In his book Other People’s Money: The Real Business of Finance, author John Kay quotes Lord Keynes’s idiom, “Madmen in authority, who hear voices in the air, are generally distilling their frenzy from some academic scribbler of a few years back.” The men and women with authority over monetary matters are indeed mad. Mad enough to see interest rates, not as pricing the present versus the future, after all, the idea that a dollar today is worth more than a dollar in the future is axiomatic.

No, the Fed’s crystal ball sees lenders paying for the privilege of going without the present use of their money so the largest debtor in history can continue to operate. In the just released “2016 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule”  the Fed, in its Severe Adverse Scenario, foresees,

As a result of the severe decline in real activity and subdued inflation, short-term Treasury rates fall to negative ½ percent by mid-2016 and remain at that level through the end of the scenario. For the purposes of this scenario, it is assumed that the adjustment to negative short-term interest rates proceeds with no additional financial market disruptions. The 10-year Treasury yield drops to about ¼ percent in the first quarter of 2016…

Really, rates going negative would mean “no additional financial market disruptions?”  In a world with somewhere between $700 trillion and $1.2 quadrillion in derivatives exposure nothing out of the ordinary would happen?   Some will pooh pooh the big numbers because on a net basis the exposure isn’t even close to 1000 times 1.2 trillion. But, as Zero Hedge explains, “net immediately becomes gross when just one counterparty in the collateral chains fails – case in point, the Lehman and AIG failures and the resulting scramble to bailout the entire world which cost trillions in taxpayer funds.”

Money losing Deutsche Bank has $64 trillion in derivatives exposure and ZH wonders “Is it Time to Panic About Deutsche Bank”? The credit default swaps market thinks so.


John Kay longs for a day when banks simply take deposits and make loans “to firms and individuals engaged in the production of goods and services.” How quaint. Writing from a Euro/British perspective Kay makes the point that Britain’s overgrown financial system does a mere 3% of it’s business lending money.

The real action is trading in foreign exchange, which Kay writes is 100 times the value of actual goods and services traded, and derivatives where “the value of the assets underlying current derivative contracts outstanding is three times the value of all the physical assets in the world.”

Kay’s word for this casino culture is “financialisation.” In the dark days of the financial crisis when Hank Paulson told lawmakers and the American people to pony up or no money would come out of the ATMs, all but tinfoil hat wearing conspiracy kooks bought into the panic. “The notion that finance was special was uncontroversial,” writes Kay, “and the inability of many intelligent people outside finance to understand quite what financiers did reinforced that perception.”

Of course now we have Dodd-Frank and Nancy Pelosi claims those 15 million words will keep the big banks operating without a hitch.  Kay is pretty sure a crisis is just a few keystrokes away unless bankers find that old time religion of simply disintermediating deposits into loans. The various Basel accords have only resulted in regulatory arbitrage and the author tells the reader an explanation for why these rules were “bound to fail was provided by the early critics of socialism and central planning, such as von Mises and Hayek.”

Of course the left would say all that’s needed is more regulation. Kay believes otherwise, he says there is “far too much.”  Meanwhile, as Larry Summers describes, finance is now dominated by mathematicians noodling out algorithms rather than hail fellows well met slapping backs and buying drinks at the country club.

The author believes the clever are not clever enough and meeting “clients at the nineteenth hole is more relevant to making good investments than the ability to solve very difficult math problems.”   If the math geeks have done anything it has been to create booms and busts. Since the turn of the twenty century, bank failures spike with frightening repetition.

Kay mentions Adam Smith’s  agency problem as a contributor to financialisation and instability. Wall Street and the world’s other financial centers are run for the benefit of senior management instead of shareholders.

Plenty of millionaires were made with bonus money selling collateralized debt obligations (CDOs). Home mortgages were stacked like Jenga blocks as illustrated in the movie “The Big Short.”  The best mortgages placed at the top of the tower, with lower stacks containing lower quality mortgage paper. But, the overall risk was not changed “by this repackaging. There was no alchemy through which a collection of loans on weak security to unreliable borrowers could be anything other than just that,” Kay explains.


The belief was that property values always go up, and, as Kay points out, “in the long run, that conventional wisdom is often true.  But time horizons in the finance sector are shorter: I’ll be gone, you’ll be gone.”

“I’ll be gone, you’ll be gone,” is Kay’s catchphrase for financialisation. He repeats it often. In today’s finance world, take the money and run. The trend is your friend. It’s a world run by Keynesians and perhaps we should heed what Keynes wrote in Chapter 12 of The General Theory.

This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

Or more famously he wrote, “Long run is a misleading guide to current affairs. In the long run we are all dead.” In other words, I’ll be gone, you’ll be gone.

In the end, the author naively wishes retired politicians were elder statesmen, not lobbying for big bucks. Civil servants should serve the public, journalists are too easily captured by their sources, and academics have failed to speak truth to power. However, as Milton Friedman coined and Richard Nixon announced, “we are all Keynesians now.” Look where it’s got us.

Lord Keynes summed up the fate of all bankers. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.”

More ruining is on its way.