 Dwi'n gweithio i chi, fel yw'n cymdeithasol yng ngyfnodol ysgrifennidol. Felly, rydyn ni'n gwybod bod ymgyrchu'r cyd-dyn nhw'n gwybod i'r ddau'r ddau'r hyn yn ddublir. Mae'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau'r ddau. Mae rydyn ni'n fwy oeddordeb Wandshtreat i Llywodraethodd Ac Canery Wharf ac ryw maen nhw ffrifsedig o dan nhw. Felly, ryw oedd rydyn ni'n gwneud rydych chi dda ran ddau'r ddau'r ddau yn ddau'r ddau. Bun o'r diwylliannol yn y dyfodd ar hyn y dyfodd,rrych, i ni, i fynd i beth sy'n ddau'r ddau'r ddau. Mae'n meddwl o'r llwyffydd o'r meddwl o'r llwyffydd yn ymddangos i'r bwrdd a'r llwyffydd yn yr anhygfaen. Felly, yna'r gweithio cyngor, yna'r gweithio cyngor o'r anhygofydd, y mae'n meddwl a'r gweithio'r meddwl o'r gwell. Mae'n meddwl i chi'n meddwl i'w ffrindau cyngor, os ymddangos i'r meddwl hynny, we obviously need to have trading in foreign exchange in order to make trade in goods and services possible. But the volume of trading in foreign exchange is something like 70 times the volume of trading in goods and services. yn ddweud o unrhyw rhaid o'r ffordd y byddai i bwysig i'w Llywodraeth i fylliant iawn, rhai 70 mae'r holl o bwysig o'r holl o'r holl o'r holl. Rhaid o'r holl o'r holl o bwysig o ffodol chyfedru cyfwyr wedi gweld y cyffredin. is currently estimated by the Bank of International Settlements to be something like between six and seven hundred trillion dollars. That's about six or seven times the total national income of the world. And of course that's not the value of the assets to which the derivative contracts relate, it's the value of the contracts themselves. We have the growth of high frequency trading, which is estimated now to account for getting on for around about two thirds of the volume of all trading on the New York exchange and something like half of trading in London. High frequency trading, for those of you who are not familiar with it, is people lodging orders, most of which are not actually fulfilled. But when they are fulfilled, typically selling and holding securities that are bought, for extraordinarily short periods of time, and lodging orders for lengths of time that may be measured in fractions of a second, that it matters how close your computer is to the exchange computers because the interval that it takes for data to travel along fibre optic cables even from the exchange's computer to your computer actually may make a difference, a fundamental difference to the profitability of trading, so that exchanges now sell what they call co-location, which is having your computer right close by. High frequency trading produced what was known as the flash crash a couple of years ago, where the value of a whole variety of stocks, I quoted in New York, went crazy, some of them were quoted in large companies, were quoted at zero for a few minutes, for example. The most scary thing about that flash crash is that people still don't really understand how it happened. It was, as it were, computers going berserk, and it came under control again when, in effect, people unplugged the computers and went back to kind of manual trading. Perhaps more seriously still, if I look at the balance sheets today of UK banks, they total about £7 trillion. That's quite a lot, it's about four times British national income. But if you ask what proportion of that turns out to be lending to real non-financial businesses, the answer is it's about £200 billion, or about 3% of the total. If you ask what these assets and liabilities are, the answer in the main is that they're the same in the sense that the assets are mainly the liabilities of other banks and the liabilities are mainly the assets of other banks. So what is all this for? It's a question I always liked the rhyme at Humboldt Wolf wrote, best part of 100 years ago, that said, in the city, they sell and buy and nobody ever asks them why. But since it contents them to buy and sell, God forgive them, they might as well. But actually if the consequences of doing them are as people in this room know to their, in most cases, substantial personal cost, that this has to be paid for by the public at large, we need to ask more penetrating questions about it than Humboldt Wolf did. There's also, if one starts to think of it in these ways, even more basic question to be asked. Suppose we have an activity that consists very largely of people shuffling bits of paper back and forwards to each other. There's a common sense that suggests that people shuffling the same bits of paper back and forwards to each other can't either add very much value or make very large amounts of profit out of the process. If this activity is really the way we're describing, how on earth is it so profitable? Why is it that financial services businesses appear to make so much money and why is it that people in financial services businesses learn so much? Having posed these questions from one perspective, I now want to look at the industry from another, which is to ask what do we really want the financial sector to do? Well, I think the financial sector, it's obvious that real economies need financial services. It's very clear that a large part of the reason why poor countries remain poor is that they have very underdeveloped financial services sectors. And to get to reasonable stages of development, we need financial services. We need financial services, I think, to do at least four things. We need financial services to provide the payment system, to enable us to receive our wages and salaries, to pay our bills and so on. And both individuals and businesses need financial services to operate a payment system. That's essentially a utility like gas and electricity and telecommunications and water. It's one of these basic core infrastructures of the economy, and if it stops functioning for more than a few hours, in fact, the economy grinds to a halt. Although Ireland is often quoted as the most powerful counter example to that, as a result of the Irish bank strike of the 1970s in which the banking system closed down and the economy continued to function. It's not clear whether that could happen in quite the same way now. It's an interesting question. Second thing that the financial services sector does is capital allocation. It gets money from particularly people to businesses who need it from people who saved it. But as I've already indicated, the amounts which are involved, certainly in getting it to businesses that need it, are really very small relative to the size of the financial services sector. That's not the main part of what banks do. And actually much the largest part of what banks do in terms of lending to the real economy turns out to be residential mortgages, helping people to buy their houses. That accounts for about two-thirds of bank lending to the real economy in countries like Britain and Ireland. Now, that's very important. But in truth, lending in residential mortgages is not very difficult. It's something that was done quite well 20 years ago in both our countries by building society managers who were typically people who had left school at 16 or 17 and worked their way up on rather simple financial organisations. And interestingly, it seems they did it rather better than the computer scorers and rating agencies and smart guys with MBAs who took over these businesses for them. Third thing we need is we need our financial services to help us manage our personal finances. Most of us go through life and we have phases when we spend more than we earn and phases when we earn more than we spend. And if we manage these things well, we try and roughly even them out over our lifetime. And we need institutions to help us in doing that. And we have savings markets that provide these opportunities, although actually the returns on these savings markets have been really rather disappointing over the last decade or so. And it turns out that a rather large proportion of the returns which have been earned have been absorbed by increasingly large costs of intermediation before they actually go to save us. And the final thing that the financial services system needs to do for the real economy and actually the one which is most talked about if you raise the question of financial innovation over the last two decades is risk management. What has financial innovation been about? It's been about enabling us to manage risk better. If I went out into O'Connell Street and asked people, do you think the world has become more or less risky as a result of financial innovation over the last two decades, people would think I had taken leave of my senses. What on earth do people mean when they talk about that? A rather curious thing when you get down to it is that what is meant by risk management is actually the management of risks that were created within the financial sector itself. That is the set of risks that the very sophisticated tools which have been developed within the sector have been designed to handle. They have not done anything positive. Indeed, we understand some of the negative things they have done to manage the risks which are faced in everyday life by ordinary people, the risks which are basically to do with ill health and premature death, the risks that are to do with relationship breakdown, the risks that are to do with redundancy and unemployment. These are the kind of risks that would worry people out there in O'Connell Street and their risks which, as far as they are dealt with at all, are dealt with by social institutions. These are the things, then, that we need the financial services sector to do, to provide a payment system, to enable us to do capital allocation, to manage our personal finances and to help us manage risk. If you look at that list, I would like you to notice three things about it. Firstly, it is quite modest. It is important, but most of them are quite simple things that can be done by relatively limited organisations. Secondly, they are not currently done terribly well. Not any of them done terribly well. Perhaps the most important of them, capital allocation, is done, I think, particularly badly. Large firms today in Britain and Ireland and most of the developed world are essentially self-financing. They generate more cash from operations than they actually invest. Small firms need seed capital no longer in the same way as they once did to cover plant and machinery because the truth is one of the things that the growth of what we all think about in the knowledge economy is businesses just need less capital than they did, but new businesses badly need capital to fund the operating losses of developing new businesses and new ideas, and that's something our capital markets don't provide very well. Personal finance, I've criticised, and risk management actually, financial institutions help with a few things like the risk of a car accident and certain kinds of life insurance, but not very much or very fundamentally. They're not done very well, but most of all they're not things, any of them, they're not things that need people who are paid telephone number salaries. What people who are paid telephone number salaries are doing is the business I described earlier of trading in existing assets or of supervising people who are trading in existing assets, and that brings us to the question I posed earlier. If they're so busy trading with each other, where does all the money come from that they make out of it? Well, that's an interesting question that has worried me for quite a long time. One of the first times at which it started to worry me was when I sat on the board in the 1990s of what was then the Halifax Building Society which converted to become a public limited company and became, in that sense, a bank. But in my view, the road to nemesis for that particular organisation began not when it converted its organisational form, but on the day when it was decided that the Treasury operation, which had basically historically existed as a service department for the funding requirements of the bank, should become a profit centre in its own right. Proper banks made money out of trading and debt in various ways, and so should we. And I asked the question when I saw the numbers for the profits that were anticipated from this operation, I asked the question who is going to lose the money that we are going to make out of this operation? It seemed to me an obvious question since the value of fixed interest securities is essentially fixed. Anyway, the reaction was as though I'd made a rather rude noise. And I was sent off to be educated by the traders into how they would make this money. I'm bound to say I didn't feel very much wiser at the end of the day, and I didn't find it a particularly enjoyable day in any sense, or feel impressed by the intelligence or acumen of the people who were involved. And I went on worrying about that question. Now you may think that the fact that the organisation collapsed in 2008 and was rescued by the British government perhaps gives a partial answer to my question. And I think fundamentally it does. Because part of the answer to my question and the one which I want to focus on right now is the one that says the explanation of the profitability is that perhaps it isn't all that profitable. Perhaps the common sense that suggests that people exchanging bits of paper with each other won't make very much money out of it is right. That the apparent profitability is in this sense more apparent than real. Nicholas Nassim Taller by thought put it quite well in describing the years from 2003 to 2007 and it's a way that will I think resonate a way of framing it that will resonate I think rather strongly with an Irish audience it says we borrowed a lot of money from the future and then the future came. And I recall a striking presentation in Ireland in which an accountant took two accounts of a series of years where two failed Irish companies. One was Waterford Wedgewood and he showed how for that business profits gradually declined until they became negative and eventually the business disappeared. And the other was of course Anglo-Irish Bank where what the equivalent graph showed was rapidly increasing year on year profits every year until suddenly it made the largest loss of any organisation in Irish history or indeed the history of most of Western Europe. There was clearly something wrong with the measurement of the so-called profits in that particular case and this is a general problem. Again in a way that will be familiar to an Irish audience I think. I was always impressed when John Kenneth Goldbraith's book about the great crash talked about the bezel and the bezel is the amount by which the world is better off after a thief has stolen something but before the people from whom he's stolen it have discovered that the money has gone. And Charlie Munger who is Warren Buffett's partner has talked of the fee bezel it doesn't have the same ring in the phrase as the functionally equivalent bezel and I think you in Ireland were victims of one of the largest functionally equivalent bezels in history. Where do these kind of mechanisms come from? Well let me give you three illustrations of how people can think themselves rich and have done so in the financial sector. The simplest of course is the Ponzi scheme that is the scheme by which you pay high returns to early investors in a project from the suckers who are attracted by these high returns to come into the business later. And of course we've just heard of Bernie Madoff who ran the biggest illegal Ponzi scheme in history but there are of course plenty legal Ponzi schemes around. If we ask ourselves how we can create wealth by passing round the same bits of paper to each other then it's very easy, we start at one end of the room you sell a bit of paper for a euro to the person sitting next to you who sells it for two euros to the person next for three euros and so on and everyone in the room has made or quite a lot of people in the room have made a euro profit there is of course somebody in the room who will be landed with a bit of paper when people notice it wasn't any more valuable at the moment than it was to begin with but that may be quite a long way off. And of course these legal Ponzi schemes were what happened in the new economy bubble or indeed to a large degree in the Irish property boom. So we can have the Ponzi scheme this process of selling essentially the same assets to each other at higher and higher prices it's a bubble that will burst one day but that day may be quite some way away and people will report quite large profits in the course of doing so. A second kind of device for thinking yourself rich I'd like to describe is the martingale strategy. Now the martingale is a very old and familiar betting strategy and the rule of the martingale is every time you lose you increase your stakes to the point at which on the next throw of the coin, horse or whatever it might be you will win enough money to more than recoup all your existing losses. You keep as it were doubling your stakes in every successive game. Now there are two well known and seemingly contradictory properties of martingales. One is that if you keep playing the strategy for long enough you are bound to win and the other is if you play the strategy often enough you are certain to be ruined one day. And the apparent contradiction between these two observations is something which has engaged people for several centuries. The martingale is another strategy in this area the strategy of which every rogue trader who is finally exposed by some appalled bank has been guilty. But of course the people who are exposed by the appalled banks are the people for whom the ruin actually arrived and there are quite a lot of people for whom the ruin actually doesn't arrive. Of course I think there's a particular interest in the martingale strategy because it seems to me the managers of the Eurozone are today engaged in what is probably the largest martingale strategy game in the history of this kind of betting. The strategy of every time you lose doubling up your bet in order in the hope of recouping all that you have already got lost. Third strategy is what I call tailgating and I call it tailgating because I spend a lot of time nowadays in South of France where I drive on motorways and you will know if you do that you are endlessly tailgated by people who flash their lights as they drive a metre or so from your rear bumper. Now the interesting thing about tailgating is that it's a strategy that pays 99.9% of the time you move over and the person who tailgates you gets to his destination a minute or so quicker than he otherwise would and he congratulates himself on his skillful driving. Sometimes of course tailgating doesn't pay consequences are often disastrous when it doesn't pay but they are infrequent and when it does occur there is a kind of cognitive dissonance that dissociates the consequences from their behaviour. People say to themselves and they say to themselves often with some justification that it wasn't my tailgating driving that caused the accident it was the obstruction on the road that led the person in front of me to break it was the unexpected blowout on the part of the car in front it was some proximate cause that gave rise to the particular accident but of course it is inevitable that these kind of strategies will blow up from time to time and a lot of what people in the sector call carry trades are essentially transactions that have this tailgating property. They pay most of the time but occasionally they lose and they lose disastrously but strategies that have that property have the characteristic that people who engage in them congratulate themselves and are congratulated by the superiors on their acumen and that puts pressure on other people as it does on people who don't drive badly on French order routes to imitate the behaviour of the people who are engaging it in the first place. I've simply taken illustrations of three broad types of strategies I have three or four more which I'm not going to bore you with at lunchtime today but I simply want to illustrate the ways in which it's possible for people to imagine that activities are more profitable than they in fact will turn out to be in the long run and I think what we've seen as a result of so-called innovation in the financial services sector is a world in which these strategies have come to the fore what should we do about it? Well I'm going to need longer than I have today to run through that. I think if you've understood what I've been saying about the way these kind of problems and activities are embedded in the structure of the industry as it has developed you will understand why it is that I believe that we're not going to tackle these issues by creating ever more detailed behavioural rules one only has to say that the so-called Basel 3 rules on capital regulation and requirements for banks run to several hundred pages I think one just has to say that to understand why this is not going to work in terms of stopping the kind of behaviours which I've been describing or indeed giving ourselves a financial system which secures the kind of stability we all want for it I think our remedies have to have much more to do with structural reform structural reform that goes back to the idea that we move away from financial conglomerates and have financial activities done in separate silos we need simpler activities that have less complicated interconnections with each other we need to ensure that high risk activities some of which we need to make the financial sector function are undertaken either in partnership type structures or in hedge fund type environments where there's a close relationship between the people of managing the money and the people who are providing the money and not have these kind of activities embedded in wide-ranging financial conglomerates and so on we should be addressing issues to do with the structure of the industry and the structure of regulation and stop believing that we are going to find train regulators who are incapable even of catching a crude crook like Bernie made of that we will train them to be people who will successfully second guess the risk management strategies of Goldman Sachs anyone who believes that has no understanding of the realities of what regulation means on the ground but above all we need both inside and outside the financial services sector to understand that we've lived through a decade in which the financial sector has not performed the basic tasks which I was describing very well in which taxpayers had to put very large amounts of money into the system in which savers have done pretty badly and in which a lot of people who work in the sector have made a great deal of money and I think one only has to describe that outcome to recognise that it's not a situation which is either, which is sustainable either politically or economically and if we don't address it in some more serious way we risk problems that will jeopardise not just our economic stability but our political stability as well thank you