Responsible Investor

Now is the time to rebuild markets responsibly

Investors must ensure the credit crunch doesn’t happen again by thinking and acting responsibly.

It might seem churlish, and perhaps even a little cruel to tell institutional investors involved in fire-fighting the current market flames, that the seeds for the proliferation of this crisis, and ultimately for ensuring it never happens again, lie partly in their hands. But it’s true. Worryingly, long-term investors have been willing to sacrifice fundamental economics at the altar of excessive speculation. The mesmerising pace of collapse of some of the world’s biggest financial names has prompted some to point out that Warren Buffet’s 2002 assault on derivatives as ‘weapons of mass destruction’ looks terrifyingly prescient, but in reality it was just good financial sense that few wanted to hear. Buffet’s analogy is all the more apt if you consider that the impact of weapons of mass destruction has been more deadly in terms of what wasn’t found: there were none located in Iraq. The world’s most successful ‘long-term’ investor, warned that what you don’t find with some derivatives contracts are financial market staples like collateral, guarantees, correct valuations, or realistic earnings forecasts. Those observations made six years ago have been spot on regarding the market for mortgage-backed securities based on sub-prime lending and mixed toxically into the broader market. What Buffet said you

could find is complexity, greed and “mark-to-myth” securities values: “The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen).” Yet many institutional investors either bought or watched important counter-parties buy into certain derivatives products like there was no tomorrow. Few questioned the prevailing orthodoxy. John Maynard Keynes, the UK economist, famously said: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.” The analogy sums up what many outside of financial markets, and increasing numbers within, now believe: that large parts of the market have become a dangerous froth, puffed up on precarious, fiendishly complex lending and trading practices. Financial markets should not be the tail that wags the dog. Too much of the valid institutional pursuit of strong returns has focused on short-term gain and not long-term growth. The latter demands robust questions about the structure of financial markets and their place within broader economies and society as a whole. It also requires that long-term investors act collectively, along with regulators, to assess the viability of market

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