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Complex computer algorithms running markets, not humans: John Kay -

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MARK COLVIN: "We've locked ourselves into a dysfunctional cycle of quarterly earnings reports, while too many executives enrich themselves at their investors' expense."

That's not Occupy Wall Street talking - it's the visiting Professor of Economics at the London School of Economics, Fellow of St John's College, Oxford, and Financial Times columnist, John Kay.

John Kay’s latest book is called Other People's Money. To quote him again; “The scale of exposures on financial derivative contracts, the esoteric best that financial institutions make between themselves, is today around three times the value of all the assets in the world.”

He says markets have become unreal, and he told me they’re increasingly run not by human traders, but complex computer algorithms.

JOHN KAY: It's not people at all, and at least in the old days you could sort of see what was happening.

MARK COLVIN: Is there a reason to be in the markets now?

JOHN KAY: Well it's still true that over the long term you've made more money holding real assets - equities and properties and so on - than you have in bonds, and that's even more true today with interest rates at ridiculously low levels.

But what we need to do is actually direct finance back to its real purposes, which are, well, helping to put household savings in their most productive uses, and that's not what this trading activity between computers is about or bears any relation to.

MARK COLVIN: So you say that the price of stocks has exceeded the price of bonds, but is that susceptible to a bursting bubble?

Is there a bubble coming?

JOHN KAY: Well the returns on equities have historically exceeded the returns on bonds, and that will be because we've now got a lot of market volatility.

If you invest for the short term you will lose, but it's probably still true that if you're taking a reasonably long time horizon, you will do better in stocks than you will in bonds.

And you have to learn to live with that time horizon, because you want to be free of the volatility that's created by these market traders, and you certainly don't want to be the patsy who is the victim of these kind of trading strategies.

MARK COLVIN: Day-trading is a mug's game.

JOHN KAY: Day-trading is a mug's game, yep.

MARK COLVIN: And you want more responsibility placed on the big players in the market, you want people sent to jail.

Does that make sense if machines are doing all this work?

JOHN KAY: Well it means you have to take control of the machines.

What I want to happen is two things: one is I want to break up these conglomerates, so I want to go back to the kind of activity in which retail banks are rather boring banks, in which market-making, taking positions and stocks, is something that is done by in partnerships or in small hedge funds by people with their own money, or the money of people who are keeping a close eye on it - not with your money and mine.

I want to separate that business out from the business of giving advice to companies and issuing new securities.

So I want to silo these activities, and then I want to say that the people who run these businesses are responsible for what goes on in them; either they're financially responsible, in the sense that it's a partnership or a similar activity, and they're responsible for the risks they're taking, or they're responsible in the sense that if you're in charge of a bank, and a load of people inside the bank are stealing the money, it's not just them that goes to jail, but you go to jail, because you should have done something about it.

And the truth is, only the threat of one or two people going to jail would transform the sector.

MARK COLVIN: I saw a study this morning that said that the majority of the money going to the frontrunners in the US presidential election campaign is coming from Wall Street, to both parties, huge sums going from Wall Street.

So what optimism do you have that these markets will be controlled by candidates, most of whom get most of their money from Wall Street?

JOHN KAY: Not much to be honest.

And unless we do something to tackle the political power of the financial services industry, then we're not going to get reforms of the kind I described, nor are we going to get either of the things which I think we need, which are a finance sector focused on the needs of the real economy - which means businesses and households, rather than itself - and a system which is actually resilient, which means that the rest of us are not victims of the kind of shocks and shifts that were part of the problem, were the problem, in 2008.

MARK COLVIN: And Australia was considerably less affected in 2008 than most other countries.

Have you got any suggestions a) as to why, and b) as to how we can avoid the next bullet?

JOHN KAY: It's an interesting question, and two of the major countries which were free of this crisis, or largely free of this crisis, were the two old British Commonwealth countries: Australia and Canada.

And I've wondered what differentiated these, and what I think did differentiate them was both these countries retained much more of the old-style retail-oriented banking culture, which I recognised from my kind of childhood in Scotland, it was the way in which these Scottish banks used to be run, before around the turn of the century, when they were taken over by crazy guys who diversified it into activities they don't understand.

But you in Australia retained a large part of that culture, and that largely affected the way you ran your regulatory system as well.

I think regulation and the natural culture of the industry have to run in parallel, otherwise it doesn't really work.

But that was how things panned out better in Australia. You were also lucky because there was a commodity boom going on at the same time.

MARK COLVIN: We might not be as lucky with that the next time.

JOHN KAY: And you're certainly not as lucky as that right now.

MARK COLVIN: John Kay, author of Other People's Money. And you can hear a longer version of that interview on our website from this evening.