It's the start of the new year -- traditionally a time for lists and resolutions. So, in the spirit of the season, here is my list of the top 10 thoughts on how the financial system can reclaim its place as a positive force in society, contributing consistently to economic growth and higher standards of living.
1. Re-frame and re-state the covenant between society and finance. The financial crisis caused many to question the assumptions underpinning our system of financial capitalism. It's a system where finance is "as much... an ordering principle in our lives as the rising and setting sun, the seasons, and the tides," in the words of Robert Shiller, Sterling Professor of Economics at Yale University.
An intense international debate continues about the role, benefits, costs and risks of finance -- but no consensus has emerged as to what society expects from our financial system. Until we can state these expectations clearly, all efforts to give us the financial system we deserve are destined to fail.
2. Complete and simplify reform of financial regulatory infrastructure. Five years after the financial crisis, we're only 50 percent of the way through implementation of the Dodd-Frank Act. Much has been done to make the financial system safer, sounder and more secure, thanks mainly to requirements for more capital and less leverage on the balance sheets of major financial institutions.
But uncertainty about proposed rules, the complexity of written ones, and lack of coordination across national boundaries are all causing financial institutions to pull back from activities that could lead to more robust economic growth, something we desperately need right now.
3. Restore ethics, integrity and client focus to the financial-services industry. Financial-service organizations need to mediate between investors (sources of capital) and organizations that can productively deploy capital to boost the economy and enhance our collective standard of living. Finance needs to focus, as former Rotman School of Management Dean Roger Martin puts it, on "real markets" rather than "expectations markets." Finance needs to deliver on what Charley Ellis, a highly regarded investment expert, calls, "the iconic statement, 'the needs of our clients always come first.'"
Unless and until we reconnect financial institutions to their mission and purpose -- helping real clients in the real economy -- no amount of legislation or regulation or rulemaking will enable the financial system to be a consistent, stable provider of societal benefits.
4. Restore investor trust and confidence in financial markets. Investor trust and confidence were severely damaged by the financial crisis and have yet to be fully restored. Technology glitches (like the 2010 "flash crash," Facebook's IPO and Knight Capital's trading error), along with high-frequency trading and America's debt-ceiling brinksmanship continue to scare individual investors. As long as these investors don't trust the financial markets, they will remain over-allocated to the "safety" of cash while inflation eats away at zero percent returns.
5. Manage an orderly deleveraging of public sector balance sheets. How skillfully and smoothly we can unwind the enormous amounts of debt incurred by developed nations is the single biggest factor in whether developed economies grow and stock and bond markets deliver positive returns over the coming decades.
Policy makers knowingly ran this debt up to keep the financial system from collapsing, and then, later, to keep economies from plunging into depression and deflationary spirals. Now it's time to pay the piper -- but how? Using which combination of tools? Fiscal austerity, higher inflation targets, currency devaluation or financial repression (low interest rates)? And over what time period? At what cost to whom?
6. Address imbalances in the finances of developed nations. First cousin to the challenge of deleveraging is the challenge of getting the fiscal accounts of the U.S. (and other developed nations) back into balance. In the short term, that means balancing the budget and not adding to public debt at the rate of more than $1 trillion a year, as the U.S. has since 2008. Over the long term, it means addressing the entitlement promises that governments have made and cannot afford to keep.
7. Address the retirement savings gap. The current patchwork quilt of retirement-savings vehicles -- Social Security, defined benefit pension plans and defined contribution vehicles (401(k) and 403(b) plans) -- is woefully inadequate when it comes to fully funding the retirement liabilities of aging baby boomers.
Financial firms will need to do a better job of educating savers and delivering product innovations if we are to keep people from outliving the money they have accumulated over their lifetime.
8. Solve the "conundrum of low returns." In the era of what highly respected economists like Carmen Reinhart predict will be as much as two decades of slow growth due to debt overhangs, it will likely to be even more challenging than in the past to generate returns that will enable investors -- individuals, pension funds, nonprofit organizations -- to meet their goals, such as preserving purchasing power, paying pensioners and meeting administrative costs.
9. Design a new system of housing finance. Remarkably, serious work has yet to begin on restructuring the single most important contributor to the last financial crisis -- the U.S. system of housing finance. Today, almost every new mortgage loan involves some kind of support and participation from the U.S. government.
A rebound in home values, low interest rates and the profitability of Fannie Mae and Freddie Mac are masking the fact that private capital is not yet ready to support one of society's most important policy objectives: affordable housing -- and won't until the housing-finance system of the future is more clearly defined.
10. Retool the financial system for sustainability. The ethical legitimacy of an economic system driven by growth without regard to the long-term costs to our life-sustaining ecosystem is being called into question. The biggest flows of money today are going to investment strategies that reward responsible corporate behavior and enlightened environmental, social and governance practices. What will "sustainable finance" or "regenerative finance" look like in this kind of world? How will it differ from the system of financial capitalism that has become the dominant socio-economic model in the world?
Few would argue with this 2012 assertion in Harvard Business Review: "In general, finance does serve a crucial economic purpose."
But it is a long way from there to Yale professor Shiller's vision for a financial system that advances the goals of a "good society." Making progress on these 10 items will get us a lot closer than we are today.