January 04, 2018

Philip Augar, the ‘banking crisis of 2008’ did not dent at all Milton Friedman’s ideas that “sowed the seed of shareholder value”

Sir, Philip Augar quotes Milton Friedman with: “that business is not concerned ‘merely’ with profit but also with promoting desirable ‘social’ ends . . . They are — or would be if they or anyone else took them seriously — preaching pure and unadulterated socialism….” “to make as much money as possible” for the owners, “while conforming to the basic rules of society”, “A call for boards to overturn the status quo” January 4.

And he follows up with “This sowed the seed of shareholder value... It took the banking crisis of 2008 and the ripple effect of financial disaster to expose the flaws of the theory”

What is Augar talking about? Banks, in order to make the highest risk adjusted profits, just followed the “basic rules of society”, in this case set by their regulators who, with their risk weighted capital requirements for banks told them: “Go out and make your biggest risk adjusted profits on what is perceived or decreed as safe”

And that is precisely what banks did, initially making huge profits, but also creating dangerously excessive exposures to “the safe” like AAA rated securities and loans to sovereigns who had been assigned a 0% risk weight, like Greece; which exploded.

I cannot understand how Augar can argue that has dented Milton Friedman’s thesis. If anything it clearly demonstrates the dangers of having some very few define and impose “the basic rules of society”.

He opines “boards need to develop a mindset that challenges rather than seeks to justify the status quo” That is correct, but does that not include papers like the Financial Times too?

Sir, why has FT not dared to challenge the status quo by for instance demanding regulators to give a straight simple answer, not disguised in incomprehensible technicalities, to the question of “Why do you want banks to hold more capital against what has been made innocous by being perceived risky, than against what is dangerous because it is perceived safe”?