Wealth managers need to be reminded that if they don't rebut well-intentioned but misguided attacks on the industry, it will not be just the rich who lose out.

“I am sure they [opponents of international financial centres] will find an excuse for blaming the offshore world for the current eurozone sovereign debt crisis."

Tim Ridley, former board member of the Cayman Islands Monetary Authority, speaking in London last week.

One of the potential traps of working full-time in a sector such as wealth management and finance is that it is all too easy to lose sight of how this industry is viewed from outside.

I am a voracious reader of news – I have to be – and I can see how mainstream media commentators, politicians and the general public regard wealth management, along with financial services more broadly, in a bad light, often rightly. A challenge is to show what complex-sounding financial services deliver to the broader public. If the value of financial services is not spelled out, then inevitably, vote-hungry politicians will enforce damaging policies.

Three recent examples of misguided attacks on financial services highlight the problem. First of all, take the case of a conference on offshore financial centres. Last week, in the gloriously Victorian setting of the National Liberal Club in Whitehall, I attended an event focused around the Cayman Islands and organised with the help of the Society of Trust and Estate Practitioners. Besides the collection of bankers, lawyers and accountants was yours truly as a panelist. The event was moderated by John Humphries, the pugilistic BBC broadcaster and quiz show host.

Humphries asked how the industry can feel happy when billions of dollars – some of it probably criminally sourced - is stashed in tax havens rather than used to help the starving millions? Trite, you might say, and grossly unfair. But that sort of comment is what a lot of intelligent people think and say.

Of course, there were strong rebuttals. For example, it was pointed out wealth is not zero sum: If I am wealthy and invest it outside my country of residence, I am not taking from the mouths of the poor if I have acquired that wealth fair and square in a free market (it is obviously different where criminality or political favouritism is involved). Also, why is my not having my wealth almost confiscated at rates of 50 per cent or more by the State somehow "taking" it from someone else?

Also, it was pointed out that offshore centres' standards of corporate governance, legal robustness and transparency are as good as, and frequently better, than those of the Group of 20 major countries that chide offshore centres. (OECD staff salaries are tax-free, by the way). There is considerable evidence – as shown by the UK’s recent Foot Report on the role of offshore centres – these places act as useful booking centres for wealth that ends up being managed in the UK, supporting thousands of jobs. What is more, efficient, tax-neutral jurisdictions such as the Cayman Islands enable investment funds to maximise client returns – which you might think would impress pensioners and those expecting to comfortably retire.

These points need to be made in the wider media, not just specialist conferences. And just as important, the way that low-tax financial centres challenge a potential OECD tax cartel needs to be made. By forcing even high-tax, high-spend politicians to curb their taxing by the threat of competition, tax havens perform the unintended benefit of keeping taxes lower than otherwise would have been the case. Consider it a version of Adam Smith's famous "Invisible Hand". (On the other side, tax emigres, arguably, leave those behind having to pay more tax to make up the difference).

“Social optimality”

A second example of how financial services come under attack came from the very man who leads the UK financial regulator. Lord Adair Turner, chairman of the Financial Services Authority, reprised an old tune: many financial transactions are “socially useless”. Seen in one light, he seems to suggest that a large chunk of what the City does should be shut down.

In a speech at Southampton University, the FSA chairman said: “We need to challenge the idea that financial innovation is axiomatically beneficial in a social as well as private opportunity sense. Much of it focuses on the zero-sum activity of tax avoidance and much of it only creates apparent value because the buyers of products do not fully understand the risk-return characteristics of the products being sold.” And in another point, he said: “We need to challenge the idea that more trading and more market liquidity are always economically beneficial.” And his third: “We need to challenge the idea that the bigger the financial system is the better. It may not be if the industry is involved is rent-extracting rather than value added activities.”

Let’s unpack this. First of all, his talk – which contains a lot of interesting ideas – overlooked, as far as I can tell, the major responsibility of central banks and their low-interest rate policies in causing the credit boom and ensuing collapse. For example, in the early noughties, US official interest rates were negative, and almost anyone could get a mortgage. If interest rates really reflected supply and demand for savings, some of this craziness would not have happened. Also, while Lord Turner touched on the idea without naming it, he did not say whether the idea of fractional reserve banking is relevant here in his comments on "unstable credit creation". (FRB is a process whereby a bank is allowed to lend out more credit than is covered by deposits). The “Austrian” school of thought argues that fractional banks, when propped up by central bank lending in particular, cause boom-bust cycles. This admittedly controversial idea deserves more attention. (To view a recent related article, click here). 

The “socially useless” charge that Lord Turner made particularly concerns me. How can he or anyone else judge what is the "socially" right size for a financial sector relative to other economic activity? Suppose we had a free market in money and banking and none of the artificially created credit from a central bank (plus no tax bailouts, no lenders of last resort, no legal tender laws, etc). Even with more prudent lending, we would still need to hedge price fluctuations and require speculators to bear that risk. (This is how the mighty commodity trading market in Chicago and the Lloyds of London insurance market started). Maybe this would not involve some of the bizarre-sounding instruments that we associate with the 2008 bust, such as credit derivatives, but there’d still be options and futures trading. It is astonishing, in my view, that the head of a national financial regulator mocks the virtue of rising liquidity as a good thing. Liquid markets aid price discovery; they are a function of relatively low barriers to entry. (On a related point, here is my recent review of a book about credit and banking risk practices).

Tobin tax

A third example of financial markets under misguided assault, in my view, are the calls by the EU last week to slap a so-called Tobin Tax (named after the economist James Tobin who once suggested the idea) on financial transactions. Predictions vary, but anyone familiar with the issue of tax incidence – the idea that taxes are costs and will be passed on – can see that such a tax will drive up prices for certain financial products, cut returns, increase borrowing costs, or all three at the same time. The ordinary man or woman who wonders why it costs so much more to get a mortgage or buy foreign currencies on holiday may not join the dots between these things and taxes, but the connection is there and should be explained.

Explaining to the wider public that bashing banks, tax havens and markets, however superficially persuasive, is bad not just for the rich but the population in general may seem fruitless, particularly when there is so much else to do. But history can offer us inspiration. I thought of this last week as I sat in the National Liberal Club. That building was erected by the-then Liberal Party, whose founding figures, such as John Bright, Richard Cobden and William Gladstone had campaigned to axe tariffs in the mid-19^th Century. Their anti-tariff campaign, and championing of responsible capitalism (they did not ignore the nasty underside of the Industrial Revolution), was hugely effective. And one reason for their success is because they made the link between free markets, finance, and rising living standards for the ordinary man and woman. That connection needs to be made again.