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Tomorrow's truths

It could have been dismissed as yet another tome devoted to deciphering the Crisis. But in predicting the global trends and explaining how they can be of use, the book demands a read by serious investors, says P.V. Subramanyam.

First, a caveat: this book is not for the common man. It’s not the level of complexity but the dry style that makes this a serious recounting of financial history. Still, managers, analysts and students of finance could benefit from a perusal.

As the global financial meltdown works its way through different economies, a great deal of literature is being built on it. Despite this, our understanding of the issue is, at best, superficial. The only certainty is the inevitability of booms and busts—from tulipmania in The Netherlands in the 17th century to the present sub-prime crisis, human behaviour has not changed.

It has now been universally accepted that many factors contributed to the crisis. One of these was the belief in self-governance. It is difficult for any participant to regulate himself, almost like an accountant saying, “I can do my own audit.”

Another lesson for regulators is that size does matter. Big guys need regulation more than the small fry because ‘they can take the market down’. If the financial sector is currently facing a crisis, it’s because the socalled ‘too big to fail companies have failed’.

In The Future of Finance, renowned futurologist, Adjiedj Bakas, and international marketing expert, Roger Peverelli, analyse how the global economy got into such a hellhole, whether there was a pattern, and what one can learn. This analysis of what has happened in the recent past may help us know what the future will look like— for banks, insurance companies and pension funds.

In the foreword itself the authors talk of a singular risk—the incentive structure. This is not difficult to understand in the Indian context. A life insurance company is run for the benefit of its shareholders. However, the incentive structure to sell the products often creates a conflict between what is good for the shareholder and for the employee.

PERSONAL FINANCE VERSION 2.0
The book identifies four mega-trends beyond the current recession. Here’s a look at how they are likely to impact your finances
Globalisation: A New World Economic Order
Emerging markets will gain a strong foothold. Sovereign wealth funds will become large shareholders of western banks.
Demographic Changes: Greater Product Differentiation
The production of too many goods to satisfy individual demands will make it difficult to analyse the prospects of a company.
A Connected Society: New Market Place Dynamics
An investor will have to learn how to react to micro changes and stock markets across the world, not just those in his country.
Revival Of Ethics: Emphasis On Health And Happiness
Corporate social responsibility will be the buzzword as we will redefine how wealth is to be created and how it is to be used correctly.

Similarly, bankers taking balance sheet risks to earn higher ‘fee income’ pose a huge threat. If the company wins, the employee gets a bonus, but if the money is lost, it’s the shareholder who loses. The employees, read hedge fund managers, traders in investment banks, portfolio managers and the like are compensated by a percentage of the profits, whereas the losses are borne only by the shareholders! Is it any wonder that the employees found it easy to take huge risks in the sub-prime housing loans?

The other risk in compensation comes from the timing of the bonus. In case of a bank lending to a company, it is possible that the incentive is linked to the recovery. However, in a private equity deal, the bonus comes through on ‘doing the deal’, which basically means that the incentive is paid when the money goes out, not when it comes in. The authors’ conclusion: risk management is too important to leave it to professional risk managers.

The authors also provide detailed analyses of four mega-trends that can bring about radical changes across the sector. They postulate that those who understand these changes can look forward to a bright financial future.

To back their claim they have included valuable contributions from people like Geritt Zalm, who spent 12 years as finance minister in The Netherlands, Merrill Lynch Netherlands vicepresident, Ricardo Fakiera, and other senior managers from the largest enterprises in the financial world, including the ING Group, Royal Bank of Scotland and Zurich Financial Services.

The collective wisdom is that the financial services industry will have to make structural changes. Globalisation will give rise to an entirely new competitive arena, with emerging markets such as China, India, Russia and Brazil gaining a strong foothold on the economic world stage. Sovereign wealth funds will become large shareholders of western banks and insurance companies. Corporations such as Google will apply for banking licences. And, perhaps, a country with just 8% of the world’s population may not be needed to solve all the world’s problems.

The book is divided into three parts. The first part summarises the history of money, the origin of financial institutions, as well as bubbles and other financial crises. This includes the current one, and the authors hint that among the reasons for the crisis is the way the US Federal Reserve is structured. It’s a joint venture of a number of private sector banks and may, therefore, be less independent than we think. The detractors believe that it lowered the interest rates too fast and too much.

The second part provides an overview of the four mega-trends that are set to change the financial services sector over the coming decades, and the last part addresses the key challenges for financial services providers. It also contains a blueprint, which can serve as a management agenda for the next four to five years.

The history has been captured well. This is not so much a boom to bust story as it is an analysis of the salary/compensation risk. CEOs and financial managers will find it useful, though laypeople might not be fans of its academic style.