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Saturday, 3 March 2012

Welshing Bookies

In the streets of terraced houses in which I grew up in the era before betting was a fully open licensed trade it was not uncommon to hear of a bookie - a man who received bets informally, usually on horse or greyhound races - miscalculating the odds that he had offered and was found to be unable to pay winnings to the people whose selections had won their races. I cannot recall any account of such a man [they were, to my knowledge, always men: though I suspect there must have been some women in the trade] being killed by an angry mob; but it was common to hear of them being treated with extreme violence, ordered never to appear in that community again, tarred-and-feathered, threatened with castration and otherwise subjected to the sanctions that ordinary people could apply to those who failed properly to provide them with an illicit service.

Gambling - as commonly understood - is strictly regulated in the advanced economies. The USA has been slow to allow various activities on the internet and this negativism is not luddism: the potential for gambling to become addictive is real and the internet allows large numbers of people to commit vast sums to bets placed with companies that are registered in states where enforcement is weak or subject to corruption. Individuals using credit cards or opening their bank accounts in such activities can be ruined in seconds. Recent UK court cases featuring Pakistani cricketers made millions aware of the range of possibilities that now exist for corruption in all sorts of games. Nanny states have sophisticated regulatory systems that seek to ensure that gamblers understand the contract that they are making, the subject-matter of each bet, the value of their own assets that they are putting at risk, the relative value of the stake they put down to the winnings they will take if their bet is vindicated, and the odds against winning. The regulator also ensures that the trader in bets is solvent and able to meet obligations, and does so on demand.

Thus betting has become increasingly like banking used to be: risk-taking in defined conditions with regulatory systems to ensure solvency and compliance with the law. Meanwhile, banks have increasingly allowed their star traders to act more and more like gamblers who press outward the boundaries of their betting; and by 2007 they had incurred obligations that vastly exceeded their reserves. Assets accumulated in the traditional banking business were only a fraction of the liabilities that stood in the name of their 'proprietary trades'. If the banks had welshed on those day-to-day obligations, due to their gambling losses, the entire system of international, national and local business would have imploded. So governments bailed them out.

In the nineteen fifties [when police still patrolled every beat every day, on foot] if a policeman saw a mob chasing a man, crying for his blood and their money, as often as not they would allow the man to be caught and 'given a good hiding' before they intervened to disperse the mob. In 1907-9 governments were in the position of the policeman as creditors demanded back their deposits from the banks; but instead of standing back they came forward with magic sacks of newly-invented money with which to enable the banks to meet their obligations. When the market realised that the banks had this support the immediate crisis was resolved and very little of the magic money was actually passed out from the banking nexus.

The banks' stabilisation has lasted until now: with some very tricky moments: and not a few of the difficulties have come from Greece. The EU and the IMF have been prepared to keep the Greek state [just] solvent in return for certain undertakings. Meanwhile banks and other agencies have found that they could not sell all the Greek bonds that they bought before the crisis: though some speculators have been prepared to buy some types of Greek debt, heavily discounted, in the hope that their investment would pay off handsomely in the event of a complete rescue; but the European Central Bank and others have no wish to oblige the speculators. Finally towards the end of this past week the Greek authorities have agreed with some creditors that existing bonds will be replaced by new ones each worth 46.5% of the bonds they replaced. For some speculators who bought the debts at less than 45% below par the deal was profitable. It was also welcome to those institutional investors who had already written down the value of Greek debt in their own books by more than 55%, in that their loss was mitigated. Other creditors of Greece will be offered the chance of swapping old binds for new: voluntarily or by compulsion. Whatever they might think of the justice of such a 'haircut' [the 53.5% cut in their nominal asset value] the creditors were stuck with it.

Some of the creditors had bought betting slips that are often mis-described as 'insurance' against such a default. These Credit Default Swaps - CDSs - have several times been mentioned in this blog. In 2008-9 AIG paid-up on the contracts that fell due to be met until they were bust, and then the US government lent them billions more to carry on doing so until the demand was met. In 2012 the financial institutions that had issued the CDSs were obliged to pay up; if the Greeks had staged what was described in the contracts as a credit event. Here is where arises the parallel to a 'fifties bookie: in the former case the punters knew what they had bet on what horse, and what they were due to be paid. The issuers of CDSs know what they owed] if there is a credit event but they, and not the punters, nor some independent regulator, would decide what was such an 'event'.

So when the issuers of CDSs gathered on March 1 as the committee of the International Swaps and Derivatives Association it took less than two hours for the [reputedly] 15 members to agree that no credit event had occurred: so none of them would have to pay out. There was no independent assessor or regulator involved: the bookies welshed and there was no comeback. The descent of the 'banking' world into gangsterism proceeds.

Gambling remains relatively well regulated. Hence I have proposed, and do so again, that derivatives, swaps and related contracts should be subject to Gambling Commission regulation and absolutely severed from the legitimate Financial Services sector.

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