capitalism Act requires directors in firms making more than $1 billion to ‘consider’ stakeholders, not simply shareholders, when making choices.

Citations Worth Noting for Part 3: Chapter 14:

v  Andrea Sella, ‘Wedgwood’s Pyrometer’ Chemistry World, 19 December 2012.

v  Derek Lidow, ‘How Steve Jobs Scores on Wedgwood Innovation Scale’, Forbes, 3 June 2019.

v  US Securities and Exchange Commission, ‘What We Do’, 10 June 2013.

v  John Kay, ‘Shareholders Think They Own the Company – They Are Wrong’, Financial Times, 11 November 2015.

v  Martin Wolf, ‘Shareholders Alone Should Not Decide on AstraZeneca’, Financial Times, 9 May 2014.

v  Lynn A Stout, ‘The Shareholder Value Myth’, Cornell Law Faculty Publications, Paper 771 (2013).

v  John Kay, The Truth About markets: Their Genius, their Limits,  their Follies (London: Penguin, 2003).

v  https://bcorporation.net/

v  https://www.blackrock.com/corporate/investors-relations/2018-larry-fink-ceo-letter

v  Bank of England, HM Treasury and Financial Conduct Authority ‘Fiar and Effective Markets Review: Final Report’ (June 2015).

v  Nell Derick Debevoise, ‘Why Patagonia Gets 9,000 Applications for an Opportunity to Join their Team’, Fortune, 25 February 2020.

v  ‘The Business Case for Purpose’, Harvard Business Review Analytic Services Report (2015).v  Marc Andreesen, ‘It’s Time to Build’, Andreessen Horowitz, 18 April 2020, https://a16z.com/2020/04/18/its-time-to-build/

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Value(s) by Mark Carney: Chapter 12 Breaking the Tragedy of the Horizon: Key Takeaways / Analysis / Citations

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Chapter 12 Breaking the Tragedy of the Horizon

Key Takeaways

One of James Carville’s Clinton ‘92 campaign slogans was “It’s the economy, stupid”. For Carney is “it’s the transition, stupid!” If you can get private financial institutions to truly back the transition then you can contribute to being a good custodian for generations to come. Carney’s work for Glasgow COP26 centres on organizing the plumbing for these financial institutions. In chapter 15, “Investing for Values” Carney explored this further. In this chapter, Carney argues that there are three technologies: 1) engineering, 2) political and 3) financial that need to be marshalled to address climate change.

Engineering Technology

Driving Scale and Innovation: There will need to be major improvements to these hard to change sectors. Very hard to outlaw fossil fuels (ie. decarbonize) which are cheap and do not have a large upfront CAPEX:

  • Zero-carbon economy, electricity today is 20% green and is projected to be 60% by 2060;
  • Energy creation needs to be moved to a 90% market share with a mix of wind and solar. To what extent do we electrify everything and do it with green electricity depends on storage and loading challenges since solar and wind are intermittent. And we need to look at power efficiency in products we use;
  • Global electricity has to increase 5x by 2050 and needs to be generated by renewables according to Carney;
  • In the UK, off-shore wind farms were expected to generate £140/MWh by 2025 back in 2013 but then in 2014, they revised the number to £107/MWh, in 2016 they revised it down to £57/MWh; In the US, $59/MWh is the cost of coal and now onshore wind-farms are at $26/MWh and solar is $37/MWh….cheaper then coal!

Electric Vehicles (EV)

  • Hard to reduce dependency on fossil fuels (again, the euphemism is “decarbonize”);
  •  Use hydrogen for public transport;
  • Tax breaks for EV;
  • Build the infrastructure for electrical and hybrid vehicles;
  • Car companies build vehicles in 3 year cycles from planning to off the factory floor so planning for more EV now is critical, even if batteries and charging stations are a problem;
  • EV is not appropriate for long-haul trucks according to Carney;

Aviation and Shipping

  • Going to be very challenging to reduce dependence on fossil fuels (i.e. decarbonize);
  • Nothing is currently commercially viable according to Carney;
  • The cost of not using fossil fuels is $115 – $230 USD per ton in aviation and $150 – $350 USD per ton in shipping;

Industrial Sectors

Currently responsible for 32% or 17 GtCO2e annually, cement manufacturing, plastic, aluminum, chemical, fashion, furniture and home appliances. The consumption of energy is massive;

  • A lot of the green technology does not really exist yet;
  • There are four ways to reduce: use hydrogen (the product being H2O), electrifying processes, using biomass and carbon capture technology.
  • Carney places a lot of reliance on carbon capture and sequestration at the point of production which involved pumping CO2 emissions into a saline solution deep underground, which is theoretical since the cost of pumping CO2 under every factory around the world has not been fully explored or whether there would be a centralized CO2 pumping station for a given geography;
  • Carbon capture, use and storage (CCUS) are currently about 1% of renewable investments so this is not a hot market;
  • Direct air carbon capture and storage (DACCS) involves sucking CO2 out of the sky where CO2 is much more diffuse then at the point of production, and therefore the economics right now are between $40 – $400/ton if extrapolated from the small test plants currently testing this technology.
Illustration and Painting

Political Technology

Setting the Right Goals. Carney argues that we need to understand the consequences of our preferences. But he also wants to convince you that his preferences are the best and you should follow him:

  • SDGs He isn’t talking about new means of engagement with the polity but rather focuses on the fact that nations will fall short by the end of the century, hence the need for Sustainable Development Goals (SDGs) which are part of the UN’s collaborative framework. There are 17 goals with 169 targets as part of the SDGs.  
  • Nationally Determined Contributions (NDCs) are determined by each country and easily fall victim of the tragedy of the commons. At the Paris COP 15, the target that was agreed to was actually 2.8 degrees Celsius above pre-industrial levels by the end of the century.
  • Greta Thunberg and the societal response: Carney was impressed by her. He showed her the Bank of England’s gold reserves. At the UN Climate Action Summit in September 2019….
  • Thunberg said “You have stolen my dreams and my childhood with your empty words and yet I’m one of the lucky ones. People are suffering. People are dying. Entire ecosystems are collapsing. We are in the beginning of a mass extinction and all you can talk about is money and fairytales of eternal economic growth. How dare you!….We will not let you get away with this. Right here, right now is where we draw the line. The world is waking up and change is coming, whether you like it or not.”
  • There was a Global Climate Strike in 2019 with 7.6 million people in attendance in 185 countries…the media struggled to tall a compelling narrative, but the 6th Mass Extinction is coming according to Carney.
  • Carney argues that revolutions happen abruptly as Cass Sunstein argues, when a tipping point is met, when it becomes socially acceptable (like wearing masks for example).
  • Values depend on consumer focuses. 

Financial Technology to Ensure That Every Financial Decision Takes Climate Change Into Account

Carney argues that companies must take the race to net-zero seriously. For Carney, the financial system needs to take climate change into account, because that’s where the smart money is headed already. Firms can report their own climate disclosures. COP 26 in Glasgow is going to focus on the financial approach. There is money to be made in the transition. And Mark Carney argues that the smart money is turning green.

  • Harnessing the power of economics to effect change is the most sensible force for good, in Carney’s eyes.
  • Carney points out that the amount of money needed for the low-carbon shift is about $3.5 trillion in the energy sector per year and twice the rate currently invested in the energy sector….
  • Climate-resilient systems are needed at a cost of $90 trillion;
  • Carney argues that the private sector is more then money, we need their innovative drive that is incentivized towards net-zero;

Carney’s 3Rs, these are the three areas needed to make this work: reporting, risk, returns

Reporting: TCFD network: a solution by the market for the market which Carney forcefully argued didn’t work in the 2008 financial crisis….at any rate, their total assets under management is over $170 trillion which includes the largest banks, pension funds asset managers and insurers. The largest AUMs are asking to disclose their carbon footprint in line with the TCFD.

The metrics used are

  • Disclosure of risk, governance and strategy for climate change;
  • Consistent metrics across sectors;
  • Scenario analysis typical in financial modelling and equity research.

The disclosures cannot be static! They should be dynamic such that they reveal financial risks/opportunities. Ask the company to explain how they will reach net zero….

Regulatory Reporting

financial regulators input climate-related financial reporting in their roles.

  1. At the Bank of England, Carney says the Prudential Supervisory Authority are a division of the bank with advice on how insurers should address climate change.
  2. Make the TCFD reporting mandatory at the Federal/National level! IFRS and IOSOCO (which regulate securities) have to agree to make reporting standardized.

 Risk Management

As mentioned in chapter 11, there are physical and transition risks. Climate change differs from most other risks in that:

  • Climate change is unprecedented as they have not fully happened yet;
  • Climate change is massively impactful in every country and globally;
  • Climate change is foreseeable right now using the scientific method;
  • Climate change requires action today for horizons in the future that we cannot be predict accurately.

The Bank of England has stress-tested the UK financial system for various climate pathways, scenarios. Climate stress tests about engaging the developers of the model in the contingencies and factors at play.

Returns

The creation of green and transition bonds is an important catalyst. Carney believes that helping companies moving from brown to green is a consultative practice. The typical best plans are as follows:

  1. Defining a net-zero objective based on scope 1 (all direct emissions: fuel combustion etc), scope 2 (indirect emissions: electricity purchases) and scope 3 emissions (all other indirect emissions: end products).
  2. Outlining clear milestones and metrics for senior management;
  3. Board of Directors level governance;
  4. Executive compensation based on meeting these metrics……

Green bonds will not be sufficient to pay for the green future. Value will be in identifying the transition. ESG are focused on the s and the g. Investor should be able to calculate the e net present value. “We need 50 shades of green.” (325, Value(s)). Needs to be able to get a sense of how serious a given company is at the senior management level. Embedding metrics in the motivation. The efficacy of transition plans. 

  • Mark Carney says the UK should lead the climate change strategy in Glasgow….hence he is advising Boris Johnson.
  • Decarbonization is going to be a financially viable source of investment; if you are pulling carbon out of the process then the investment will come to you as an additional value proposition.
  • Buying offsets is opaque and only 98 million tons of CO2 were traded at a total market value at $295 million, there is no central market. There are no uniform carbon credits and there is a lot of friction so Carney argues for standardization…
  • The cost of the green tech is high for developing countries but it makes sense to provide that do developing countries as a value added services….how to capture that value once the developing country firm has that technology is not so clear.
  • Climate policies suffer that same challenge that central banks deal with: the temptation to lower interest rates over long-term stability of inflation. We want to prevent short-termism in finance and now on climate.
  • Short term costs are hard for politicians, there is a lack of credibility. 
  • Political parties need to get broad support across the spectrum. 
  • Specific climate polities should be looking at the economics. More transparent tracking of climate policies.
  • Governments should have sustainable growth committees. Carney wants to provide tools for the Bank of Canada and England decision making and targets. The idea is that market will allocate capital and then break the tragedy of the horizon. 
  • Continued growth is not a fairy tale as Thunberg argued.
  • Policies should be focused on technological innovation.
  • Clear and consistent communications.
  • More likely that investment and returns will be made clear.
  • Policy makers and future costs of doing business need to be calculated and part of the solution. 
Previous Chapter
Next Chapter
Introduction: Humanity Distilled Chapter 1 Objective Value
 Chapter 2 Subjective Value Chapter 3 Money & Gold
 Chapter 4 Magna Carta  Chapter 5 Future of Money
 Chapter 6 Market Society Chapter 7 Financial Crisis
 Chapter 8 Safer FinanceChapter 9 Covid Crisis
 Chapter 10 Covid Recovery Chapter 11 Climate Crisis
 Chapter 12 Climate Horizon Chapter 13 Your Values
 Chapter 14 Values in Companies Chapter 15 ESG
  

Analysis of Part 2 Chapter 12

  • Not clear that the private sector would want to take on the opportunity to meet net-zero BEFORE a large global catastrophe that is clearly caused by human-made climate change such that customers demand either the private sector have targets in place or the public sector enforces such practices. It will be a train-wreck to check every single companies manufacturing to ensure they have the carbon capture pipes operating properly. It is so easy to pollute. The fines must mark the cost of violating the rules far more prominent.
  • Ironically, what caused the financial crisis are the individual actors being disassociated with the system level. What Carney hopes is that this be flipped around with climate change. Suddenly, decisions should be made at the system level with a simple boiled down abstraction of 42 +/- 3 GigaTons of CO2 per year must be our pollution cap. However, there is another disassociation that must occur here; namely financial experts in urban centres, far away from the oil fields are talking about transition as if the oil companies are going to just love this whole ‘climate-change agenda’. The consequences of the model make short-term harm very real for the oil industry workers who enjoy their work. I don’t mean we’re wrong about climate change because oil workers might stand to lose economic opportunities due to an imposed legislative or imposed financial capital re-allocation away from fossil fuels, but slave owners in the US lost their economic future because of the threat of legislative decision-making, they were willing to go to war and die in the name of a moral wrong. So, we, including Carney, need to get serious about “Oil Country”. 

Ø  Carney doesn’t necessarily call out who the polluters are…he doesn’t put pen to paper to say that fossil fuel companies are the problem and could be part of the solution. And what to do about Alberta’s transition? Carney doesn’t talk about a way to help Albertans who have driven the Canadian economy forward in terms of GDP should be compensated…and or supported in retaining economic development locally against the back drop of the Rookie Mountains. Think about how Britain settled the slavery questions in 1834 by compensating the owners of slaves? Then think about how the US settled the slavery question between 1861 – 65? Oil is like slavery in some ways as I argued a decade ago.

“When Abraham Lincoln wanted to curb slavery, he was battling the entrenched interests of the Southern US states. Slavery was a moral wrong, but slavery was also central to the Southern US economy. ” – Professor Nerdster

  • Efforts to have a global corporate tax neglects to acknowledge that the best situation is where every other country is paying that tax but you have a loop hole.
  • Just because you can build something doesn’t mean you should. Do people want self-driving cars? Do people want to charge their cars? This is where regulation forces the issue.
  • Carney’s really skates on thin ice in this chapter because industrial processes rely mostly on energy to melt and shape the products that we enjoy, most items in your house have a carbon footprint that you never see but enjoy the fruits of, the cost to create that same product without generating CO2 is likely significant today. Bill Gates’s How to Avoid a Climate Disaster is pretty much explanation of how this complex set of problems can be solved. Many companies would not exist if it was illegal to pollute….This issue is where the rubber hits the road, unless there is total control of the means of production by some over-arching legal body, there will be an incentive to use fuel…let me think about this further. This is where manufacturing products on the moon becomes more attractive as CO2 there is additive….impractical in my life time but, you know….fun to think about.
  • With what power can Carney achieve having his preferences reflected in the world? What Carney and others are missing is the way to show the end user the consequence of their preferences. While people do tend to seek out like-minded people, and shun polarization, running for public office would be his best route….. What funding model do we have?
  • Carney seems to fail to acknowledge that what Greta Thunberg is ignoring is that the transition could be very painful and as such not materialize as she extrapolates it ought to. She is also a child, probably should be in school. The consequences of climate change are heavy in her mind, the consequences of transition aren’t thought out. Both are subjective, terribly difficult to predict and forecast…even with climate physics firmly in the corner of “2 degrees Celcius is a big deal…”
  • The global climate strike didn’t really move the needle, did it? Is that really how we measure sentiment on climate change being a mainstream concern?
  • Reporting has been tried before, startups were created to create a global standard but then failed; Amee.com. Companies do want to participate in green-washing but not so much on their own accord anything that undermines stakeholder value is a threat to the CEO’s job.
  • TCFD network: a solution by the market for the market….which Carney forcefully argued didn’t work in the 2008 financial crisis….
  • Self-interest trumps the interest of others. That’s what COVID illustrated. The self-interest of profit generation is so strong that you would wonder if Carney lives in a fantasy land…no, he just happens to be correct about the climate physics at play, may need more salesmanship. 
  • You start to wonder if Carney is a heavyweight with all the details, annotations and facts but a lightweight with bandwidth of human nature between self-interest and self-lessness . Maybe he’s got an overly focused vantage point on reality. For example, take a pan for your kitchen. How much did that pan cost? Is it anti stick? $25CAD pan. Now why is that pan so cheap? The material supplier doesn’t have a carbon pollution tax right now. If you impose a carbon pollution plan on that manufacturer because they are in your legislative geography then another kitchen pan producer who doesn’t have that constraint will. Game theory! Learn it a weep. And there are way to game the system further. The temptation to lie about emissions is massive as Volkswagen did it. OPEC oil producers do it. So let’s be serious about human nature too! We are cheeky monkeys!

Citations Worth Noting for Part 2: Chapter 12

  • Ezra Klein, ‘How to decarbonize America’, The Ezra Klein Show, 27 August 2020.
  • Department of Energy and Climate Change, ‘Electricity Generation Costs’ (July 2013).
  • Energy Transitions Roadmap report version 1.5 (2020)
  • Goldman Sachs, ‘Carbonomics: Innovation, Deflation and Affordable De-carbonization’, Equality Research (October 2020).
  • Climate Action Tracker, ‘Warming Projections Global Update’ (December 2019)
  • Cass Sunstein, ‘How Change Happens’ podcast. London School of Economics Public Lecturers and Events, 14 January 2020.
  • Cass Sunstein, How Change Happens (MIT Press: Cambridge, MA, 2019). 
  • UN Environment Programme, ‘Emissions Gap Report, 2019’ (26 November 2019).
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Value(s) by Mark Carney: Chapter 10 Covid Crisis: Fallout, Recovery and Renaissance: Key Takeaways / Analysis / Citations

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Chapter 10: Covid Crisis: Fallout, Recovery and Renaissance

Key Takeaways

The reality is that mobility did decline as people accepted the lockdowns. State legitimacy is ensured by containing the virus. A lot of what Carney is saying here is a summary of what is relatively uncontroversial. He discusses the framework for the common good. Is that it is possible to calculate that value of a given person? The solidarity of citizens is important to note here, because the view was that no one should die in this pandemic regardless of age (or rather that folks did not want to contract this virus). 

Other topics: 

  • Perceived fairness of healthcare: you cannot have one set of rules for the rich and another for general citizens.
  • Value of a senior versus other citizens. 
  • The young will have to pay twice in increased taxes and the depression of the moment.
  • Kids with internet had an advantage in home schooling. 
  • Value creation and destruction increased under Covid.
  • R0 as the metric is a useful anchor just as the 1.5 degree Celsius  increase to evade the most harmful effects of climate change. 
  • Managing R0 was the core activity of this pandemic as far as governments were concerned.
  • Carney rationally described how the government that is presented ought to appear competent. 
  • Local businesses will be emphasized over global for years to come.
  • There will be future black swans, no kidding. 
  • We have continued to move towards market society however, in this Covid crisis, we have “acted like Rawlsians and communitarian rather than utilitarians and libertarians.” (260, Value(s)).

Covid and Climate Change

  • Carney predicts that the pandemic’s post active phase will see an increase the societal confidence in science, demands for stakeholder capitalism
  • Carney then draws a parallel between Covid and climate change. Using science to inform decision making for example. Having targets. How no country can isolate for each other in a pandemic or a climate crisis. 
Previous Chapter
Next Chapter
Introduction: Humanity Distilled Chapter 1 Objective Value
 Chapter 2 Subjective Value Chapter 3 Money & Gold
 Chapter 4 Magna Carta  Chapter 5 Future of Money
 Chapter 6 Market Society Chapter 7 Financial Crisis
 Chapter 8 Safer FinanceChapter 9 Covid Crisis
 Chapter 10 Covid Recovery Chapter 11 Climate Crisis
 Chapter 12 Climate Horizon Chapter 13 Your Values
 Chapter 14 Values in Companies Chapter 15 ESG
  

Analysis of Part 2 Chapter 10:

  • Leadership means being a custodian to the long-term. It’s not about you, says Carney.
  • There is a so what to this chapter….it falls short of saying anything about how the issuance of debt what appropriate or not. He didn’t talk about work from home or how the virus works which is a missed opportunity.
  • Carney seems to downplay the fact that the biggest failing of the pandemic is actually that government are operated by people who are focused inwardly in their own self interest within the architecture they have inherited. And such there is a lack of real time data to respond to the real society as it is occurring. There is a high lack information between citizen and government. The government should get out of the way for those who want that and step in for those who need help. Being able to distinguish between complex contradictory people as we all are is critical. It’s a credit card for UBI, it’s an interface to detail ones preferences voluntarily, it’s a relationship that is not simply a marketing blast….
  • Carney makes sweeping claims here that are sufficiently inoffensive to warrant much comment. There are no innovative sliders that he trials in this chapter, there was a lot of spicy behaviour in Covid but Carney manages to keep it very potatoe. 
  • Surprised he doesn’t go after thie no mask wearers and other violators of lockDown. We tend to forget that these regulations were ignored by millions of people as they were ill enforced… 

Citations Worth Noting for Part 1: Chapter 10

  • World Health Organization, ‘Coronavirus disease 2019 (COVID-19) Situation Report – 11’, 31 January 2020.
  • Christian von Soest and Julia Grauvogel, ‘Identity, procedures and performance: how authoritarian regimes legitimize their rule’, Contemporary Politics 23 (3) (2017), pp. 287 – 305.
  • Stephanie Hegarty, ‘The Chinese doctor who tried to warn others about coronavirus’, BBC, 6 February 2020.
  • Ruth Igielnik, ‘Most Americans say they regularly wore a mask in stores in the past month; fewer see oher doing it’, Pew Research Center, 23 June 2020.
  • Timothy Besley, ‘State Capacity, Reciprocity, and the Social Contract’, Econometrica 88(4) (July 2020), p. 1309 – 10.
  • Allan Freeman, ‘The unequal toll of Canada’s pandemic’, iPolitics, 29 May 2020.
  • Daniel Kahneman, Thinking, Fast and Slow (London: Allan Lane, 2011).
  • Timothy Besley and Nicholas Stern, ‘The Economics of Lockdown’, Fiscal Studies 41(3) October 2020), pp. 493 – 513.
Business, Finance, Politics, Science, Strategy

Value(s) by Mark Carney: Chapter 9 The Covid Crisis: How We Got Here: Key Takeaways / Analysis / Citations

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Chapter 9 The Covid Crisis: How We Got Here

Key Takeaway

This chapter discusses the discovering of COVID and all the other asks of this pandemic that we are all very familiar with. Carney was the governor of the Bank of England until February 2020. Economic and family priorities. 

The Covid crisis emphasized:

  1. Solidarity: companies, bank, society
  2. Responsibility: for each other, employees, supplies, customers.
  3. Sustainability: where the health consequences skew towards seniors while the economics consequences skew towards millennials and Gen Z.
  4. Fairness: sharing the burden, providing access to care.
  5. Dynamism: restoring the economy with massive government intervention and private sector resurgences…..

Duty of the State:

Carney goes through a review of political philosophy from Thomas Hobbes (1588 – 1679) to John Locke (1632 – 1704) to Rousseau (1712 – 1778) to suggest that in exchange for giving up certain freedoms, the state promises to deliver protection to its citizens. Much the same with central banks; that the public gives up the detailed nuanced control of the money supply in exchange the financial system delivers prosperity. 

Capacity of the State must have: 

1) legal capacity: ability to create regulations, enforce contracts and protect property rights: these include social distancing regulations that aimed to reduce transmission of COVID 19; 

2) collective capacity delivering services;

3) fiscal capacity: power to tax and spend: state capacity has moved from 10% of GDP to 25% to 50% of GDP with corresponding services to protect citizens from COVID 19.

Other Points:

  • Poor compliance in democratic societies;
  • Stock piles were not restocked;
  • Bill Gates Ted Talk from 2015 was not actioned by any one actor;
  • Many countries didn’t have PPE and depended on China’s production initially; 
  • No country is really prepared for this particular kind of pandemic;
  • South Korea had a pandemic in 2015 and Carney repeats the often mentioned success of South Korea through contact tracing and geo-targeting of users;
  • Governments need to be better at coordinating: there were departmental territoriality;
  • In simulations for pandemics this was very evident.

Cost-Benefit Analysis for Hard Choices:

  • There was a weighting of variables to decide whether to lockdown or otherwise.
  • The effects of lockdown: domestic abuse were hard to do that. 

Calculating the value of a human life: is hard to do. But there is actuaries to put the intrinsic versus investment value of a life or the net present value of all future cashflows that person is predicted to generate. Life is priceless. Sometimes the calculation is about the productivity of the person in life…..

Schelling’s “The Life You Save May Be Your Own” points out that the value of a life principally the concern of the person living it. Value of a Statistical Life (VSL) became the industry standard. The example Carney provides is the a risk of death in a high-risk job might be 1 in 10,000 and employees receive $300 of danger pay, therefore the VSL is $3,000,000. There are several other methods: 1) stated-preference, 2)hedonic-wage, 3) contingent etc. And different countries use different metrics in similar circumstances. In Canada, the estimated range of a human life is $3.4M to $9.9M CAD meanwhile in the US, the estimated range of a human life is $1M to $10M USD. Healthcare looks at quality-adjusted life year (QALY) and cost-utility versus cost-benefit analysis. Schelling’s assumption about how a person can evaluate the value of their life. VSL usage is a moral choice. Wealthcare many not be measured properly according to Carney. Another model is the VSLY Value of a Statistical Life Year. The question remains: do all lives have an equal value or is it the number of life years should be treated as equal? 

Previous Chapter
Next Chapter
Introduction: Humanity Distilled Chapter 1 Objective Value
 Chapter 2 Subjective Value Chapter 3 Money & Gold
 Chapter 4 Magna Carta  Chapter 5 Future of Money
 Chapter 6 Market Society Chapter 7 Financial Crisis
 Chapter 8 Safer FinanceChapter 9 Covid Crisis
 Chapter 10 Covid Recovery Chapter 11 Climate Crisis
 Chapter 12 Climate Horizon Chapter 13 Your Values
 Chapter 14 Values in Companies Chapter 15 ESG
  

Analysis of Value(s) Part 2 Chapter 9 

  • While it is complicated, I would have liked Carney to have explained the system of money creation in simple terms as it pertains to the pandemic. The level of government issuance of support has been massive. It is imperative folks understand how stimulus money is created.
  • The perception that money is created out of thin air, subject to political pressures is not true. Zeitgeist and other explanations of the money system are warped thinking. There friends and family going around saying that central banks ‘just print money’ whenever it suits them…
  • Here is a good explanation of how the central bank enables money creation:   To support small businesses and citizens out of work: Is the government increasing tax or are they printing money during the pandemic? The stimulus money was not coming from new taxes so here the government raises through borrowing. The government issues treasury bills to three groups of savers: 

(1) public sector (other parts of the government, 

(2) the private sector (people and companies), 

(3) foreign entities.

The government agrees to pay those savers back with interest at a future date. In the short-term the government uses that cash sucked out of the economy in exchange for the treasury bills to issue stimulus cheques back into the economy. Keynesian economics says that the more stimulus there is, the more economic activity which enables more private savings which then fuels more transactions for bonds. The government can borrow, unlike an individual, through this system as long as the economy is growing at the same or greater rate then that of the debt. The economy is growing at the same rate as debt then the debt to GDP ratio will be stable. If the debt to GDP ratio is stable, then the government can argue for continued investment in its debt securities (ie. bonds).

An additional layer of complexity is that: (4) the source which is the Mint in Canada and the Federal Reserve in the US does not print actual paper money much any more but does indeed ‘print out of thin air’: electronic money, that is credited in the treasury department’s account. In exchange, the Fed then holds treasury bills. The key consequence of issuing too much money with this source (4) is inflation whereby more money in circulation is chasing the same limited number of goods available thus driving the price upward of the individual goods. The 10 year Treasury Note then starts to go up and inflation creeps in. In this case, the Fed needs to increase interest rates to counteract/dampen the purchasing of the demand side….. 

  • The fines for violating COVID rules have an earned media dynamic: we know that the virus is spread through gatherings where one ore more participants has the virus. When someone gets an ‘arbitrary fine’ it effectively markets better than other forms of advertising such as digital. The injustice of the fine is earned media.
  • There are Canadians under the false impression that government at the federal, provincial and municipal level are not allowed to make rules that ‘violate’ the Charter of Rights and Freedoms. Well, a constitution has to be enforced, my friend… 
  • This time will be different which was Carney’s number one lie in finance seems to be fillable here to say, why would you think that in a future pandemic in say 2055, that our children will be able to respond better then this time?
  • Just are Carney fails to explain how the central bank manages the money supply, he too here fails to give a basic description of the “obvious’ nature of the COVID 19 virus. Its unique gestation period in which it sheds without the host having any symptoms for T+7 days is very novel unlike other viruses that are initially extremely aggressive, for example, ebola or SARS.
  • The threat of future pandemics is very real until it isn’t at all. If COVID had the immune effects of HIV then the response would have been more severe in North America. However COVID can be contracted and the likelihood of death is 1 – 5% based on comorbidities. We’ve literally spent the last year talking about this virus. The next virus if it were HIV but airborne, the human race would be in full black plaque mode. Freedom loving + scientific illiteracy are a potent weapon.
  • Lack of understanding the characteristics of the virus.
  • In ability to connect barriers that create friction such as laws, walls and masks have the underlying same logic; they do not prevent all the negatives from happening but laws, walls and masks make the unwanted thing from happening, obviously.

Citations Worth Noting for Part 1: Chapter 9:

  • John Locke, A Third Concerning Toleration, in Ian Shapiro (ed.), Two Treaties of Government and A Letter Concerning Toleration, 1689.
  • Jean-Jacques Rousseau, The Social Contract.
  • Thomas Piketty, Capital in the Twenty-First Century (Cambridge, Mass.: Harvard University Press, 2014).
  • Derek Thompson, ‘What’s Behind South Korea’s COVID-19 Exceptionalism?’, Atlantic, 6 May 2020.
  • A.E. Hofflander, ‘The Human Life Value: An Historical Perspective’, Journal of Risk and Insurance 33(1) (1966).
  • Cass Sunstein, The Cost-Benefit Revolution (Cambridge, Mass.: MIT Press, 2018): OECD (2012).
Business, Finance, Politics, Science, Strategy

Value(s) by Mark Carney: Chapter 8 Creating a Simpler, Safer, Fairer Financial System: Key Takeaways / Analysis / Citations

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Chapter 8 Creating a Simpler, Safer, Fairer Financial System

Key Takeaway

The Problem with Humans versus Objects – Determinism:

Carney makes the classic case that value measurement losses sight of intrinsic or objective reality and then there is a burst of the bubble and wealthy people lose their shirts. This touches on the central thesis of Random Walk Down Wall Street. Many economists have this instinct to try to explain reality by convincing themselves and then others that people are perfectly rational actors. Carney points out that this rational actors theory is wacky: adding that economists envy physicists and engineers, economists love neat equations and want a deterministic model of reality but that’s just too bad, economist! Determinism, meaning that any input will have a predetermined outcome in the model, doesn’t work when the subject of your experiment has agency/choice. Try telling a toddler that they are rational! Lol.

Sir Isaac Newton said it best: “I can calculate the motions of celestial bodies, but not the madness of people. ” Now, fun fact, Newton wrote that having lost a huge investment by speculating in the famous South Sea Company which basically involved misleading investors into thinking that the British empire had opened up South America to trade when in reality, they were actually capped at 1 ship per port per year in South America….But of course, human being aren’t going to let facts get in the way of investment momentum that drives prices up! Get on the train, folks! And again, because humans are awesome, we will #$ck with you’re predictions whether you like it or not.

Case in point, not everything that is going up is a bubble. Value that is disconnected from fundamentals of accounting are more likely to be a bubble says Carney but there are no guarantees. The investment could be a castle in the sky or just a really good investment…

2008 – 2016 UK:

The lost decade in the UK where there was political fragmentation of the economy is from 2008 to 2016, according to Carney. The real household income did not grow in the UK for that decade (technically 8 years…but whatever). There was a decline of trust in experts. Finance lost its integrity, prudence and became more protectionist. It came crashing down on the poorest in the financial crisis as discussed in the previous chapter. The G20 had to make radical adjustments and reforms. Value was disconnected on the way up and re-calibrated on the way down. 

No, I’m not gonna put Thug Life shades (sunglasses) on Queen Elizabeth II. I have some modicum of decency left in me. I thought about though…

When Queen Elizabeth II asked:

“Why did no one notice the credit crisis?” The answer: signed by 33 distinguished economists said ‘it was the failure of the collective imagination of many bright people in the UK and internationally to understand the risk of the system as a whole.’

So another factor is certainly, the lack of systems thinking! What I do may not have a positive / negative impact on me, but it could have a positive / negative impact on others. 

The decline in the trust for experts comes from experts being: 

  1. too academic and therefore disconnected to practical reality… 
  2. simply creating bearers for others to understand their view point and choosing to capture value instead of communicating valuably. 
  3. Unable to see the credit crisis coming…
  4. Lack of systems thinking / solidarity / or, in other words, the reliance on the invisible hand / free market as infinitely wise. 

The fault lines were:

  1. too much debt;
  2. excessive reliance on markets for liquidity;
  3. Complexity in derivative markets;
  4. Huge regulatory risk,
  5. Misaligned banks and imitators. 

Getting Global Support for Reforms: G20 finance ministers backstopped the entire system. 

G8 treasury leaders. They didn’t think that the system would self equilibrate as a solution. As such, they created a new plan with the FSB (financial stability board). It is the United Nations for finance. Mario Draghi had an immediate impact on the financial system as the chair. The FSB developed over 100 reforms. And Mark Carney succeeded Draghi as chair of the G20.

Chairing the G20 Finance Stability Board comes with several important lessons:

  1. You must have a clear vision; you need political backing. FSB has the power to recommend reforms, however the national legislatures must put these reforms in place…
  2. You must get the best people you can around the table. Bureaucracy is not helpful here. The group is composed of central bankers, regulators, finance ministers….
  3. You must build consensus that entrenches ownership. Dany Rodrik sees an intractable problem here: a trilema of economics, democracy and sovereignty…We have a seeding or pooling influence. No country is obligated to implement these reforms however it is in everyone, globally that these reforms be implemented at the national level. Commercial banks were happy that “heads they win tails we lose” with the bail out but there were positive reforms made via FSB. 

Mark Carney’s Three Lies of Finance:

Financial crises happen frequently, if you hear someone say any of these lies, then take note: 

  1. “This time, it’s different”
  2. “Markets always clear”
  3. “Markets are always moral”
  1. “This time, it’s different”: what’s happening today is fundamentally different from all prior human history….Nope, don’t believe this lie. Usually, a new innovation is compelling because of its initial success, complexity and opacity. Solving the stagflation of the 1979s and 80s with new monetary stability that were democratic, effective, evident remits, strong governance….The Great Moderation from the 1990s to 2008s also paralleled, technological growth, non-financial consumption, such that it was easy to become complacent. And people assumed housing prices can only go up. This optimism is known at the business cycle. Carney refers to this as the Minsky moment: where lending is abruptly pulled back when financial experts realize there is a correct brewing and thus causes the economic downturn to more severe. In 2008, “Minsky went mainstream.” (186, Value(s)). 
  1. “Markets always clear”: at the right price, excess supply and demand will clear (ie. the supply will meet demand). Labour markets are efficient and clear? Sorry, nope they are rigid and sticky. If money is efficient, then they will reach equilibrium? Sorry, nope markets are incredibly ineffective in reality. Markets do not always clear because life is not a textbook. You can’t describe the real world because people are too complex for any mental or predictive model. Synthetic credit risk; the risk was spread all up. Panic ensues with risk being pooled. The real world is far more complex, we cannot anticipate all of human activity at any given time. Calculating every scenario is impossible, Newtonian physics doesn’t quite work in every scenario and physics doesn’t even involve tricky human beings.
    1. Keynes in General Theory shows that when having his students rank the prettiness of faces in exchange for a prize, it’s more important to calculate what the average opinion believes the average opinion is. Keynes noted that this is what happens in markets where everyone else was thinking, the derivative of the derivative of what other people will do matters more (subjective utility). Keynesian saw the instability is on spontaneous preferences, the full consequences are only based on animal spirits. The belief that markets are always right was what enabled the last bubble and the next bubble. Markets are populated by people however, fickle people.
    2. Cass Sunstein argues that 1) preferences in public differ to what is in our heads, 2) social obligations impact our acceptance of new things. For example, if 1000 people protest something, then we will be more amenable to that something as well. Read: Robert Schiller’s Narrative Economics. Critical mass opinion happens in finance as well. The Minsky cycle works on average and average opinion. How do markets become more differentiated? There is a spontaneous urge to make a decision rather than a complex weighted calculation of the mathematical benefits x the probabilities of a given consequence of the decision…
  1. “Markets are moral”: FICC (fixed income, currencies and commodities markets) have a lot of fraud in them even though they determine the cost of resources, food, housing, government debt prices etc. The commodity squeezes in rye in 1868, cocoa in 2010, and ‘wash trades’ in Manhattan Electrical Supply on 1930 and the Tera Exchange in 2014 show a recurring phenomenon. There have been a lot of squeezes. Planted rumours to drive up a cost happens frequently wherever traders are bored or desperate. Tweaking LIBOR and FX involved manipulating these foreign exchange benchmarks rates for the interest across firms at the expense of retail and corporate clients in the billions. Technology evolves and laws are passed. Engineers of the subprime crisis were clubby and colluded online, globe bank misconduct costs were $320 Billion for $5Trillion of assets. People were colluding online and few were held to account. And there was no rush to take the blame. Trust in the UK went from 90% (1980) of UK citizens thinking banks were well run versus 20% (in 2008). Financial firms help the real economy. The FICC markets, markets are ever more important to people. FICC markets can go wrong with poor regulation. Carney argues you need Hard infrastructure (regulations, foreign exchange benchmark objectivity) and Soft infrastructure like corporate culture, informal codes and policy handbooks. Light banks. Central banks participate in fire insurance. Mistrust between companies and hesitate to invest in firms. FICC infrastructure is key, soft codes of infrastructure, weak banks. Relies on informality. 

Carney argues that the solutions are the following: 

  1. Trust: G20’s Financial Stability Board helps by acknowledging that the market is amoral and will not always clear  by instilling greater trust, less complexity.
  2. Smarter: Ensure traders remain pro-market (shouldn’t be a problem) but support smarter regulation. 
  3. Avoid Lies: Ensure financial professionals avoid the attractiveness of the 3 lies. 
  4. Realistic: Recognize that regulation will not bust the cycles since innovation is always happening but ensure that  regulators be understanding. Implement policy that make real markets more robust with market infrastructure that creates the best markets for innovation.
  5. Transparency: In 2008, Over the Counter derivative trades were largely unregulated, bilaterally settled (closed door) and unreported, but now 90% of new single currency interest rate derivatives are centrally cleared in the US i.e there is transparency. 
  6. Systems Thinking: Ensure financial professionals recognize the importance of protecting the system as a whole.

Risks in Emerging Markets are a danger for another financial crisis where the lie that markets always clear continues. China’s economic success contains a lot of shadow banking (SIVs, mortgage brokers, finance companies, hedge funds and private asset pools), there are lots of repo financing, major borrowers and banks with significant opacity. There is now a worrying amount of debt in China that could leave Ray Dalio reevaluating his career choices once again. There could be a major margin call / run on Chinese assets, with first mover. There will be mismatches of markets. There could be a rush to get out of the Chinese market: this is the risk of being trapped when the assumption that markets will always clear (buyers and sellers will find each other) is exposed as wrong. Cyber to crypto crises could also trigger another financial crisis.

Risks in Illiquid Assets treated as if They Are Liquid:

New risk is the global assets under management of $50 trillion in 2010 to $90 trillion in 2021. But $30 trillion is promised to be liquid when it is illiquid assets. Carney’s addressed this problem of not having consistency between liquidity of funds’ asset versus their redemption terms while he was governor of the Bank of England with the help of the FCA (Financial Conduct Authority):

1) liquidity of funds’ assets should be valued as either a) the price discount needed to do a quick sale of a vertical slice of those assets OR b) a time period needed to sell the asset without a price discount. 

2) Investors who redeem get a price for their investment that mirrors the discount required to sell a proportion of a funds’ within the special redemption notice period;

3) the “redemption notice period mirror the time needed to sell the required proportion of a funds’ assets without discounts beyond those caputed in the price received by redeeming investors.” (196, Value(s)). 

During the 2008 crisis: 

  1. Liquidity disappeared with cash-powered banks refusing to lend;
  2. There was a ‘run on repo’ which increased the haircuts on collateral to de-risk counterparties which were shadow banks that then collapsed;
  3. In Europe, the debt crisis compounded these problems driving up nationalist sentiments…

There is now the liquidity coverage ratio and net stable funding ratios…but there are weaknesses with US repo market troubles in 2019- 2020. The Fed’s open market operates calmed down…Carney doesn’t know where the next bubble will burst but he has a few ideas.

Bagegot’s principal of being the lender of last resort thus preventing short-term liquidity shortages from causing wide spread insolvency.

Bank of England presentation by Mark Carney…

Central banks have challenges:

  • Figuring out if the firm is solvent when the market is against that firm’s assets and the market can be wrong longer than that firm can stay liquid;
  • What constitutes good collateral, can always lend government bonds and in the 2008 crisis, it didn’t appear to have an impact on the functioning of the system, banks horde
  • The penalty rate means the firms come late because it convey weakness.

Central banks have now moved to doing transparent auctions of liquidity to many counter-parties which includes banks, broker-dealers, an central counterparties in the derivatives market. Bank of England has a contingent term repo facility….

An Anti-Fragile System – This Time is Different – What Was Done to Banks:

  • Public trust was harmed most by the mantra of too-big-to-fail banks. 
  • Banks didn’t pass lending out enough which amplified inequality. 
  • Privatization of profits while socializing the losses harmed trust.
  • Public paid $15 trillion in bailouts, government guarantees against bank debts and special central bank liquidity projects….. 

G20 FSB brought in standards to create an anti-fragile system:

  • Banks are less complex. 
  • Banks have a ‘living will’ and are reorganized so they have a firewall between the banking that continues to serve families and business even if their investment banking division is imploding. 
  • Trading is less between banks thus shifting to lending to customers.
  • Public funding has dropped by 90% post-crisis with market discipline…
  • Senior leadership can be expected to bare the cost of failure.
  • Can’t legislate virtue but can legislate incentives around how senior leaders train staff.
  • Improving cyber penetration attack resilience. 
  • Looking for risks across the economy, thinking system level about where the next crisis is least likely to be and make sure that is focused. 
  • Macroprudential policy: addressing systematic risks….cyclical risk when the financial system loosens up, debt grows and complacency sets in, the Minsky effect is severe…
  • Macroprudential policy: addressing systematic risks…structural risks when there is a wbe of exposures to derivatives risk, which means the need to have liquidity buffers, restrictions on mortgage lending, shutting down the shadow banking approach.

Bank of England serves the purposes “To promote the people of the United Kingdom”

Restoring Morality to Markets:

Oscillating regulation, light touch versus total regulation. 

  • Aligning compensation with values;
  • Increasing senior management accountability;
  • Renewing the vocation of finance.

Longer-Term Horizons Focus the Mind: Bonuses in the UK are now managed with compensation by delayed by 7 years. If there is misconduct then bonuses can be clawed back, according to Carney. Business mission statements tend.

FICC Markets now have new guidelines:

  1. have clear, proportionate and consistently applied standards of market practice;
  2. are transparent enough to allow users to verify that those standards are consistently applied;
  3. provide open access (either directly or through an open competitive and well-regulated system of intermediation);
  1. Allow market participants to compete on the basis of merit; and
  2. Provide confidence that participants will behave with integrity.

Effective markets are those which also:

  1. Allow en users to undertake investment, funding, risk transfer and other transactions in a predictable way;
  2. Are underpinned by robust trading and post-trade infrastructure enabling participants to source available liquidity;
  3. Enable market participants to form, discover and trade at competitive prices; and
  4. Ensure proper allocation of capital and risk.

Drawing on the Magna Carta:

Having the right principles is essential. Keep pace with the innovation. Senior Managers Regime (SMR) individual accountability. Values need to be exercised like a muscle. SMR makes sure senior leadership is accountable even if many of them were involves in the 2008 financial crisis. Employees must be connected to their communities. 

Previous Chapter
Next Chapter
Introduction: Humanity Distilled Chapter 1 Objective Value
 Chapter 2 Subjective Value Chapter 3 Money & Gold
 Chapter 4 Magna Carta  Chapter 5 Future of Money
 Chapter 6 Market Society Chapter 7 Financial Crisis
 Chapter 8 Safer FinanceChapter 9 Covid Crisis
 Chapter 10 Covid Recovery Chapter 11 Climate Crisis
 Chapter 12 Climate Horizon Chapter 13 Your Values
 Chapter 14 Values in Companies Chapter 15 ESG
  

Analysis of Part 1 and Chapter 8

  • Mark Carney can look to Mario Draghi for inspiration since, Draghi is now the Prime Minister of Italy (as of 2021). Central Bankers can cross into the political sphere. Currently Draghi is trying to get bank mergers to happen in order to clean themselves up. So like Carney, using the power of politics to effect change is sometimes valuable where as a central banker, you cannot effect change. Analogies, and history does not have predictive power, Italy is very different from Canada, however it is instructive that getting into a position of power may not be a high hurdle for Carney. Finance catteacts people with no socience training, because they are looking for absolutes. These folks lean deterministic. 
  • A bit odd that the Senior Managers Regime (SMR) doesn’t really connect because the people who self-select to work in banking are frequently math. The problem is that the people with the experience made decisions in the financial crisis that seem to benefit themselves disproportionately company to the general public. It is similar to having doctors make decisions for hospitals, there is a conflict of interest in being in control and regulating oneself. 
  • Perhaps the bad behaviour is in Crypto…
  • Great economic shocks cause institutions to recalibrate and reform. It isn’t the individual actors that drive such change but rather macro externalities where no one internally can be blamed that cause reform. 

Citations Worth Noting for Part 1: Chapter 8:

  • Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different: Either Centuries of Financial Folly (Princeton: Princeton University Press, 2009)
  • Raghuram Rajan, Fault Lines: How Hidden Fractures Still Threaten the World Economy (Princeton: Princeton University Press, 2010). 
  • Hyman P. Minsky, ‘The Financial Instability Hypothesis’, Levy Economics Institute Working Paper No. 74 (May 1992). 
  • https://www.youtube.com/watch?v=PIRHM_Dz_fQ Adair Turner
  • Kenneth J. Arrow and Gerard Debreu, ‘Existence of an equilibrium for a competitive economy’, Econometrica 22(3) (1954). 
  • Gilian Tet, Fool’s Gold (London: Little, Brown, 2009) which shows that derivatives were distributed throughout 100s of balance sheets through the pooling and distribution of that risk. Similar in essence to a decentralized ledger.
  • John Maynard Keynes, The General Theory of Employment, Interest and Money (London: Palgrave Macmillan, 1936).
  • Wlater Bagehot, Lombard Street: A Description of the Money Market (Cambridge: Cambridge University Press, 2011). 
  • Financial Stability Board, ‘Strengthening Governance Frameworks to Mitigate Misconduct Risk: A Toolkit for Firms and Supervisors’ (April 2018).