Archive for the ‘business’ Category

Bank Regulation: the answer is transparency

If you haven’t seen yesterday’s epic rant by Paul Mason, Channel 4’s economics correspondent, do now.

But there’s a problem with regulation: it doesn’t work. 

Regulators are never as well-resourced as the banks. So they can’t afford to employ the smartest people. Or not for long, anyway – a good career move is to spend a year or two working at a regulator, then move into compliance with a major bank. Gamekeeper turned poacher.  When you work in compliance at a bank, you’re not a policeman – you wouldn’t last long if you kept on preventing profitable deals (the ones that in the end go to paying your salary).  Your job is to provide the whitewash.

So there’s a brain drain from the regulators to the banks. What’s more,  much of  the young talent working in the regulators has an eye on this career path so won’t do anything to mess it up.  Like get involved in pursuing an enforcement case against a possible future employer.  And the regulators really don’t like pursuing enforcement cases, particularly not criminal ones. The lawyers are lining up on both sides to take their fees, and the banks won’t skimp on paying for the best. If the regulator loses, there’ll be questions asked in Parliament about the waste of taxpayer’s millions, and the banks will be saying “we told you we were perfectly innocent”.  If the regulator wins, the bank puts the cost down as a routine cost of business and fires the compliance officer for failing to apply enough whitewash.

And what were the auditors at RBS doing? Who appoints them? Duh.

There is an answer, though. Less regulation, more transparency.  Much, much more transparency.  So much transparency that it completely changes the way the City works.

No secret deals.  A secret deal is a dodgy deal, so make unenforceable any deal that has any element of secrecy. 

Publish everything IN REAL TIME.

Let us be the auditors with a GoogleBot.

If I can’t find out everything about a deal as it happens,  from my smartphone in the cafe over the road, it’s not transparent enough.

It’s how it used to be.

Well, not quite. But trading was much more public when it was by open outcry on public trading floors. Deregulation and electronic trading came in at about the same time.  Before then, honour – “my word is my bond” – and as much transparency as the technology of the time afforded kept all but the most egregious cases under control.

(And read Stiglitz).




Disguising deflation

A deflationary world

This is a post about the conventional world economy, particularly the USA and the UK.

Both economies have been suffering from low-wage employment growth. Unemployment, normally a clear indicator of a failing economy, has fallen; and so have wages.

Both have had major financial crises and both governments have had to stage bank rescues.

The Eurozone and Japan are also primarily in sync with this movement. The Eurozone has suffered worse because it has had less QE.

There are a few differences, cultural, institutional, but essentially, the whole developed world has been stagnating since at least 2008, with the underlying malaise probably starting as much as a decade earlier.

The facts are that despite the key commodity (oil) being at well-above-average real price levels for most of that time, inflation has remained low and wages have fallen. We have, essentially, been living through deflationary times, saved only by quantitative easing.  Without the actions of both the Federal Reserve and the Bank of England, things would have been much, much worse over the last six years. Unfortunately, QE could not solve the underlying problems and now it is being withdrawn, they are likely to emerge with a vengeance next year.

I could be wrong; I often am and in this case I  really hope so. But I  don’t think so.

Classical economic theory (on all sides of the fence) says that recessions are the consequence of inadequate demand. Keynesian analysis says that the way to deal with that is for government to increase spending and/or reduce taxation during a recession, thus putting more more money in people’s pockets and increasing demand.  These two things aren’t, however, equivalent. On the liberal right, tax-cutting is the preferred mechanism because it lets people, not governments, decide how to spend the money and determine where the demand goes; the interventionist left favours more public works (the Mersey Tunnel, the Tennessee Valley Authority, re-arming for the second world war).  Intervention means that the money is actually spent;  individuals and companies, as is their right,  don’t always choose to do so, particularly when there’s deflation about.  The monetary authorities (central bankers) respond to this by devaluing money, making real interest rates negative. This is normally a strong incentive to spend, after all, why keep the money in the bank losing value? One of the problems of today’s global economy is that consumers, and particularly companies, haven’t been spending their money.

Quantitative Easing (QE): blowing bubbles

QE is a emergency lever used by central bankers to devalue money when the interest rate lever has come to the end of its range.  Global interest rates have been near-zero since the crash.  The central bankers create money to buy bonds from financial institutions. Creating money without creating a corresponding amount of stuff inevitably devalues it, which is the point of the exercise. However, QE has operated at a scale far beyond that originally intended.

The problem with QE is that it is used to buy assets: government securities, commercial paper, and in the US in particular the toxic securitised debt that had triggered the first crisis. This has the result of pushing up asset prices.  Suppose a bank holds $1bn of toxic debt, which it sells to the Fed. The result is that it has $1bn of cash instead of the toxic debt. That needs to go somewhere; held as cash, it will decline in value. So it spends it on other assets. Up to a point, this is a good thing. For related reasons, banks have been under great pressure to “strengthen their balance sheets”, since many had to be rescued during the crash.  New international rules on capital adequacy have come into force and QE has helped them meet the requirements, most clearly in the USA. German refusal to let the ECB do much in the way of QE, allied to the Eurozone’s structure, means that some Eurozone banks have found it harder to pass the new stress tests.    But beyond a point, it is a bad thing: it pushes up the price of assets, creating asset bubbles. There are lots of these around the world, fuelled mainly by dollar QE.  London property is one.  If the bubbles are relatively local, they can burst without bringing the system down.  The market for luxury property in Istanbul – definitely a QE bubble –  has been hit by regional unrest. But the collective effect of asset bubbles bursting is that investors lose money and the effect of the QE evaporates.  A significant factor here is the way insiders offload inflated assets just before the bubble bursts, thus passing off the losses to schmucks, or retail investors as they are more politely known.

The underlying problem is much more serious and none of the actions of the authorities since 2008 have done anything to address it.  It is structural,  based on continued weakness of real productive industries outside the newly-industrialising countries.  Growing income inequality creates a large class of people able to afford only the most basic goods and another, much smaller class of super-rich people with nowhere to put their money. Together, these two groups’ spending isn’t enough to support a prosperous middle-income, working class.  Making money by making useful stuff has been eclipsed by making money from inflating assets. Austerity policies have exacerbated and prolonged the structural problems.

I continue to believe that QE was, perhaps is, a necessary evil, but not a sufficient response to the structural failings of the global economy.  On its own, all it has done is  disguise the intrinsic deflationary phase; that needed addressing by significant state intervention on capital infrastructure projects.

The end of QE without solving the underlying deflationary nature of the economy threatens to bring deflation out into the open. That’s what I’m worried about for next year, although I believe that it’s more likely that central bankers will resume QE to prevent that particular disaster. I really don’t think they have a choice; it’s governments who need to act.

ConDem Fail on Corporate Taxes

It’s a pity that the ConDems, who claim they want to make the UK the best place for corporates in the G20, haven’t bitten the bullet and done what needs to be done – which is to abolish corporation tax.

Ok, there’s a little matter of the £40bn hole it would leave in the budget, but abolishing corporation tax doesn’t mean going without the tax that they currently pay.

There are several reasons companies shouldn’t be taxed. First off, they don’t have a vote – and it’s wrong to tax non-voting entities. We lost some quite valuable colonies a few years back because we didn’t get that particular point.

Secondly, and much more important, corporation tax is regressive.  We shouldn’t tax companies on their profits, we should tax shareholders on what they get out of the companies they invest in.  Not all shareholders are fat cats – ultimately, when you disintermediate the  pension funds – most  are either pensioners or people saving for a pension. Fat cats should pay tax at the appropriate  rate for fat cats, and pensioners should pay tax at the appropriate rate for pensioners. But if you tax the company, you tax them all at the same rate, which is regressive and wrong.

You may think that most corporations are scum – and some, like Shell in the Niger Delta are – and that therefore they shouldn’t get such a big tax break.  But that’s an irrelevant value judgement; because this isn’t a proposal about whether y corporate profits should be taxed, but how and where the tax should be paid – and that’s the answer to the £40bn hole: it would have to come from income and capital gains tax. It would be much fairer if it did.

Shell, the FT and the Niger Delta

Amnesty International raised money from personal donations to pay for a full-page ad in the FT today, timed to coincide with Shell’s AGM. However, the FT refused to publish it and a twitter campaign is under way.Here’s a link to it.

Shell’s record in the Niger Delta is appalling. Environmentally, this is just as sensitive an area as the Mississipi delta now threatened by the Horizon spill; but it’s in Africa.  Actually, it’s in Nigeria. It’s in the country that would have been called Biafra, had its secession movement that led to the 1960s Nigerian civil war succeeded.  Oil is controlled federally, and memories of the civil war still linger, particularly the chilling phrase uttered by the Yoruba prime minister at the time, Obafemi Awolowo: “starvation is a weapon of war”.  There are many smaller ethnic groups  in the Niger Delta, between Port Harcourt in the east and Warri in the west. It’s a land of creeks and mudflats, mangrove swamps, rainforest  and palm-oil, mahogany and rubber plantations in varying states of decay, and it has been neglected by the Federal government largely because of the population equations. Nigeria, like much of Africa, still votes on ethnic lines.  The poet and activist Ken Saro-Wiwa campaigned against Shell’s operation; he was hanged by the last military government. Shell claims that it complies with Nigerian law; it pays the Federal Government and its officials for its drilling permits; it doesn’t need to deal at a state or local level.  So it doesn’t; and activist groups like MEND – the Movement for the Emancipation of the Niger Delta – have spawned some armed resistance and have kidnapped oil workers on the offshore platforms.

Shell would only have to spend a tiny fraction of what its rival BP is now spending in Louisiana to employ local people to clear up the mess coming from its activities and restore its credibility locally.  It wouldn’t take much to turn round the local economy in the Delta: it should be the most prosperous region in the country, as it has both the oil and the rainfall. Nigeria isn’t an easy place to do business –  it’s practically impossible to do anything without bribing someone somewhere along the way – and standards become more compromised the more you engage with local people and local businesses.  But Shell’s approach, in cahoots with the Nigerian Federal Government, is destroying people’s lives. It is shameful.

The green shoots of recovery?

The media is very unfair.

The noble Baroness had words put into her mouth by a reporter. What she said was that everything is uncertain.

But, the green shoots are about. Economic activity doesn’t come to a stop in the depths of a recession; people  still buy and sell stuff, innovate and some even start businesses. That’s what makes the green shoots of recovery. Sure, many of the green shoots you can see now won’t make it. There’ll be another hard frost which will kill them off. But some might, and the Baroness was right to say so. It’s not unremittingly bleak; the economy isn’t uniform.

I’m not at all sure about Baronees Vadeera, but I listened to the interview yesterday and I don’t think she said anything for which she should apologise. She departed from a misleading and dismal script, true, but this episode is about a nasty media out to nabble a dusky lady who seems to be getting too big for her boots.

Tax and Transparency

Of course, I should be doing my tax return.

Instead, I’m thinking about tax in the abstract.

It’s no secret that our tax system is broken. Broken here, in the UK, and just as badly broken in most other countries of the world. The strongest evidence is that in most countries, despite tax systems that are intended to be progressive,  the rich pay proportionately less tax than the poor.  They manage to do so because tax systems are too complicated, so that at high tax levels (I didn’t say the rich pay less tax than the poor, although, in aggregate, they do, because there are fewer of them, but that they pay proportionately less) it is worth paying a tax professional to reduce one’s tax bill.

The viability of professional tax-reducers is a strong indicator of an over-complex tax system. The more numerous and successful the tax profession in a broadly compliant economy, the more complex the tax system.

So why is tax so complicated? I think the main reason is that we tax the wrong thing. Tax is levied (mainly) on  income, which seems – at first sight –  eminently fair. But what is income? If you get paid a salary, or dividends from savings, it’s easy to see – it’s the big number on your payslip. But if you run any sort of business, you can deduct your business expenses. What’s allowable?  This is the first area of fertile ground for a tax professional.

Now, what about capital gains? So we have to invent a whole new tax to cover capital gains, because capital gains aren’t income.  Depending on whether capital gains tax is more or less than income tax, tax professionals can be called in to classify every receipt into its most favourable category.

Instead, in my opinion, we should be taxing cash flow. Cash flow is clear and easy to define and to measure. There’s no need to distinguish cash realised from disposal of an asset from cash in a paycheque.  For individuals, the only deduction would be cash invested, either as equity in a corporation, or into bonds.  In this radical new world, because it is radical, corporations wouldn’t pay any tax at all: but, instead, would be required to be *totally* transparent.  All money leaving the corporation (whether as salaries, dividends, bond interest, or on the sale of stock) would be taxable.

a new saw

An investment vehicle that consistely produces above-average returns without fraud is as likely as a perpetual-motion machine.

The hidden pyramid…

Madoff’s scam, his fraudulent investment vehicle, was a classic pyramid scheme, an illegal chain letter on a massive scale. Chain letters at least are transparent: if you are dumb enough to send money to the person at the top of the list, you know it’s going straight into his pocket.

So, as commorancy says in the comment to my earlier post, how many more frauds are out there? How many more frauds have the regulators missed? I doubt that there are many that are quite so blatant as Madoff’s. His was conspicuously lacking in transparency; he didn’t use external brokers, and his auditors were a two-bit firm from out of town. What’s scandalous about Madoff is that so many well-paid investment managers put their clients’ money into it when all the signs were there that it was a bad one. Nicola Horlick has lost £10m of her clients’ money, and she’s blaming the SEC. It’s true that the SEC seem to have been particularly lax here, but regulators don’t have unlimited resources. Ms Horlick is supposed to be smart: it’s her job to check, and she shouldn’t have to rely on the regulator to do her job for her.  She and dozens of other similarly over-paid parasites working for Santander (which has lost £3 bn), HSBC (£1bn) and others  were woefully negligent ; and if I were one of her clients, I would be consulting m’learned friends.

But that doesn’t mean to say that there isn’t a bigger problem, to which I have alluded in my earlier post. Lots of people managing other people’s money – ultimately, most of it is our pensions and savings, don’t forget – have been paid a lot of money, because they have led us to believe that they are smart. They believed it themselves, and lots of them are indeed smart. They want to believe that they were smart enough to make above-average returns for us all by making smart decisions in the market, and for a long time they have done so. Here’s how.

Now, Madoff’s above-average returns were made by paying out new investors’ deposits as dividends to existing investors. This is an old, and pervasive trick in the market; and while Madoff’s scheme was fraudulent and illegal, a lot goes on that’s legal.  Go into a bank branch; you’ll queue for hours to cash a cheque, but in the lobby will be a couple of people with no queue. They can’t do anything useful for you, but they can sell you an investment product. The bank gets a fat commission from selling the savings plan or pension product. That commission comes out of the first year’s deposits you make towards your pension. It goes to the bank’s bottom line – it’s much more profitable selling investment products than cashing cheques. So profitable, in fact, that the bank can afford to cash cheques free. Now, the  fund manager whom you are paying to look after the money in your pension fund looks at the  banks’ financial statements and sees that they are profitable. So she decides to put your money into bank stocks. You get some of the returns, which are earned from the commission paid by new depositors.

Spot the basic difference between Madoff’s illegal scam and the legal one which has been the financial services sector since 1986?

No, me neither.

The meltdown continues

When I started this blog, only a few weeks ago, the current financial crisis was barely beginning.  The blog is just a continuation of the rants round the kitchen table my friends and I have been having for years, and tt is tempting to argue that the financial meltdown could all have been avoided if only the world had listened to what we were saying. Tempting, but wrong.

We knew the meltdown was coming. It has been obvious to anyone who could do basic financial arithmetic that everything was badly out of kilter and a correction was coming. The Icelandic banks’ balance sheets were shot to pieces at the start of the year – and their juicy interest rates were a forlorn attempt to attract enough deposits to put them right. Smarter investors spotted the danger and stayed away, even with today’s inadequate transparency levels.

Transparency isn’t a panacea. Making good financial information available isn’t enough: it has to be read, in good time; and most people are too greedy and too lazy do so. There’s no point in opening the blinds if no one is going to look in, and the financial markets are driven by greed.

But one aspect of the meltdown has been the failure of the credit ratings agencies. Perhaps they could have done a better job, had they had transparent access to the raw financial data? Perhaps. But the way they get paid is all wrong. Who pays them? Ultimately, it’s the debt issuers – the organisations whose credit rating is being assessed.  This model is obviously broken.

Full financial transparency, however, does make an alternative credit rating model possible. Instead of using ratings agencies, software bots like Google’s web-crawler would constantly crawl the accounts of the world’s companies. There could be open-source and commercial bots, and it would be up to the user to choose which results to trust.  With open-book accounting, automated credit-crawlers could replace the ratings agencies and would probably do a better job.

This is something that the regulators need to consider for the future.

Alternatives to Banking: re-inventing mutuality

Another day, another bank in crisis – this time it’s a German commercial property lender, Hypo RealEstate. (Very Germanic name, no?).  Expect more consolidation, as the few remaining well-capitalised banks take over the failing ones.

More consolidation means bigger banks means less competition means more scope for corruption in the banks that remain – and less opportunity for savers to protect themselves by diversifying between banks.

So will the regulators force the breakup of the banking monoliths that will emerge from the rubble of the crash? Along with the swarm of flying pigs?

Thought not. But these megabanks – BarclloysHTCSB in the UK,  CitiSachsFargone in the US will be even more vulnerable to thievery by their execs – and a worse deal for us, as consumers. And you can bet that they will resist the imposition of transparency with every sinew of their being. (I’m having a bit of a cliche morning, sorry).

But better, more effective competition will come from diversity. Breaking up the monoliths to create a lot of smaller versions of the same thing doesn’t achieve as much as creating new businesses, with new business models, to fill the space left by the banks that have collapsed.  Let’s think this through.

Banks provided a way for savers to put their money in productive assets, such as loans to businesses. Instead of lending our money directly, we put it (and our trust) in the bank, trusting bankers to make the complex judgements of creditworthiness about those to whom they lent it. But banks thought that they could de-skill the bankers who lent the money to real businesses and real people, using techniques like credit-scoring instead of human judgement, and they invented fake new skills with which they bamboozled us and themselves.

We don’t have to use banks to put our money into productive assets. We can invest directly in businesses: there are lots of informal community networks that do so successfully – or we could help friends and neighbours buy their own homes.  During the nineteenth century, many mutual societies were set up to do just this, but they were taken over and burned in the late twentieth century’s deregulatory madness. Mutuals are not collapse-proof, but mutuality is a good beginning. And in the twenty-first century, we shouldn’t recreate nineteenth century exemplars – because we live in technologically-different times.

Specifically, modern mutuals can and should be totally transparent.  The network-connected computer is much better than the quill pen for this.