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15 February 2009
Better The Devil You Know!
On an outing from the OECD's Parisian palace with its fabled wine cellar, Secretary-General Angel Gurria tells us that a 'failure of
business ethics' underlies the global recession, and that 'our societies are
disgusted with business practices'.
Well I'm disgusted with him. What would he know about business? He has spent
thirty years in public service and not-for-profit organizations, and has received
awards for his contributions as a 'global citizen'.
There is no failure of business ethics, except for those people like Mr Gurria
who would like to live in a cooperative in some bucolic Central European paradise
out of Fiddler On The Roof. Business is tough, indeed, and people get hurt,
but a company that fails to understand its market, or to supply what its customers
want, or to reward its employees on all the levels that are necessary will simply
go bust.
Banks have been failing lately, and have become the especial targets of the
wrath of the newly-reimpowered militant tendency, but this is not because of
'disgusting business practices', whatever that may mean, it is because they
lost sight of the rules of their market-place, and specifically they failed
to 'lend short and borrow long', which is surely the first rule for any banker.
Sub-prime mortgages are 'lending long', and such lending should be matched
by long-term borrowing, instead of which the banks relied on the inter-bank
credit market and short-term customer deposits, which is 'borrowing short'.
Therefore they were caught with their trousers down when the credit-default
swap market imploded. That itself was a nice game, in which bankers pretended
to themselves that their liabilities were insured, with the connivance of the
rating agencies, but it was hardly 'disgusting', and certainly not unethical.
It was just plain stupid.
Because of the importance of the money industry to the rest of the business
world, banks are highly regulated. Supposedly. They are also subject to the
law of the market-place. Supposedly. In fact neither of these things is true,
and that is where the problem truly lies. Apart from Lehman Brothers, no bank
has been allowed to go bust, and that is ridiculously bad governance, creating
a moral hazard bigger than the iceberg that sank the Titanic. What banker in
future will ever bother to be prudent? It is a catastrophe of the first magnitude.
As regards regulation, governance has equally failed at its task. The BIS is
a trade union, and could never have been expected to self-regulate in a way
that might disbenefit its members; but what about governments? Are they too
uneducated to have understood what was happening? No, they are just too short-sighted;
they can see only as far as the next election. No politician ever stops a boom,
because that amounts to electoral suicide. Who's left, then, to muck out the
stables? Oh, it's the OECD, and the rest of its scholastic fellows, the IMF,
the World Bank, the United Nations and so on. And where were they when they
were needed? When Wall Street and AIG and the Masters of the Universe were sowing
the seeds of their own destruction? Drinking claret, making speeches and greenifying
their world, that's where they were.
It's a big failure of supervision and law-making, there's no doubt about that,
but calling it 'disgusting' and looking down your nose at business is no way
to cure it. There needs to be a new Bretton Woods, with an institution representing
banks, governments and multilaterals which will create a global regulatory framework
and supervisory body for the financial industry. It won't happen, of course.
Instead we shall continue to get Mr Gurria and his ‘Fairer, Cleaner and
Stronger' dream-world.
Better the devil you know than this angel!
You have been
reading an entry on the following blog:
It's very confusing to read the newspapers at the moment, with
every economic pundit peddling his or her own nostrum for how to right the wrongs
of the banking sector. And over Davos the air has been positively blue with
a cloud of conflicting agendas for our economic future.
Well, I'm a financial journalist as well. If they can do it, why
can't I? So here goes! You have been warned; now is the time to stop reading.
To begin with a history lesson: Bang!
Big Bang, that is. The process by which partner-based investment
banking firms were absorbed (at mind-blowing cost) into commercial banking firms
who wanted to be 'universal' banks. Mostly this happened in the early 1980s,
and the process largely demolished the centuries-old model in which people with
capital formed private partnerships in which they could make or lose money without
any embarrassing onlookers such as shareholders.
It's fact that investment banking (m&a, ipos, what is now
called private equity, and all the trading that is associated with these activities)
can make silly amounts of money, and occasionally lose it as well. How can there
be any objection to that if it is done in private? There never was any; the
problem has come with the fact that the clever wheeler-dealers who make these
enormous sums of money now do it in the full public view, and that makes them
vulnerable.
The marriage of private and public banking, with a substantial
injection of 'popular capitalism', led to securitization, itself nothing new
(every public company has been 'securitized'), but a dangerous weapon in the
hands of deal-obsessed investment banking magicians. This was the moment at
which, with hindsight, the regulators should have set up a structure to measure
and control the risks being generated by new instruments such as CDOs. But the
regulatory structure is compartmentalized in every country as well as internationally:
retail banking, insurance, futures and so forth.
Understanding the reasons for the collapse that ensued is not
to withhold blame: there was a Faustian pact between the politicians who need
growth to show off to their electorates (and certainly don't understand 'rocket
science'), the inexperienced young bankers who dined out on toxic mortage debt,
and perhaps most culpable of all, the ratings agencies, themselves totally unregulated
and unsupervised, who allowed and encouraged the ball to continue long after
midnight. But it's very difficult to blame the investment bankers; they were
just doing their job.
There's no going back, however. Any sort of forcible separation
between commercial and investment banking a la Glass-Steagall will simply set
back international economic growth by a decade. The ignorance of politicians
about investment banking and the popular anger that results can be cured by
education - you can see this process taking place already as more and more hacks
like myself come to understand that investment bankers are a necessity. 'The
unacceptable face of capitalism' was Edward Heath's comment, and the Germans
simply call them 'locusts'. But we have to accept them, like root canals and
traffic wardens, as a part of our complex society.
As to preventing the next 'crash'? Well, we can't. While human
nature stays as it is, booms and busts are as inevitable as love and infidelity.
What can be done is to fine tune the regulatory systems, try to bring them up
to date and to stop them lagging behind innovation quite so badly in future.
And most of all, say no to any 'solution' put forward by politicians, because
they are the very last people capable of understanding the problem.
The British government is now face to face with the consequences of the mistakes
it has made over the last ten years in regulating and taxing its gaming sector.
It is scarcely the only country to have trodden the same error-strewn path,
but in the case of the UK the damage is greater because of the highly profitable
industry which the government's policies have now almost destroyed.
'For many reasons, increasingly few companies active in the British market
are now regulated by the Commission,' bleats Minister for Sport Gerry Sutcliffe.
So what has happened?
In 2001 the Government replaced its age-old system of taxing punters with a
15% tax on gaming gross profits (and operators also have to pay VAT plus corporation
tax plus a super contribution on any horse-racing turnover to a superannuated,
cosy old industry nag called the Betting Levy Board). This step wouldn't necessarily
have been fatal on its own, but when Internet betting started to supersede the
betting-shop kind, and UK-based operators began to desert in droves to Malta,
Gibraltar, Costa Rica and the Channel Islands, the government imposed a 15%
tax on Internet gaming profits for all those firms which it licensed, and created
a tough licensing regime under the Gaming Commission. But it could only license
firms on its own territory and was forced to allow in all EU-based firms, without
being able to tax them.
Now, with gaming tax revenues disappearing down a black hole, it is having
a King Canute tantrum and wants to impose licensing (and hence taxation) on
all the firms that operate in the UK (ie advertise there for punters). But why
should the EU permit this? There are perfectly adequate regulatory, licensing
and taxation regimes in Ireland, Malta and Gibraltar, all EU Member States,
and where the ex-UK betting firms now prosper. Under what circumstances are
they going to allow the UK to steal their revenues, or to replace their rules
with a new set? And under what law can the UK forbid another properly-licensed
EU operator from advertising freely throughout the EU?
The ECJ's Gambelli ruling in 2003 was unequivocal: gambling is a service and
is subject to EU freedom of establishment rules. There is no way in which one
EU Member State is going to be able to impose its own legislative practices
on another one. The EU Commission has already attacked France on this issue.
It is a mystery how Minister Sutcliffe could be so badly advised as even to
try.
What the government should have done was to accept the inevitable and offer
a light-touch, low-tax regime to compete with Malta et al, instead of hiding
benhind a hypocritical ('protect our children') smokescreen. All it really cares
about is the tax, and now it has lost that along with the gaming industry. The
existing law is a dead letter, as the government is implicity acknowledging:
you can ban a foreign firm from advertising on the Internet, but Berkshire is
not Beijing, and if a 16-year old wants to place bets with a Costa Rica poker
site using his father's Swiss credit card and bank account, who is going to
stop him?
Even now it is not too late for the government to come to its senses, but under
Pastor Gordon Brown's presbyterian theocracy, and faced with the Treasury's
emptying treasure-chest, what chance is there of that? The few remaining British
gaming firms will now pack their bags and leave. 'Mene, mene, tekel upharsin'.
Penelope Wise
Penny Wise but not Pound Foolish! But remember: I am not offering investment advice. My comments are just for your general information; I do not recommend investments, and you should take professional advice before entering any investment contract.
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