The city forgets its raison d'etre and stampedes out of control.

Once upon a time, in the good old days life was rather simple.
Everybody knew that the Stock Market served the purpose of bringing together people with an interest in backing companies and those who needed capital to develop their businesses.
Investors knew that they were investing in companies whose shares were quoted on the markets - the better, more successful ones amongst them generally studied companies very carefully and invested for the long term, just like Warren Buffett does to-day.

Now, all of that is changing. Investing in companies is becoming a fringe activity, speculating on share price movements and even more exotic forms of gambling, using a profusion of rather mysterious financial devices are becoming the norm.
The result of all of this is almost entirely destructive - companies are undermined by 'investors' who care not a jot about their long-term health, small investors are exposed to unknown levels of risk for uncertain rewards - we are seeing a system that is roaring madly out of control.
Who are the drivers of this madness? - mainly the large investment banks, which have become little more than vehicles for speculation.

Lest readers believe that we have taken leave of our senses, we would like to quote verbatim a piece by Anthony Hilton, the respected City editor of the 'London Evening News', published on May 11 2004.

Easyjets shares plunged 30% last week when the company announced, in common with other low-cost airlines, it was having a tough time.
Nokia shares fell 30% the week before for similar reasons.

Something very serious is happening here.

What these movements underline is how hedge funds have come to dominate the activity of the London Stock Exchange and trading in the big international blue chips.
The City pressures companies to promise growth as a precondition for taking an interest in the shares. When a company fails to live up to the promises it has been pressured into giving, it is savagely punished.
The hedge funds know there is money to be made by selling the stock short at the faintest whiff of disappointment. They have the money and power through their close relationships with investment banks like Goldman Sachs and Morgan Stanley to deal in huge volume.

So 110 million shares changed hands in the hours after Easyjet's gloomy announcement, according to chief executive Ray Webster. That is more than 50% of the free float of the company because 42% of the 360 million shares in issue are held by founder Stelios Haji Iaonnou and his family.
Activity on that scale is out of all proportion to the nature of the profit warning and the change in Easyjet's prospects.
It shows how distortion, manipulation and the use of overwhelming force have become endemic in the market.

Some commentators have said that Webster is wrong to complain about this treatment, but he is surely not alone in thinking that this was not how stock markets were meant to work. The stock market is where people with an interest in backing companies meet people who need capital to develop their businesses.
That is its reason for existence.
Hedge funds and the prime brokerage activities of investment banks are turning the place into a casino where genuine long-term investors and companies are overwhelmed by their superior financial resources.
If this continues, the stock market is stripped of its usefulness and becomes of as much value to society as a high-stakes poker game.

Already the market is no place for an individual investor. Increasingly, however, it is no place for professional institutional fund managers either. It is not just a question of the chaos caused by excessive volatility.

Institutional investors do not get access to the fine terms and choice deals brokers reserve for the hedge funds. They lack the technology and access to deal on the finest terms. They no longer get first sight of the choicest deals. On the contrary, they suspect that every deal that they do is likely to have a hedge fund or two riding on its back.

Some institutions have even started offering higher commissions to brokers in the hope of encouraging more favourable treatment. It underlines how worried they are at being treated like second class investment citizens.

The City spends a lot of time considering plans to reward executives with shares.
The premise is that the growth in the share price will be a reflection of the medium-term success of management in growing the business.
Hedge funds and prime brokers are destroying the nature of that premise, and if they continue unchecked they will destroy popular support for the stock market itself.

Meanwhile they simply devastate the morale of managements who see share price movements that bear no connection to the work they are actually putting into a business.

The 'Economist' magazine of August 28, 2004 also weighs in with its own concerns. Under the heading, Worryingly, big banks are in danger of turning into little more than hedge funds, it states.........many investment banks - and commercial banks with investment-banking arms - have decided that trading is, after all, a wonderful business. They already seem to have forgotten the lessons of the late 1990's, when many reduced their trading activity because many thought it was too risky
More worrying still is the fact that the bets the banks are now making in their trading operations are much bigger because markets are less volatile. In such markets bigger bets are necessary to meet profit targets. And in consequence the biggest worry of all is what happens to the world's financial system if a large bank or fund runs into trouble as a result of trading losses...... It has happened before. In 1998, many banks were pushed to the edge when Long-Term Capital Management, (What a gloriously misleading title! - authors), a giant hedge fund, fell apart, a financial meltdown was avoided only when the federal reserve co-ordinated a bail-out by the fund's bankers. The level of speculation is greater now than it was then.

So, the banks and financial markets are destabilising companies, excluding genuine long-term investors in industry and threatening the whole system of industrial capitalism.

John Maynard Keynes hit the nail right on the head many years when he said, Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done.

It seems that there is a desperate need to establish more responsible and less speculative means of bringing together companies and capital - and it is likely that they should be new and outside the scope of the current financial markets - they have probably become too corrupted by the speculators to be good cases for reform.