Professor Michael Mainelli, Executive Chairman, The Z/Yen Group
[An edited version of this article first appeared as "Long Finance", Journal of Risk Finance, Volume 10, Number 2, Emerald Group Publishing Limited (April 2009) pages 193-195.]
The Ultimate Question?
The credit crunch and the liquidity crisis lead to an obvious diagnosis – the financial system is defective. And an obvious question – "how would we know when the financial system is fixed?" Unfortunately, this question is rarely posed.
Everyone has their favourite fixes (including this author – changes to credit market structures, to credit rating agencies, to auditing, to accounting, to regulation, to risk management, and fundamentally, to competition). Looking back over the past two years, it is apparent that everyone has stumbled and bumbled from incident to event to problem to fix, yet almost all have failed to separate temporary fixes from permanent solutions. Permanent solutions are impossible to discern until stable truths emerge. In fact, permanent solutions need permanent questions, such as "how would we know when the financial system is working?"
Perversely, one permanent question might be, "can a 20-year-old responsibly enter into a financial structure for his or her retirement?". Such a question raises a host of related issues. The question draws in actuaries, accountants, life insurance, savings, investments, security, fraud, risk, returns and firm defaults. An average 20-year-old today should, under reasonable actuarial expectations, live to 95. Most 20-year-olds with whom I talk assume they’ll live to 120. So the question implies a financial structure that should last 75 to 100 years. Looking over the past 75 to 100 years that covers two world wars and, since 1970, 1973 Oil Shock, 1982 Third World Debt Crises, 1987 Black Monday, 1988 Junk Bond Busts, 1990s Japanese Bubble, 1994 US Bond Crash, 1995 Mexican Crisis, 1997 Asian Crisis, 1998 Russian Crisis, 1998 Long Term Capital Management’s failure, 2000 Dotcom Crash, 2001 September 11 Disruption, 2002 Argentina Crisis, and, of course, more recent events.
What We Have Here Is A Failure Over The Long-Term
But crises come and go. Over the long-term a 20-year-old should assume that their "financial structure" might wobble a bit, but not fall down. Yet The Economist ["Where Have All Your Savings Gone?", 6 December 2008, page 11] observes: "Any American who has diligently put $100 a month into a domestic equity mutual fund for the past ten years will find his pot worth less than he put into it; a European who did the same has lost a quarter of his money". So 20-year-olds, and others, vote with their savings. At household savings rates below 2.5% in the USA and below 3% in the UK, large numbers of people seem to have realised that saving is a bad deal in the long-term.
Since the dawn of modern finance two centuries ago, the financial system has rarely been stable enough for long-term planning. Long-term planners too vote with their savings. Long-termers often put their cash out of short-termers’ reach using offshore centres, or "international business centres" as some would prefer to be known. By way of example, the Isle of Man is neither an especial tax haven nor secretive, yet remains popular for long-termers. I contend that the Isle of Man’s popularity, and other clean offshore centres, stems in part because an offshore financial structure removes some of the risks of government short-termism in onshore economies. You can plan for a slightly longer-term in the Isle of Man than in London or New York City.
Long Finance Foundation
So, how can 20-year-olds responsibly enter into a financial structure for their retirement? Honestly, I don’t know, but I do believe that the question matters and can help us to structure research. In some ways, the question is analogous to another posed by the computer scientist Danny Hillis in 1995, how could one build a clock to last 10,000 years? Dr Hillis’ question led to the 01996 (sic) Long Now Foundation, providing a counterpoint to today’s "faster/cheaper" mindset by promoting "slower/better" thinking. From the Long Now Foundation emerge projects such as a timeline tool (Long Viewer), a library for the deep future (Long Server), and tracking bets on long-term events (Long Bet). Another venture with long-term aims is Carlo Petrini’s Slow Food movement. Perhaps we need a Slow Finance movement or, my favourite, a Long Finance Foundation.
Once you look at the problems involved in Long Finance, you realise that many of today’s sustainability issues arise because society’s core risk/reward transfer system, finance, isn’t capable of handling long-term risk/reward transfers. Financiers have emphasised specialism – knowing more and more about less and less, when perhaps they should emphasise eclecticism, knowing less and less about more and more. How do you build a financial structure for long-term forestry, for fisheries, for global carbon emission reduction, for flood control? Do these need to be specialist structures? A Long Finance Foundation might structure research at different levels, e.g.:
Personal - how can 20-year-olds responsibly enter into a financial structure for their retirement? How can young people better understand long-term obligations, e.g. credit?
Financial – how do we match savings and investment? Can we build more secure financial institutions, banks, insurers, products?
Corporate – can, or should, companies plan for 100 years? What would a corporate pension look like?
Societal – how can we match long-term risks and rewards for scarce assets? What are fair ways to transfer wealth between generations?
These are truly research questions without answers. The answers might reveal themselves to be a boring slog of regulatory reform, or a concession that there are no answers. The answers might be revolutionary, e.g. direct personal pensions – you are chosen to join an impartially selected group of 600 people distributed around the globe who, under the management of a central coordinator, are responsible directly for each other’s retirement. The central coordinator directs your ‘pension cohort’ to save and sets outs the long-term transfers of risk and reward. The cohort is your most important social network because it, not the state, is responsible for financial security in your retirement. You might even go visiting some of the cohort over the decades while you travel on work or vacation. Just don’t call it a long-term bet.
When discussing Long Finance with the German ambassador to the UK, he pointed out to me that his grandfather, who started his pension in 1916, drew it down in the 1960’s after two world wars, the Weimar, etc., while many English and USA pensioners lived in poverty. His point being that financial structures are social constructs. Anglo-Saxon socio-financial constructs need a lot of work. Given recent events, the financial system, if not broken, reveals itself to be incapable of dealing with the long-term. Once we accept today’s financial system limitations, we can start to ask ourselves how we might design a financial system that can take care of Long Finance. I’ll bet it’s worth founding a Long Finance Foundation for this research – or you can collect from me in 02078 when I’m 120.
A number of people have directly and indirectly inspired Long Finance, typically by being patient enough to listen. To Adrian Berendt, Georg Boomgarden, Brian Donegan, Bob Giffords, Jack Gray, Ian Harris, Andrew Hilton, Martin Kremer, Paul Moxey, Caroline Oades, Jan-Peter Onstwedder, Richard North, Neal Stephenson, Raj Thamotheram, Greg Williams and Patrick Young, thank you!