A vibrant and professional financial services industry is essential to a prosperous economy. Only market economies can provide citizens with the standards of living that the people of western Europe and north America have come to expect. A market economy requires a financial sector to direct investment to the most productive uses and to monitor the performance of large businesses. This finances the operations of governments and, by borrowing short and lending long, enables borrowers and lenders to operate on different timescales. A well-functioning financial sector serves the individual financial needs of its citizens, allowing them to save and to borrow to meet their changing needs during their lives. It protects citizens, or enables them to protect themselves, against the risks they encounter in daily life.

The liberal capital markets of Britain and the US achieve all these things—not particularly well, but better than any other system, and certainly much better than the state-controlled economic systems of the old Soviet bloc. But the scale of activities needed to allocate capital efficiently is a fraction of the resources that the financial services sector employs today. We have created a monster (see Jonathan Ford in Prospect, November 2008 “A greedy giant out of control”). The scale of resources the sector demands, its financial rewards and its political influence are all excessive. It sucks in talent that would be better employed elsewhere, and distorts the values of whole societies. Moreover, twice in the last decade—the technology bubble of 1998-2000 and the credit bubble of 2003-07—financial follies have threatened the stability of the world economy.

What has gone wrong? Financial markets have always been unstable. But the origins and scale of the present crisis are to be found in the development of financial conglomerates. Deregulation and globalisation encouraged the financial institutions of Britain and the US to acquire and diversify. The banker’s traditional activities of borrowing and lending were combined with asset management and advisory services—the business of selling and underwriting securities for large corporations. These conglomerates traded in a wide range of markets on their own behalf as well as for their customers. The once conservative universal banks of continental Europe took the opportunity to use the cheap funds provided by their retail depositors to speculate in global capital markets. The complex institutions that were created were riddled with conflicts of culture and of interests. They proved largely unmanageable—and were largely unmanaged. As the credit crunch developed in 2007-8, it became increasingly clear that the senior executives of these businesses did not really understand what had been going on within them.

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