Daniel: A tiny fraction of all banking activity—less than 3% in Britain, for example—actually goes to businesses making things. You know, building cars, developing software, growing food. Sophia: Wait, less than three percent? That can't be right. That’s shockingly low. What on earth are the banks doing with the other 97 percent of our money? Daniel: That is the central, explosive question at the heart of a book that has become a modern classic on this very topic: Other People's Money by Sir John Kay. Sophia: And Kay isn't some outsider throwing stones, is he? I remember reading he's a distinguished economist, knighted for his work, who has been inside the halls of power, advising governments. That's what makes his critique so devastating. Daniel: Exactly. He’s not an anti-capitalist radical; he’s a deeply respected insider. He wrote this in the long shadow of the 2008 financial crisis, and it was immediately named a book of the year by publications like The Economist and the Financial Times because it so perfectly diagnosed the sickness in the system. And his diagnosis starts with a wonderfully simple story... about an ox.

Sophia: An ox? Okay, you have my attention. How does an ox explain the modern financial system? Daniel: Well, Kay opens the book with this brilliant parable. It starts in 1906, at a country fair where there's an ox-weighing competition. A statistician named Francis Galton is there, and he notices something amazing. Hundreds of people guess the ox's weight, and while individual guesses are all over the place, the average of all the guesses is remarkably, almost perfectly, accurate. It’s a beautiful demonstration of the "wisdom of crowds." Sophia: Right, I've heard of that. The collective is smarter than any single individual. A feel-good story. Daniel: It starts that way. But then, Kay's parable takes a turn. The fair organizer, seeing how well this works, decides to get rid of the physical weighing scales, which were old and unreliable anyway. From now on, the official weight of the ox will simply be the average of everyone's guesses. Sophia: Huh. Okay, I can see how that might be a problem. You're measuring the measurement, not the thing itself. Daniel: Precisely. And then it gets worse. To make the competition "fair," new rules are introduced. No one with privileged information, like the farmer who actually feeds the ox, is allowed to participate. Professional analysts are brought in. But what do they analyze? They quickly realize that the key to winning isn't guessing the ox's real weight. The key is to guess what the average guess will be. Sophia: Hold on, so they're not even looking at the ox anymore? They're just analyzing... each other? Daniel: That's the genius of the metaphor. Their job becomes predicting the psychology of the crowd. They create complex mathematical models, not to estimate the ox's weight, but to estimate the average estimate of the ox's weight. The entire industry becomes self-referential. They're all just staring at each other, trying to guess what the other person is thinking. Sophia: That is a perfect analogy. It’s like a group of weather forecasters who stop looking at the sky and just spend all their time trying to predict what the other forecasters will say. It's a closed loop of nonsense! Daniel: A perfect, and very profitable, closed loop. And then comes Kay's devastating punchline. One day, everyone arrives at the fair, and the ox is dead. Sophia: Oh, no. Daniel: It had starved. In all the excitement of guessing its weight, in all the complex analysis of market sentiment and prediction models, everyone had forgotten to feed it. Sophia: Wow. And the ox… the ox is the real economy. Daniel: The ox is the real economy. It's the companies that need loans to expand, the infrastructure that needs funding, the households that need mortgages. And Kay’s argument is that the financial sector, in its pursuit of trading profits, has become so obsessed with guessing the guesses of others that it has forgotten its fundamental purpose: to feed the ox. Sophia: And that brings us back to that shocking statistic you opened with. That's how you get to a point where less than 3% of banking assets are actually funding the "ox." The other 97% is just the analysts trading bits of paper with each other inside the tent. Daniel: Exactly. It's trading in securities, derivatives—which are essentially bets on the performance of other securities—and high-frequency trading where computers trade with other computers in microseconds. Kay cites this incredible example of a company called Spread Networks that spent hundreds of millions of dollars to build a new, straighter fiber-optic cable through the Appalachian Mountains, just to shave a single millisecond off the trading time between Chicago and New York. Sophia: A millisecond? For what? Daniel: For nothing that benefits you or me, or any real business. It's purely for high-frequency trading algorithms to get their orders in a fraction of a second before a rival algorithm. It's an arms race within the closed loop. The people in the tent are just getting faster at guessing each other's guesses. Meanwhile, the ox is getting thinner.

Sophia: Okay, that explains the detachment, the absurdity of it all. But if they're just trading paper with each other in this closed loop, how are they making such obscene amounts of money? Where do the profits actually come from? If I trade a baseball card with you back and forth, no new value is created. Daniel: Ah, that is the million-dollar—or rather, trillion-dollar—question. And Kay's answer is that much of the profit is an illusion. He introduces this fantastic concept from Charlie Munger, Warren Buffett's partner, called the "febezzle." Sophia: 'Febezzle'? That sounds like something from a Dr. Seuss book. What in the world does it actually mean? Daniel: It's a brilliant term. It's short for "functionally-equivalent embezzlement." The original "bezzle," coined by economist J.K. Galbraith, is the time between when an embezzler steals money and when the victim realizes it's gone. In that window, the embezzler feels richer, and the victim feels no poorer. There's a temporary, imaginary increase in the world's wealth. Sophia: I see. It's phantom wealth. Daniel: Exactly. And the "febezzle" is the same idea, but without any crime being committed. It's the illusory wealth created by a bubble. Think of the dot-com boom or the housing crisis. For a while, everyone feels rich. Your house value is soaring, your tech stocks are skyrocketing. It feels real. But it's an illusion, a febezzle, that is waiting to be destroyed. Sophia: And the financial sector got very, very good at creating these illusions. Daniel: They became masters of it. Kay uses the story of Enron, the energy company that collapsed in a massive scandal. Enron pioneered the use of an accounting practice called "marking to market." Let's say they signed a 20-year contract to supply gas. Instead of booking the profit each year as they delivered the gas, they calculated the entire expected profit over the full 20 years and put it on their books as profit on day one. Sophia: That sounds completely insane. They're counting money they haven't even come close to earning yet. Daniel: It created enormous, immediate, and entirely fake profits. It was a giant febezzle. And this kind of thinking, this focus on creating upfront, tradable "value" out of future promises, infected the entire financial system. They weren't just trading assets; they were trading claims on other claims, creating a house of cards built on illusory value. Sophia: Which inevitably has to collapse. And when it does, the febezzle vanishes. But the bonuses the bankers paid themselves out of those fake profits... those are very real. They don't vanish. Daniel: They do not. And that brings us to the final, and perhaps most infuriating, part of Kay's argument: the profound lack of personal accountability. When the system collapses, as it did in 2008, what happens? Sophia: The public bails them out. Daniel: The public bails them out. And the institutions themselves get fined. Kay points out that J.P. Morgan paid over $25 billion in fines in just two years. It sounds like a huge number, a real punishment. Sophia: But it's not, is it? It's just the corporation paying. It's a line item in their budget, paid for with shareholder money. The individuals who made the decisions, who ran the departments, who got rich from the febezzle—what happens to them? Daniel: Almost nothing. They claim to be "shocked and appalled" at the behavior of some rogue underling. They testify before Congress, saying they are "physically ill" at what happened on their watch. And then they retire to their yachts. Kay contrasts this sharply with what happened in Iceland after their banking system collapsed. Sophia: What did they do? Daniel: They put the bankers in jail. The chairman and chief executive of the failed Kaupthing bank were sentenced to prison. Iceland understood that fining a corporation is like fining a building. It doesn't change behavior. The only thing that changes behavior is personal consequence. Sophia: That's infuriating. So in the US and the UK, it's a system where the upside is privatized—the executives keep the bonuses—but the downside is socialized—the public pays for the bailout and the shareholders pay the fine. There's no personal risk for the people at the top. Daniel: It's a system that is perfectly designed to encourage reckless behavior. There is every incentive to create a massive febezzle, pay yourself handsomely from it, and then feign shock when it all comes crashing down.

Daniel: So when you put it all together, you see the full, horrifying picture Kay is painting. You have a system that has become dangerously detached from the real world—the dead ox. It's creating enormous, illusory profits—the febezzle. And it operates with almost no real personal consequences for failure. Sophia: It's not a system with a few bad apples. Kay's point is that the barrel itself is rotten. The very structure and incentives of modern finance are the problem. Daniel: Precisely. And it forces you to ask a very fundamental question, one that I think is the core of the entire book. Sophia: What is the purpose of finance today? If it's not primarily serving the real economy, if it's not feeding the ox, then who, or what, is it actually serving? Daniel: It's serving itself. It has become its own purpose. And Kay's proposed solution is radical in its simplicity: re-establish personal responsibility. He has this one line that I think should be carved in stone above the entrance to every bank in the world. Sophia: What is it? Daniel: "If you take the remuneration, you take the rap." Sophia: Wow. Imagine if that were the actual rule. If you're the CEO, and your bank gets a billion-dollar fine for misconduct, that money comes directly out of your compensation and the compensation of your top executives. Daniel: The whole system would change overnight. The focus would shift from managing regulations to managing actual risk. The incentive to create a febezzle would evaporate if you knew you were personally on the hook when it disappeared. Sophia: It's such a simple, common-sense idea. It makes you wonder why it's considered so radical. So, the next time you hear about record profits in the financial sector, or see another headline about a multi-billion dollar fine, maybe the question to ask isn't "How smart are they?" but "Whose ox is being forgotten?" Daniel: That's the perfect takeaway. It reframes everything. Sophia: A powerful and deeply unsettling book. Thanks for walking us through it, Daniel. Daniel: This is Aibrary, signing off.