The Capital Institute Presents: An Agenda for Genuine Financial System Reform


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An Agenda for Genuine Financial System Reform

Ask yourself: What would a financial system need to look like to serve the emergence of regenerative economies?

This is a call to transform finance. That transformation will remove obstacles to the emergence of a healthy, regenerative economy, and will materially shrink the financial sector in the process.

Legendary systems scientist Donella Meadows[ii] once wrote that vision is the most vital step in the policy process. Unfortunately, our policy process rarely dares to imagine a new vision. Instead, it begins with implementation without even questioning underlying worldviews and the models that arise from these worldviews.

What structural reform is necessary even in a world where we rid the finance industry of irresponsible behavior, fraud, and reckless greed? Finance, both its reductionist ideology and its extractive practices, is perhaps the single most influential factor in our unsustainable and degenerative economic system. Crucially, we are running out of time to fix the environmental crisis our current economic system has created.[iii] This year alone we have seen fires, floods, a 100 year pandemic in Covid-19, and various social movements like Black Lives Matter (BLM) that we believe partially stem from responding to the exacerbated effects of climate change in predominantly BIPOC communities known as Environmental Racism.[iv] These issues can and must be addressed by where and what we invest in to create real change, as we will discuss below. The present moment demands a new shared vision of the purpose of finance, and a bold, comprehensive policy reform agenda. Put simply, the reforms of Regenerative Finance is the application of nature’s laws and patterns of systemic health, self-organization, self-renewal, and regenerative vitality to socio-economic systems.

Our vision for finance first clarifies means and ends. The purpose of Regenerative Finance is to serve the emergence of a new economic system that works for people and the planet, generating a broadly shared prosperity. Any serious policy framework must serve this end.  Otherwise, as is often the case, so-called “policy reform” is reduced to a game of cops and robbers — a reactive response to the worst of the ethical shortcomings so prevalent in finance. The most prominent financial reforms in the modern era, Dodd Frank and Basil III[v], were the collective response to the worst transgressions of the financial crisis of 2008. But capital controls and other regulations intended to limit bad behavior and systemic risk, useful as they are, hardly amount to a vision for prosperity. At Capital Institute, we define Regenerative Finance as the application of nature’s laws and patterns of systemic health, self-organization, self-renewal, and regenerative vitality to socioeconomic systems.

 

 

Holistic Approach

We assert that the boundaries between the public sector and private sector in finance are largely artificial.  What we have in practice is an interdependent continuum, with the public sector (government financial flows, central banks and their subsidies and backstop to the banking system and now even the entire public capital markets, public and quasi-public financial institutions, and the regulatory architecture) playing a fundamental and foundational role like no other industry.  Therefore, no policy agenda for financial reform is possible without taking a holistic view of both public and private finance.  Therefore, those of us in the “sustainable finance” community need to focus as much energy on the public sector as we do the private sector. Remember, public sector investment’s sole purpose is to be in the interest of the common good, not to maximize return on investment (calculated in the conventional reductionist fashion.) What better place to begin!

We will also see that the public-sector imbalances and structural flaws are at least as problematic as the private sector imbalances and resulting improprieties, something missed when we look at financial reform through a reductionist, “fix the leaks” lens. The 2008 mortgage fiasco, for example, was in part a private sector finance failure of reckless greed and fraud. However, it was also a failure of public policy and public investment due to the well-intended but misguided, and outsized influence of the Federally sponsored mortgage agencies Fannie Mae and Freddie Mac. The proposals we share below are an attempt to present a path forward to a more proactively designed financial system in service of life and a finer future by aligning the design with living systems patterns and principles.

The Importance of First Principles and a Living Systems Paradigm to Defeat Collapse

Our approach to a policy agenda for financial reform has been to follow a path we believe Meadows would have endorsed. It is grounded in the science of living systems, anchored by the eight principles of Regenerative Economics first introduced in the Capital Institute’s 2015 booklet, Regenerative Capitalism: How Universal Principles and Patterns Will Shape the New Economy[vi].

We have asserted that Regenerative Economics is the next phase of evolution of our economic thinking, extending the insights of Ecological Economics to embrace a full living systems paradigm in order to unlock the regenerative potential that must be our new source of prosperity, displacing extractive and undifferentiated growth.  The destination for true financial reform, therefore, must be to catalyze the emergence of an economic system that is regenerative of all individuals, all communities, all life and the planet itself.  We imagine a network of place sourced[vii], interconnected and interdependent regenerative real economies, each emerging in the unique context of culture and place. It is a vision that looks at bioregions as a central unit of analysis, where geological imprints and human culture intersect.  Such a vantage point will complement and challenge our conventional look to Nation States and Corporations as the preferred unit of analysis.  In this vision, global corporations see themselves as members of multiple bioregional economies before they see themselves as a top down global hierarchy.  It is a vision in which such a global network of regenerative developmental activity self-organizes and replicates in a tapestry of diversity. Such regenerative economies behave as living systems themselves, evolving to such a degree that they eventually transform or fully displace the tired extractive and degenerative economic system that is no longer fit for purpose. That system now threatens life as we know it on planet earth, while failing to address the morally repugnant social inequities and racial injustice that are sowing the seeds of worsening political upheaval if not revolution.

Systemic breakdown and even the collapse of Modernity may well be underway.  Indeed, such a reality has already begun to define the 2020s, which began with Australia on fire, floods and hurricanes ravaging the globe, desertification marching steadily on, political extremism and autocracy overtaking a growing share of the world’s nations as well as numerous failed states. And now the Western United States is on fire during the worst pandemic to befall humanity in a century causing depression level unemployment and an unprecedented strain on fiscal balances. And just when it could not get any worse, we see the eruption of a long overdue global protest movement in response to the horrific murder of George Floyd in Minneapolis at the hands of the police while he lay handcuffed, face down, on the pavement. The pressure seems unbearable at times.

In contrast to the devastation we are seeing in our societies and in the natural world, the vision of a regenerative economy is guided by a holistic understanding of living systems design and guided by our eight living systems principles. Such a living systems frame is remarkably aligned with the many wisdom traditions that have stood the test of time, particularly from indigenous cultures, the only human cultures that have sustained themselves throughout the course of human history. Within this living systems frame, we can hold the breadth of shared human values such as equity, dignity, security and compassion that rest at the heart of any vision for a just society. But human values are not the same as living systems principles. The premise of regenerative economics is that the former can only be sustained over the long run if our political economy is aligned with the latter.  Just as we must obey the laws of physics, we must align our economic system with living systems patterns principles.  This is the urgent message of the moment.

Specifically we embrace the science based ecological limits of our finite planet articulated by Johan Rockstrom, et al, as “planetary boundaries.”[viii] These must be understood not as targets, but as non-negotiable thresholds we must respect in order to protect the integrity of earth systems upon which all life depends.

We also recognize the imperative of social floors, such as access to healthy food, clean water, healthcare, and education. The specific social floors are inevitably more subjective than ecological thresholds but they are not independent from the thresholds (ex. Think about different economic purchasing power required for basic needs in different regions of the world). Together though, these ecological limits and social floors have been cleverly visualized by Kate Raworth as a doughnut in Doughnut Economics.[ix] The Doughnut thresholds broadly align with the United Nations’ Sustainable Development Goals.

Finance is a critical and powerful leverage point to shift the system. To have a chance of meeting the current moment and restructuring the economy to anything resembling “sustainable”, finance must be transformed for the primary purpose of serving the emergence of regenerative economies, the only true path to “sustainability” as an outcome. We will not constrain our argument by any preconceived ideological limitations on what finance can be, should be, or should be allowed to do beyond this clear purpose: to serve the emergence of regenerative economies. Anything that is in conflict with this purpose must be discouraged if not eliminated. Anything in support of this goal must be encouraged and perhaps incentivized. Other than that, we let the 8 principles for a regenerative economy[x] guide us and the chips fall where they may.

Admittedly, a practical implementation plan is still forming in our imagination, made harder by our broken political system and the necessity of global adaptation to a significant degree. But without a clear vision and goals, and a more accurate model aligned with reality, reality with how living systems actually work, we have no chance of designing policy prescriptions with a practical implementation plan to help guide us where we really need to go. Limiting ourselves to policies that are easier to achieve politically but do not transform the destructive path we are on is a waste of precious time.

The following ten part framework for regenerative financial reform is the crux of the final act, Act IV[xi], of the Capital Institute’s booklet Finance for a Regenerative World[xii]. Only if we align finance and the economy it must serve with the patterns and principles of living systems, can we expect these systems to sustain themselves over the long term.  In doing so, we will unlock the seeming miraculous potential demonstrated by life itself directly into our economies, as the source of true human thriving into the future.

Some will reject this vision as unrealistic or utopian, some may balk at the scope and scale of these proposals.  They threaten activities and even the mere existence of many powerful interests, so implementation will be a long, and hard-fought struggle.  Some of these policy shifts will have a progressive tone, while others will sound more rooted in free enterprise thinking grounded in the entrepreneurial energy that is so vital to our economies.  Living systems patterns are what they are.  They belong to no political parties or ideologies.

We believe that these policies would collectively shift finance and investment — and with it, the entire real economy — decidedly in a regenerative direction.  Perhaps more importantly, they would curb the most extractive and degenerative elements of the present financial system.  It is not hyperbole to suggest that the future of life on earth is dependent upon our success in finding the will to implement such policies on a global scale.

 

 

 

Ten-Part Framework for Regenerative Financial Reform

 Allowing our 8 Principles of regenerative economies[xiii] to guide our judgments as explained in detail in the full paper[xiv], here is the policy reform agenda that I propose for the United States, adaptable to the context of other countries as well.

1. Curtail Speculation

  • Curb excessive speculation with an iron fist. Trading volumes will collapse by more than 50% or the policy is not effective.
  • Create incentives that encourage capital to flow into real investment rather than financial speculation, and particularly into projects aligned with the transition to regenerative economies.
  • Implement a combination of a broadly applied and meaningful financial transactions tax (FTT)[xv] as well as reworking capital gains tax to only reward critical real investment.

2. Reduce Leverage

Financial leverage in its many forms enhances capital efficiency while reducing systemic resiliency.  The system lacks resiliency, while exogenous shocks are accelerating.

  • Reduce or eliminate tax incentives for excess leverage such as the deductibility of interest other than for targeted real investments
  • Increase incentives for equity and risk-sharing partnership models.
  • Impose hard limits on excess leverage that harm resiliency while increasing pressures on employees and the environment.

NB:  The combination of the first two policies if implemented as intended, would shrink Wall Street (and Wall Street compensation) dramatically and thus will be fiercely fought.  That fight will signal we are on the right track.

3. Regulate for Fractal Structure 

A healthy financial metabolism ensures the circulation of money into small and mid-sized enterprises at regional and local scale rather than allowing ever more concentration at the top as is the case today.

  • Rebalance the structure of the finance industry to heavily penalize systemic risk and concentration. With the appropriate capital controls that are pro-systemic health, Too Big to Fail firms will deconstruct themselves in a way that is more capital efficient, leaving the system healthier in the process and requiring no heavy hand of government to “break up the banks.”.
  • Encourage structural diversity and broad circulation in the flow of capital by following the design of effective circulatory systems, such as our fractal cardiovascular system. This means encouraging a diversity of smaller regional and local financial services businesses that serve the real economy.

4. Prioritize Business Formation

  • Public finance and policies should encourage capital flow into new business formation in clusters — and into small business expansion — with emphasis on “green” business and social enterprises of all shapes and forms addressing genuine societal well-being.
  • Curtail emphasis on state-sponsored subsidies to large and concentrated business enterprises, while updating anti-trust laws for the 21st This of course means getting serious about special interests and overturning Citizens United (corporations are not people).

5. Reform Tax System

  • Reimagine the tax structure[xvi] to tax “bads” like pollution and excess speculation[xvii] rather than “goods” like ordinary income.
  • Socialize windfall profits and dynastic wealth[xviii] into both social and natural capital stocks that have been systematically depleted.
  • Shift the tax burden away from work (a “good”) and toward invested capital with offsetting incentives to high regenerative impact capital projects. This is not to say capital is bad in itself, but too much capital chasing returns on a finite planet has become a form of systemic pollution where the polluter wins and society pays the consequences.
  • Upgrade the social safety net to enhance systemic resiliency by ensuring all participants are empowered to participate in the This is good for both individual health and systemic health.  A guaranteed minimum income of various forms is likely to be part of this design, so innovation and experimentation in this area is essential.

6. Test Sovereign Money

  • Launch multiple diverse, controlled, regionally-designed, sovereign money experiments of meaningful scale, beyond QE, in accordance with Modern Monetary Theory (“MMT”) (for more on this, see Act III of this series[xix]).
  • Target renewable energy infrastructure assets, labor-intensive infrastructure repairs and upgrades, green infrastructure projects that restore vital ecosystem function, regenerative agriculture, related regional food system infrastructures, and community health care services with emphasis on prevention.
  • Experiment with education and healthcare systemic investment and a guaranteed minimum income, all of which help ensure all citizens are empowered to participate (one of our principles[xx]) in the economic transition.

7. Realign Fiscal Spending and Investment Priorities

  • First, cut government waste and outdated priorities that are not responsive to the new context of the 21st century. Eliminate extractive and degenerative public investments and tax policies such as fossil fuel subsidies, industrial agricultural subsidies, capital investment subsidies over labor, and out of proportion defense expenditures.
  • Replace these with regenerative public investments in education of all types, in physical and mental health focused on prevention, in the public health system, in the energy transition, in regenerative agriculture, in innovative social enterprises, and in the social safety net — all in alignment with forward-looking national security priorities and genuine well-being.

8. Realign Public Research Investment

  • In the new world of complexity, public investment must prioritize addressing root causes over-responding to the never-ending escalation of symptoms.   Bold new commitments to research in energy technologies, advanced material science, green chemistry, soil science, and regenerative agriculture, in public health systems and an understanding of how to invest in human immune systems, are all essential in order to catalyze innovation in these vital areas.

9. Redesign Philanthropic Incentives and Constraints to Accelerate Impact

  • Tax dynastic wealth if not redeployed to serve the common good with clear guidelines set by alignment with natural systems processes.
  • Increase incentives to accelerate the shift of dynastic wealth into charitable vehicles with greater accountability to the common good.
  • Unblock the sclerosis within the philanthropic sector that prolongs the perpetuity of individual foundations. This will involve among other steps increasing the annual distributions required by law from 5% to at least 10%, while imposing lifetime limits over private foundations.

NB:  An effective policy shift would unleash a 10-fold plus increase in annual philanthropy immediately, while catalyzing a shift far larger in the underlying investment assets which would directly target critical needs such as the transition of our energy, food, and healthcare systems.  At the same time, it would confront head on the toxic dynastic wealth that is destroying our collective social capital.

10. Establish a Capital Investment Review Board (CIRB)

  • Establish a Capital Investment Review Board, perhaps at each of the twelve regional Federal Reserve Districts, to review the regenerative quality of all public and private real capital investment programs greater than $250 million.
  • Empower the CIRB to have firm veto power over the most degenerative investments such as fossil fuel extraction and mining.

Holism Holds the Key to a New Narrative for Finance

A holistic understanding of economics rightly views the financial system as a subset of the economic system, embedded in it, and not separate from it. Finance’s proper function is therefore clear: to work in service of the larger whole, the real economy. This is no different than a brain’s work or a nervous system’s work is in service of a whole person in a human system. Such a relationship demands a fresh look at finance from outside the arcane theories and practices developed within finance, often devoid of an appreciation for the more important wider context of interdependence. Such a look will inevitably lead to unconventional and controversial conclusions, quite distinct from a “within system” critique of finance. This series of interconnected assumptions lays out a new narrative for the purpose of finance that is inextricably linked to the emergence of what I have called Regenerative Economics.[xxi]

We do have a guidebook to create a more sustainable way of living. We must look to the science of living systems – complex systems that have generated immeasurable and increasing abundance, including the miracle of life itself and by necessity, our modern economy that flows from it – as our guiding light. Such systems have sustained themselves and actually generated and accelerated ever more complex forms of life from life for long periods of time. They are also remarkably aligned with our wisdom traditions, particularly indigenous wisdom, that too have stood the test of time. A leap from a belief in our failed economics to trusting in the patterns and principles of living systems science as a design premise for human economies is “radical,” as in, getting to the root of the matter. It demands humility, and a belief in the power of intuition, synthesis, and extrapolation running ahead of empirical certainty. It values being directionally correct in contrast to being precisely wrong which is too often the case with our current economic models that are built on a foundation of flawed assumptions and inaccurate statistical models. It requires freeing ourselves from our Modern Age reductionist worldview and adapting a holistic and integrated worldview, in which relationships are more important than parts, and the whole is understood and honored as being greater than the sum of the parts.

This vision assumes that human beings are complex living systems, and that we are embedded in, and not separate from, the complex and interdependent living ecosystems that are in life giving balance, from the water cycle to the carbon cycle and much more, that provide critical ecosystem functions on this planet, life’s “essential workers” without which there is no human race much less a human economy.

The Future of Finance

As mentioned above, these policy recommendations will be fiercely resisted by the financial establishment. They can rightly be critiqued as “unrealistic.” But without a clear vision of what is needed, we have no chance of attaining it.  It is past time to begin the real conversation we desperately need.

The real problem with our many failed efforts at financial reform that seem to lead to ever more and larger financial crises is a lack of imagination. If nothing else, the Finance for a Regenerative World[xxii] series is an intentional exercise in informed imagination. The longer we resist dealing with the reality of genuine financial reform, the greater will be the damage done until at some point we reach the point of no return for society, and indeed for the human project. The stakes could not be higher.

Fortunately, with the pressure rising, the regenerative financial green shoots are emerging all around us. Our task now is to connect, nurture, reinforce, amplify, and enhance this emergence into a powerful new story of not only what’s possible, but what is essential and ultimately inevitable.

This is the future of finance. This is the critical path to a Regenerative World.

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