Con Keating on “What They Do with Your Money”

Review of

What They Do with Your Money

How the Financial System Fails Us and How to Fix It.

Stephen Davis, Jon Lukomnik, and David Pitt-Watson

Yale University Press

ISBN 978-0-300-19441-8


The authors have grand ambitions for this book in terms of policy influence, which the dust cover endorsements would support and encourage. However, when I had finished reading it, I wondered if I had read the same book.

The idea of starting by asking the question: “What’s the financial system for” is sound, but their answer far less so. The waters are immediately muddied by rephrasing this as: “What is the purpose of the finance industry?” From this we might have expected some form of gap analysis, comparing and contrasting system and industry, but we would be disappointed.

The first purpose cited by the authors is safe custody of our money. Unfortunately, they see this as a form of bailment, where transfer is of possession but not ownership. This is a recurrent problem with this work; it fails to recognise that in many circumstances, the safety is in fact referring to the instrument which we have purchased with our money. The money is then no longer ours in any way, we now have not money, as an asset, but a deposit, or a bond certificate or other instrument. Many of these instruments in fact serve as quasi money, as is immediately obvious with a transferable certificate of deposit.

Their view of banking is archaic; deposits are taken and relent to borrowers. In today’s banking system, it is the advance of credit which creates deposits, and this is the source of over 95% of private sector money. There is a cursory discussion of maturity transformation in banking, but no recognition that the maturity transformation in securities markets can be even greater in amount or duration.

It is hardly surprising, given the careers and backgrounds of the authors, that ownership figures prominently. Bob Monks is quoted: “Capitalism without owners will surely fail.”  But lines such as: “… because corporate directors are the agents of shareowners, …” are simply incorrect.

There are some crossing strands which need separation.

Shareholders own shares, not the company or its assets. Shareholders’ property or control rights over the company are far more restricted than those applicable to full and unconditional ownership of a chattel, say an umbrella. There was, and remains, good reason for this; in order to finance large and long-term projects, the capital subscribed needs to be committed and unavailable for at least that term. Indeed, it is arguable that it is the increasing emphasis in recent decades on shareholder activism and increased shareholders’ rights that is the cause of the transition of the role of public equity markets from source of capital for companies to source of cash for speculators, and indeed the declining relevance of public equity markets, more generally.

Companies are juridical persons, which resolves Monks’ concern for capitalism; they own themselves.

One recurrent recommendation is the application of the concepts of fiduciary law to financial activities. However, the book fails to distinguish adequately between financial products and financial services. Purchasing units in an investment fund is purchasing a product. The fund manager is an agent of the fund. Awarding a segregated mandate to an asset manager is the purchase of a service, and the manager is your agent. The appropriate law for the product is clearly the contractual law of market exchange, but for the service, a fiduciary setting may be appropriate and certainly should be the default.

A blanket application of fiduciary law is problematic in another regard. The burden that I take upon myself as a fiduciary is much greater than the burden under contract; I am more exposed to risk and rationally should price this. The attraction of contract based arrangements is precisely that they limit my risk exposure, and the question of fiduciary or contract form reduces to one of price and value to the parties involved. The bald recommendation would run counter to their objective of reducing costs for investors. If the abuses and embedded expense of current contractual arrangements are shown to be greater than the added cost of a fiduciary arrangement there may be a case, but this is not work undertaken by the authors. It seems to me that shifting insurance from the realm of uberrimae fidei would be a sure-fire way to ensure that cover was either unavailable or unaffordable.

There is much that is wrong with our financial system and with the finance industry, but beyond recounting other people’s earlier work on these problems, this book does little to further our comprehension or to advance our quest for resolution of these issues.

Published  with the permission of Con Keating

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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