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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:
UK Chancellor George Osborne has unveiled plans for a new Office of Tax Simplification.
The UK tax code - a somewhat amorphous concept since what is included depends
on what you choose to call a tax - is said to be around 30,000 pages long. Again
that begs the question of what you call a page, what size type, how many lines
etc etc. Anyway, no-one questions that there is too much tax legislation, and
every annual Finance Act adds another thousand pages or so. Even tax practitioners,
who you would think might benefit from complex tax legislation, are complaining
that it has become impossible to answer straightforward questions from their
clients. And the Inland Revenue has taken to making up the rules as it goes
along, for instance on tax residence, probably thinking to itself that since
no-one knows what the law actually says any more, it may as well use whatever
interpretation suits its purposes, which, surprise, surprise, is usually to
extract more tax.
The UK is not alone in having an overgrown tax code. In the USA, no-one even
seems to know how long the Tax Code really is. It has capital letters because
unlike in the UK, there is something called the Tax Code, and you can even buy
a printed copy of it from the government for a mere thousand dollars. President
George W Bush said: "The tax code is a complicated mess. You realize, it's
a million pages long." Most estimates though are down in the tens of thousands
of pages. One of the problems in the United States is that Congress quite frequently
tacks tax legislation on to other bills, being very often the only way of getting
it through. Then of course there is State-level tax legislation as well.
For there to be any chance of simplifying and shortening the tax code in an
advanced country like the US, the UK, France or Germany, you would first of
all have to understand why tax legislation grows like Topsy, and the answer,
inconveniently, lies in the word 'Democracy', ably assisted by public choice
theory. Getting and keeping political power nowadays means taking the part of
the innumerable groups, factions and interests that make up your constituency,
whether that be a small patch of countryside (for a local councillor) or a whole
nation (for the leader of a national political party). And the first thing that
any group wants from its politicians is to pay less tax, whether the group is
the motoring public, cyclists, commuters, train motormen (sorry, motorpersons),
car manufacturers, gas station operators or bus companies.
And in that microcosm of just one part of human life (getting to work) you
can immediately see the problem: these seven constituencies have conflicting
interests from a fiscal perspective. Some people belong to more than one of
those groups, as well. It's impossible to optimize a tax system to please everyone
all the time; the best you can do is to please some of the people some of the
time. But that doesn't stop politicians from trying. In the USA, where the system
is best developed (and the tax code is longest) the game is famously played
with 'pork', or 'earmarks', the little add-ons to a bill in progress that secure
the votes of enough legislators to get the bill through. Then it has to go to
the other House, and perhaps back again, each time gaining more weight. Certainly
you could never have a saying in the USA that 'a rolling bill gathers no pork'.
What is to be done, then? Abolish democracy? As Winston Churchill said: 'Democracy
is a very bad system. But all the others are worse.' No, we can't do that. So
what we do is to invent new quangos called The Office of Tax Simplification
or similar. Both Bush presidents did it; so did Bill Clinton. The only reason
that President Obama hasn't done it yet is that he has been too busy making
the Tax Code longer. Just give him time.
Reducing the number of countries would work, in terms of reducing the total
amount of tax legislation, and possibly the total number of tax lawyers. The
Romans proved that; but empire-building has become unfashionable lately. In
fact it's going in the opposite direction: in the UK, regions like Scotland,
Wales and Northern Ireland are all becoming more rather than less independent,
and along with that independence goes tax-raising and spending power, with,
yes, you guessed it, brand new regional tax codes.
Flat taxes work, too, and are even efficient at optimizing tax-gathering; but
they are a non-starter in advanced democracies. The new, Eastern European members
of the European Union got away with introducing them ten years ago because clever
Harvard-trained economists slipped them through before domestic politicians
had cottoned on to the usefulness of a bulky tax code. They are learning quickly,
now, and one by one the countries with flat taxes are undermining or abandoning
them.
So there it is: fat tax codes go along with fat people as shining achievements
of our civilization. You'll just have to learn to love them.
So here I am, in January 2011, the 25-year-old scion of an august European banking
family based in London, fresh out of Harvard Business School, and my Dad, who
is still Chairman, wants me to get some hands-on experience of actually running
a business before he steps down in a few years' time. So he's putting up USD100m
as start-up capital and he is suggesting I specialize in family offices (that's
the name given to investment management partnerships which look after the wealth
of individual families). It's an area we've never majored in, and Dad thinks
we ought to get it going. I can't disagree with that; it's probably been the
fastest-growing sector of wealth management in the last ten years, and we're
missing out big time.
Although the firm has its HQ in London, we also have substantial capital and
offices in New York and Zurich, and of course we have branches all over the
place. So Dad's first question to me (and my first
question to myself) is: "Where are you going to put the firm?"
The criteria must include:
Good communications, not just in terms of telecoms, but also good airline
connections, because clients are going to want to visit us.
Availability of qualified staff.
A good tax environment for investment purposes; we aim to have at least
several billion under management within a few years.
Now of course we could separate the sales side, the meeting and greeting, from
the investment management. But clients don't like that very much: they want
to look into the eyes of the person they are going to trust with half a billion
dollars of their wealth. So in the end, the choice of HQ cities is quite limited.
London, and New York, perfect as they are for meeting clients (and I would
have all the advantages of our existing offices and support services) can be
ruled out straightaway. The US Restoring American Financial Stability Act has put
a strait-jacket around banking operations and staff remuneration, and in Europe
the Capital Requirements Directive is even worse. No-one wants to work under
those sorts of rules, and no bank would willingly submit itself to legislation
which will double or treble the amount of capital you have to hold. Dad says
that if he wasn't already near retirement he'd move the whole operation lock,
stock and barrel to Hong Kong or possibly Zurich. And he says that there isn't
a senior banker in Europe or America who isn't asking himself the same questions.
Zurich is possible. The problem is that Switzerland is locked into a deadly
embrace with the EU, and little by little all its financial freedoms are being
whittled away. After what happened with UBS and its US clients it's a tough
sell to persuade clients into Zurich if they're not already there, and then
they're probably locked up with someone else.
So, a bit reluctantly, because of the life-style, I have to decide against
Europe. There are one or two outliers, Canada for instance, which hasn't (yet)
given in to the G20's demands. Toronto isn't a bad place to be. Then there are
the big International Financial Centres (not allowed to call them 'offshore'
any more!) like Panama, Cayman and Jersey. We'll use them, of course, for fund
management, but the skill pools are quite limited and they are ruled out on
travel grounds. They have something called fog in Jersey, and you've got the
EU breathing down your neck.
So in the end it's a no-brainer, and it's called Hong Kong. Low or no tax,
plenty of banking professionals, good connections, and right next door to the
biggest source of new wealth that there is.
"Of course," said Dad. "I knew that would be the answer, but
you had to think it through for yourself." He reflected a moment: "It's
a pity the European Parliament and the Congress didn't go through the same thought
process. As it is, they've signed a collective death warrant for their financial
sectors. Politicians!"
As he talked, I was looking for Mandarin lessons on my Blackberry.
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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