'Robin Hood' Taxes and Bitcoin

Yesterday, the Labour Party added to their repertoire for the coming election the concept of a 'Robin Hood' tax; so-called because it can be represented as a tax on 'the rich' [financial institutions] to aid 'the poor' [HM Treasury]. It was explained by the BBC as a tax on bonds and on complex financial instruments, such as those called 'derivatives', and it was projected that at the outset it would raise over £20 billion for the national budget.

If any such tax were to be introduced, we can be certain that it would regularly be increased both in its rate and in its extent; as has happened with Insurance Premium Tax. During this election campaign, some Labour figures have suggested that Insurance Premium Tax should be increased on private health insurance premiums, to provide funds either for the NHS or for social care. The direction of travel is obvious, when any new tax is dreamed up.

The original concept that gave rise to the idea of 'Robin Hood' taxes came from the American Economist James Tobin, who proposed that there should be a tax [perhaps of 1%] on 'spot' trades in currencies. Thus if a trader went into the market and swapped dollars for yen, either the seller or the buyer would have to pay the 1% tax: and thereby disclose the transaction formally to the authorities and accept the liability for the tax to be paid. The spot trade in currencies was seen as potentially disruptive to business generally; and potentially disastrous to a government's management of its economy. The reality of this threat was made clear when Britain was forced out of the ERM [the European Monetary Regime, which was the precursor to the Euro] by the weight of speculation against the pound in international money-markets. Thus it was shown that the market could be more powerful than the government that supposedly controlled the world's most sophisticated financial system.

The speculative international monetary system has never been brought under control; and it almost overwhelmed the global economy in the 'crash' of 2007-8. To prevent that collapse from becoming fatal, the US, UK and other major governments whose banking systems were closest to bankruptcy in effect nationalised the banks' debts, putting an indefinitely great taxpayer guarantee behind all the banks' contracts with each other and with their customers - except in the cases of Bear Stearns, which the US authorities steered into the arms of a much bigger bank that was rich enough to absorb its liabilities [and, eventually, to cash in on them], and Lehman Brothers which was allowed to fail but which over the next decade was revealed to have had enough assets to meet all its liabilities [when they were unscrambled slowly over the next ten years; though they could not meet their immediate obligations on the day before they were declared to have failed].

Since 2008 there have been recurrent proposals, especially within European Union institutions, for a sort of Tobin Tax to be imposed on various types of transaction. Often these have been mooted by continental interests that are envious of the London market in finance.

I have several times advocated that the Tobin concept be developed along a different route, to mark out clearly the difference between banking [the essential function of conserving customers' money, and lending it judiciously to worthy borrowers] and betting [which everyone understands, in essentials; it is always a voluntary action in which a person or a firm stakes money in the hope of making more money: while accepting the downside risk that the stake - at least - may be forfeit if the bet fails].

Despite the near-meltdown of the entire legitimate banking system in 2008, regulators have continually backed off making this distinction, between banking and betting; which I believe is fundamental to understanding and controlling high finance. Real bankers accept savings into their safe [state-guaranteed] institutions and lend a permitted proportion of the deposits to worthy borrowers. That has been the essential mechanism for funding trade and industry for millennia, and it remains so today.

But betting is mere speculation, and the daily global turnover of that business now greatly exceeds legitimate banking. The most advanced and incomprehensible class of bets, as far as the general public is concerned, is called 'derivatives': they are simply bets: however complex may be the data on which the bet is formed and the contract in which it is expressed. Other forms of bets are many kinds of 'swaps', most 'futures' and 'spread bets' and 'options'. Very clever men and women have devised an impressive range of bets, and some of them can be dressed up as means by which the risks facing a real-world business [such as the basic rate of interest changing unexpectedly or a sudden and dramatic change in the price of some essential commodity like oil or iron] can be compensated to a greater or lesser extent. Sensible regulation can be framed to distinguish genuinely prudential purchases of options or futures by firms that function in the material economy from merely-financial bets. Both are classes of bets, but it would be possible to classify them such that different rates of betting-tax would be applied.

The segment of the financial market that Tobin would target first with his tax is the trade in currencies. Now, in a world context that the good professor could not have envisaged, computers responding to highly sophisticated algorithms trade billions of dollarsworth of imaginary currencies every minute; and even a 1% tax on those transactions [if it could be levied] would fund all the national budgets in the world. But if any national authority demanded 1% of the notional transactions, to be paid on a specific date in a specific currency, that would kill the business stone dead; because collecting 'real' money that features in a state's banking statistics in respect of fanciful transactions in the cybersphere would require a link to be opened up between two universes that cannot be conjoined. The real world remains under threat for so long as the megabetting industry masquerades as part of 'finance' [or even, in some cases, as 'banking']. The financial establishment would act quickly and effectively to see off any proposal for a UK Robin Hood tax, however big a parliamentary majority Corbyn's people could round up from their flying pigs.

Meanwhile, a global attack of 'malware' [aka ransomware'] that locks up computer files against a demand for ransom, has affected over 100 countries, including much of the NHS in this country. The ransom demands ask for payment in bitcoin. Bitcoin is a wholly pernicious invention of unnamed computing geniuses, which purports to be a form of money that can exist without the sanction of any government and without control by any central bank [or an international agency such as the International Monetary Fund]. From the day it was established, it has been agonisingly obvious that it is perfect for many sorts of criminal settlements. Nevertheless, some licensed bankers and traders have seen themselves being able to add to their business portfolios by trading in bitcoin; and hitherto they have been able to persuade their regulators and the central banks to let bitcoin payments develop. The catastrophic criminality that has been evident in the past 24 hours must, surely, set the thing in true perspective. All use of bitcoin - or of any clone or derivative of bitcoin - must be criminalised

Simple Truth

The debate on the EU Budget, and more specifically about how much the UK should properly pay into it over each of the next seven years, is becoming heated. Since a majority of the 27 member states are net recipients of funds from the EU it is to be expected that a simple majority will be in favour of the biggest possible increase in the budget. The relatively few states that are major contributors to the budget will claim added weight to their arguments: but in the final decision each country has one vote and can exercise only one veto. The exercise of the veto by any country does not cancel the budget, but  holds it at the previous year's level until the next annual debate. Whatever the outcome of the forthcoming meeting may be, it will have only a small impact on the formation of individual member governments' views in preparation for the next round of discussions about the future of the Union in the Council of Ministers.

One forthcoming issue that is being heavily signalled in London as a crunch point is the deliberation on proposals that the EU Parliament has already approved for the tightening of regulation, and the unification of regulation, over the 'financial services' sector of the economy. There is a huge amount of debate about the definition of the sector. The crisis of 2007 is generally ascribed to misconduct by 'the banks': but in fact a great deal of the reckless financing was done by firms that were not registered or regulated as banks. The main continental European businesses that wandered into the risky business, which was centred on London and New York, were registered and regulated in their home territory as banks. So it seems obvious to Europeans that the new regulatory regime must focus on preventing the things the continental banks got wrong when they ventured into anglophone markets in the noughties. During 2008-9 Britain and the US responded to the crisis by making the enfeebled non-bank institutions that survived [after Bear Stearns and Lehmans had gone under] merge into banks and thereby get a measure of protection from the banks' balance sheets; which could then be supported by cash injections from government and central banks. This created an unprecedented situation where it was not technically wrong to refer to the casino segments of the markets as segments of 'banking' or of 'the banks'.

Only one company that was known as an insurer - AIG - was ruined in the crisis: and that only because a tiny London-based offshoot was so utterly idiotic as to 'insure' the financial institutions through so-called credit default swaps. The rest of the massive insurance world was completely resilient to the crisis. Yet insurance is being subjected to heavy-handed retrospective requirements that will massively disadvantage the industry. In this the EU is behaving as stupidly as did the mavericks in AIG. There has been a little give by the purblind politicos, but the international leadership of the London Insurance Market - which has been unchallenged since 1700 and remains just as robust today - remains at threat. Thus dis-aggregation of insurance from the present EU regulatory proposals is essential.

Even more important - and further from the comprehension of the eurorats as they luxuriate tax-free in their favoured Brussels restaurants - is the necessary differentiation of the functions of the casino from any sort of banking. Proposals for a 'Financial Transactions Tax', whether it is to be a fraction of one per cent or several percentage points, presumes a commonality between 'real' banking, casino 'banking', insurance, and other 'financial services' such as shipbroking and arbitration. Derivatives, swaps, spread bets and most futures are simply gambling slips: they have some legitimate uses in offsetting perceived business and social risks for real world trade and industry; but they are based on the purchase of a ticket which is priced according to an assessment of future probabilities and such calculations are therefore wholly speculative - as all bets are. Such contracts should not be counted or taxed as a sub-category of banking transactions.

A price is paid by the entity that considers that it is mitigating perceived risk through a gambling contract, and there might in the future be a payment to the gambler if the predicted eventuality occurs; but no twist of the imagination could set the contract in accord with payments under normal regulated banking contracts. The subject matter of the contract is a bet: so its legal status should be defined in accord with betting laws, the conduct of market participants should be regulated by a gambling commission, and the transactions should all be subject to gambling tax.

 Three distinct regulatory regimes are needed: for insurance, for gambling and for banking. No elaborate differentiation between 'retail' banking and [non-casino] 'investment' banking, as perceived by the British Vickers Commission, is necessary. The EU proposals for financial services as a whole, as they stand, are likely to be significantly more detrimental to business growth over all sectors of the economy, seen from this perspective, than they are recognised to be by those who think that they are defending the London Market. The learning curve that London's defenders must climb should be even steeper than that they realise if they are to present the real issue to the European authorities; and one doubts that they will have the capability even to recognise the point that is made above.

Reshaping the Banks

The Vickers Commission on the UK banking business has already proposed that the banks' 'retail' and other activities should clearly be separated; and the government has promised to enact that policy. This would in itself have made the future banks very different from those of the recent past; and now more change is in the air. New scandals have emerged very recently - the manipulation of libor and the reckless mis-selling to small firms of inappropriate [and  ineffectual] 'protection' against interest-rate changes - to add to the existing flow of compensation funds to individuals who were mis-sold payment protection insurance by their banks. International financial institutions, a swathe of small and medium-sized businesses and individuals have all been cheated by the London banks.

For several decades successive governments have complacently observed the increase of trade in the finance sector of the economy, and have taken more than ten per cent of the nation's taxes from the sector. This was seen as largely compensating the country for the destruction of material industry. That progress is now likely to be slammed into reverse by the restructuring of banking firms, by new UK and EU regulation, and by international traders moving activity away from the discredited London Market. Thus the situation is nothing less than a disaster for the British economy and for the sixty million human beings who depend upon it

The principal asset of any financial firm is its reputation for integrity in its employees' intentions and its efficiency in administration. Despite the impact of the credit crunch, London has been seen as a reliable market until very recently. Before the start of the millennium the London Market was dramatically changed from the gentlemanly world that existed until the early nineteen eighties when the Thatcher government initiated the 'big bang' which created the environment in which huge conglomerates were created which undertook almost the full range of financial services [insurance was the great exception] and developed massive markets in a great variety of new 'products'.

The traditional business of banking was to receive deposits from customers who want their money to be in safe custody until they have a use for the spending-power, to hold reserves proportionate to the deposits so that customers can always access their funds when they want them, and to lend the rest of the money they have to firms and to people who have viable economic uses for it [investment, house purchase, trade finance etc]. Alongside basic banking by 1850 there had emerged a small cohort of 'merchant banks' that managed international transactions and currency exchanges and advised firms on aspects of business development, including decisions whether to sell shares or bonds to increase their capital,  and when and how to try to take over other firms. Alongside the banks and merchant banks were specialist trades of stock-broking and stock-jobbing, discounting government securities and other niche markets: each of which was self-regulating under the oversight of the Bank of England. After the big bang these activities were brought together in new conglomerates, many of which formed as - or were absorbed by - international conglomerates; and their turnover increased massively. However, the emergence of the 'new' economies of Asia and Latin America meant that in the new millennium London's share of global banking trade and of profits quickly declined, from more than ten per cent in 2000 to less than five per cent in 2011. Many of the 'products' in which the global banks trade have been invented in London, but can be used anywhere. London remains highly innovative and attracts people from all over the world to learn and to practice their trade in London before they take their skills home. Many such individuals develop a liking for the lifestyle that has been available in London for the highly affluent, and several of those buy homes in London even when their employment has moved elsewhere. Thus house prices in the British capital remain high,  conflicting with a nationwide trend for all but the finest houses to decline in price as individuals'  access to mortgage funding becomes more difficult.

Most of the new trade that was developed since the mid-eighties of the last century was misguidedly regarded as 'banking'. It was gambling, speculation. Derivatives, most swaps and many forms of futures were  just bets: neither party owned any assets related to the deal: in the first instance they were bets about how the prices of assets would move in the future, but they quickly moved on into guesses about how derivatives, futures and swaps would move in the future. People and firms who place the right bets [for them] at the right time in the development of the market situation can make profits from which hey can mitigate anticipated losses due to risk events such as adverse currency or interest-rate movements: such hedging can be beneficial to the clever, lucky players. Many other punters enter into contracts and escape from them without making significant losses. This has all added to the 'banks'' turnover, and the traders who have been granted bonuses on the basis of their turnover have thrived. The credibility of these markets is now at risk: and it is becoming impossible for the conglomerates to hold enough reserves on their balance sheets both to be able to fund for potential losses in the esoteric markets and to provide investment funds for 'real' businesses at the same time. So investment is suffering. The way to end this nonsense, as had many times been stressed on this blog site, is to recognise the gambling contracts for what they are, and to regulate them and tax them appropriately. If it is prepared to take the risk a conglomerate could have a retail banking subsidiary, and a merchant banking, stockbroking and bond issuance subsidiary which offers a mergers and acquisitions advisory and assistance service; both of which must be separately capitalised and conformably managed according to the rules set by the bank regulators. Such a conglomerate could also apply for a gaming licence for a separately-financed casino subsidiary that managed and issued derivatives, swaps and futures. If such a subsidiary satisfied consumer demands it could continue to grow the business as a complex of hedges for clients who understand what the market is offering them and what costs and risks are involved.

London casinos attract international high rollers:UK regulation of gambling is good and creates consumer confidence. There are grounds for hope that a regulated market in swaps, derivatives and futures could thrive and grow: but let it never be called banking, nor have access to the reserves that are accumulated to support the proper activities of retail or merchant banks.

Guff at the G20

Some of the people who are regarded as the most important 'leaders' and office-holders in the world have been to the seaside in Mexico with the ostensible purpose of stabilising the global economy. The slow-motion unwinding of the eurozone has been extended by the emergent powers placing additional credit with the International Monetary Fund so that it will be available to be pumped into Europe: conditions will be specified but it is most unlikely that these would be so draconian that they would ensure that the euro collapses. Low-grade politicians who hold on to power by default in countries outside the eurozone have again admonished those inside the common currency to get their act together; once more these focus on trying to bully Germany into dissipating its savings on helping other eurozone countries. So far, Germany has declined to obey, and the President of the EU Commission has blamed 'North America' for the crisis.

My analysis firmly locates the origin of the global financial crisis in London, England. With the 'big bang' of 1986.the Thatcher government smashed the traditional division of financial transactions in the City of London between stock brokers and jobbers, banks and merchant banks, separate exchanges for different types of transaction, self-regulation within each sector and ultimate oversight from the Bank of England [which preferred to steer market members into approved ways of working by winks and nods and secret meetings]. The phrase big bang had become central to theoretical physics, to describe the moment immediately after the creation of the universe when its great expansion and diversification began. By applying that phrase to the finance sector enthusiastic commentators implied that here was a new beginning in a newly structured market that could grow immeasurably and bring great profit to the participants: who could then be taxed to meet some of the growing deficit on government income as industry was destroyed while farming and fisheries were left to wallow under heavily protectionist EU regulations. The rapidly advancing capabilities of computers enabled the markets to be operated at speeds and with complexity far beyond the former trading patterns that had depended on word-of-mouth and typewriters. New types of 'product' - most obviously derivatives and new processes for securitisation - burgeoned on an almost astronomical scale, and old contract types such as futures were reformatted and used in vastly different new ways. The world's banks brought business to London and Wall Street looked set to lose the dominance of global markets that it had gained in the nineteen-thirties and consolidated through the Second World War, Marshall Aid and Cold War. Ferocious lobbying of the politicians in Washington led to the repeal of legislation that had mandated the separation of 'retail' and 'wholesale' banking,  and had differentiated banking from broking; with the specific intention of enabling Wall Street to compete with the City of London. Small differences in regulations led globalised businesses to put some business in New York, some in London and a little in other centres such as Hong Kong and Singapore.

Thus far the London big bang was the origin for the new pattern of trade; but then the US government decided to tap into the markets in the interests of social engineering. Given that such huge and flexible financial markets existed, surely they could be required to lend money to people who sat at the bottom of the heap in society. Let even the poorest become home-owners and thus gain some pride of possession and learn to earn the money necessary to service their mortgages and care for their homes. Mortgage lenders were required to allocate some of their funds to 'sub-prime' mortgage borrowers: two government-backed institutions underpinned the mortgage market, but the wholesale market practitioners became increasingly keen to securitise 'bundles' of mortgages and re-sell the securities into the general financial markets. After a very few years just about every bank and securities manager included some sub-prime mortgages buried within their so-called 'assets'. Once it was demonstrated that hundreds of thousands of feckless Americans were not paying their mortgage debts or maintaining their houses well, it was clear that some portion of the 'value' of many hundreds of thousands of 'assets' was non-existent. Thus the trigger for the crisis was squeezed in North America, but financial institutions from all over the world were deep in the mess and the resultant reckoning is ongoing. American sub-prime lending was the mechanism for the disaster; but its origin lay in the reckless gamble by the Thatcher government.

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.

Two Twerps and Silly Milliband

On the morning of January 6 I heard an embarrassing interview between David Cameron, the British Prime Minister, and Evan Davies, a particularly drippy favourite of the current regime at the BBC who is often presented as an Economics expert. Davies's style is that of an insouciant fifth former from some long-vanished County Grammar School; including a tendency to ride hobby horses.

Today's spat was about the old chestnut of bankers' bonuses. The Prime Minister may not be as ill-informed on this issue as he routinely appears to be, but again today he spoke as if the core of the issue was bonuses paid to Directors - and particularly chief executives - and to senior managers of conglomerates that include banking divisions. In the USA and the UK, in particular, in banking as in businesses in many other sectors of the economy bonuses exceeding the nominal salary have been paid to such individuals, and many bonuses reached extreme levels during the bubble years before 2008. In retrospect it is clear that a significant minority of chief executives led their companies down routes that eventually proved to be disastrous: shareholder value was reduced - sometimes obliterated - yet it was palpable that the shareholders had not acted to curb the excess when the time was right. What Americans call "compensation" and Brits call "remuneration" has been determined [in most cases] by sub-committees of the board of directors who pay expensively for advice from specialist consultancies that compare top salaries over companies and sectors, looking at factors like the number of staff on the payroll as much as on the quality of thinking [which is almost impossible to assess] and profitability where the present strategy will  only produce results in a few years time [so that present profits owe more to past managers and policies rather than to the present lot]. Shareholders [which includes investment trusts and pensions funds, with highly specialist and well-paid managers] let themselves be led by the consultancy reports; with the result that the gap between top salaries and "ordinary" employees' remuneration increased to a degree that most people thought was obscene.

There is now a battery of propaganda urging shareholders to recapture control of compensation [or remuneration] and to narrow the gap between top and bottom salaries. Governments have been put under pressure to use taxation and regulation to diminish the purchasing-power of top people's pay packages. An additional measure that has been used widely for more than ten years requires companies to pay a proportion of the bonuses in shares in the company rather than in cash, and to put restrictions on when the shares may be sold so that the recipients cannot just cash-in quickly. For those employees who are continuing to work for the company and who have already accumulated such a heap of shares there is a huge incentive to work effectively and so increase the value of the shares; and this fact is adduced to argue that bonuses positively help to drive progress and profitability for the business. Against it is ranged the fact that the average tenure of chief executives gets shorter and shorter so that it is rare for a boss to be in post to reap what he has sown.

Control of relatively 'transparent' remuneration packages for directors and top managers never was the biggest problem, and it is now obvious that that range of stipends will be brought under control: and may even gain public acceptability.

The bigger and more scandalous problem has been accidentally and partially addressed by the imposition of temporary taxes on bonuses, and it has been mitigated massively by the recession in the world economy which has cut back the trades for which the biggest bonuses were paid during and after the bubble. I was emphasising this problem by 2005; while most commentators - even many of those who predicted the crash - appear still to be as oblivious to it as David Cameron and Evan Davies appeared to be today.

The biggest bonuses, ranging to thousands of per cent of notional base salary in the most extreme cases, were available in what has - quite rightly - come to be called casino banking. But even those who coined the phrase do not seem to have grasped fully what it means, as I tried to express the matter in my Fellows Lecture to the Insurance Institute of Ireland early in 2007. Very able people, mostly graduates in mathematics, pure science or sophisticated engineering, and often with doctorates in those disciplines, were taken into the proprietary trading subsidiaries [or sections] of companies that had taken on a complex of traditional 'financial' transactions: stockbroking, jobbing [holding stocks and shares for brokers to buy from them], corporate analysis, financial advice to businesses, assistance in issuing new shares or raising loans, facilitating mergers and takeovers, and a series of specialist services. Having brought them together, as was permitted by the relaxation of market regulations in the nineteen 'eighties [the British 'big bang' was in 1986], their bosses were greedy for growth: to be achieved by the conglomerates competing with each other for established classes of business and by developing wholly new products and the markets in which to place them. The latter area was where the brilliant scientific minds could most profitably be brought to bear. People grounded in the old skills worked in close collaboration with lawyers who could draft the terms of new contract types, and auditors who could find ways of validating the reported outcomes, and rating agencies that claimed to be able to evaluate the contracts, they developed new ways of securitising loans that had been made to 'real world' people and firms; and ways of gambling against possible outcomes in 'real' markets without ever actually buying or selling commodities or company bonds or shares or insurance policies.

Futures had been available for centuries: for example, a biscuit manufacturer could enter into a contract to get grain next year at a determined price from a merchant who bought and sold grain and believed that [to some modest extent, but better than others] they could guess probable future prices. If the merchant guessed wrong, and had to pay more to get the grain that was needed to fulfill the contract price that he had promised to sell it for, he took the loss: but if he had guessed right and the open market price for the crop on the day when he had to buy to meet the contract [the spot price] was below the level at which he would sell the grain to the contracted buyer, he made a gain.

Copying the 'real' futures market, the new wave invented financial futures. These were betting slips by which a punter [often a trader working for another conglomerate] would place his bet as to what movement would take place in the price of some share or bond with another trader who had a slightly different expectation. No shares or bonds were involved between the parties: they simply had a bet on how much the price of the bonds or shares [that were being held and traded by participants in the 'real' market] would rise or fall in a set period. If the seller of the betting slip was proved more accurate in his guesswork, he had nothing to pay out and he kept the fee for which the slip had  been sold. If the issuer of the share or bond was a worse forecaster, in this case at this time, than was the holder the issuer had to pay to the  holder whatever sum had been specified in the contract. This principle was extended to a vast range of derivatives and other instruments or products that were progressively dreamed -up. These creations existed only in cyberspace, as promises between firms, which had notional values when the contracts came to maturity. Many did not run their full course, where get-out clauses were exercised as external conditions and the internal needs of client firms changed.

Settlement had to be made periodically between the conglomerates and this was done by transfers of cyberspace credit: and trades between firms largely evened-out over the years. Nothing of value to the material world was generated as a result of trade in the more esoteric 'products': but the immense scale of the leading firms' balance sheets that resulted from totting-up the notional value of all the contracts they had bought was accepted to have justified them in increasing their securitisation of loans to people and firms in the 'real economy'. The success of the imaginary trade sanctioned an increasing use of securitisation to expand credit to 'real' householders and factory owners, and hence the credit bubble was fuelled despite minimal [or even negative] growth in the productivity of the material economy.

Massive imaginery profits were made from the imaginative trades: so the traders and product designers and lawyers - and, above all, the inventors who constantly created new species and variants of the contract types, were paid huge 'bonuses' which were volumetric commissions on turnover achieved by the skill and imagination of the team leaders and their clever supporters. The amounts that the best such people earned took the bulk of the real-world cash that was earned by the banking and advisory sections of the conglomerates. As the bubble grew in 2003-7 the banks did not have enough basic cash to pay the bonuses in full; but their directors were keen to go on expanding their cyberspace balances, for which they had to encourage the deal-makers and the secondary traders who backed-up the markets in the transferable slips. Pro-rata bonuses were paid to the creators of, and traders in, more spectacularly imaginative 'products' that were traded with ever-greater  notional values. The conglomerates paid an increasing proportion of bonuses in shares: because the cybertrades delivered no significant cash earnings to the firms whose brightest and best were dealing in them. Until bonuses became a source of mass public concern the dealers could cash their shares by seling them on the open market. But the shares were becoming relatively less attractive because the comglomerates were using most of their net cash [real world] income to encourage their dealers to expand the   scope and size of the unreal universe. The conglomerates didn't have sufficient cash left over to pay higher dividends: so firms like Barclays - which changed from being primarily bankers to being phenomenally bigger proprietary traders - did not significantly increase dividends and consequently their share prices did not grow significantly through the bubble period.

When the crash came, trillions of dollarsworth of the notional value of cyberspace contracts ceased to have calculable prices. The aftermath is still being felt, and many situations are unresolved; but it seemed obvious to the boards of the conglomerates that they had to earn what they could where they could: so they retained their dealers in the market segments that survived, encouraging them to maximise their turnover; and thus they had to continue to reward them in the way that had been evolved in the good times. The 'banks' had an intractible image problem that sat uncomfortably alongside their systemic business problem. The remuneration of the cybertraders was competing for cash earned by 'bog standard' banking with the regulators' demand that they had to keep more cash in their reserves [proportionally to their retail banking business].

To the public- including [apparently] the Prime Minister - bonuses are the income supplements paid to top directors, which have in some cases been stigmatised as 'rewards for failure'. On that assumption it seems obvious to put a cap on bonus payments in 'banks': but as has been shown above the bulk of 'bonus payments' have really been turnover commissions to dealers who are far removed from the sort of banking that involves the voting citizenry.

The simple solution to this dilemma [and a large part of the answer to the Merkel-Sarkozy nonsense of the Tobin Tax] is to classify all the problematic businesses as what they are - gambling. Take them out of the 'financial services' arena and stick them under the regulation of the Gambling Commission, with the appropriate regime of taxation. The banks can still own such firms, if they want to take the reputational and financial risk of doing so; but the true nature of the business and the proper explanation for its remuneration system would be apparent. One cannot expect Evan Davies to get the point, but there might be somebody in Whitehall who can coach the Prime Minister into an element of common sense.

UPDATE
On February 3 the Leader of the Labour party joined in the display of ignorance. He too berated "bankers'" remuneration packages withour recognising the differential between traders' commissions for turnover and directors' pay that is loosely related to the general level of 'compensation' in the business. This is another display of the fact that a well-chosen comprehensive school and Oxbridge can produce a result similar to a product of Eton and Oxbridge in becoming a clot who can join in the yaa-hoo 'debate' that is a natural development from the example set by the minority who have passed through the Bullindgon Club.  

The EU and the Eurozone. What Should be Done Next?

Superficially, the easiest thing that could have been done by the EU in the last 24 hours would be to force Germany to open its coffers to 'save' the euro by buying all the bonds that may be issued or guaranteed by the puppet governments that have been installed in Greece and Italy, and may be installed in other economically failed countries. The spokespersons for the 'markets' - and representatives of the Obama Administration - will continue to press for a 'solution' on these lines whenever it appears that the new solution to the euro crisis is open to question.

In the 'markets' so-called hedge funds and other speculative investors have been stockpiling at-risk bonds when they could buy them cheaply, in the expectation that Germany would eventually be forced to 'support' them at higher prices. Germany has declared its commitment to the European Union, and to the euro, for decades and the marketeers think that pride and stubbornness will not let them back off from supporting the new dispensation. The Obama team of died-in-the-wool pre-2008 bankers have done pretty well to consolidate the position of their former employers since the big bail-out of the rationalised banks that were cobbled together in 2007-9.But they are well aware that the ramshackle result could begin to crack if the euro was disrupted, causing the US banks' holdings of euro debt to loose value. The US has been calling-in the moral obligation that is supposedly owed by Europe for US investment in defence during the cold war of 1947 to 1991. Time has moved on. The sensibly selfish basis for US policy, past and present, is clearly recognised and contemporary Europeans do not recognise a continuing obligation.

Germany in 2011-12 does not recognise an ongoing obligation specially to assist European countries that suffered occupation or destruction during the second world war. Huge reparations have been paid, the balance sheet has been cleared, and the anti-German current within Greek protest against financial stringency is self-defeating.

Germany should in no way feel obliged to assist a bankrupt state that got itself into the mess that its proconsular ruler is trying to resolve. Greece is uniquely in that perilous situation at this moment. The Greek people will suffer dramatically lower living standards for an indefinite future because Greek governments doled out more resources than the country had generated continuously for the past three decades. Though different parties won elections from time to time, each government had a popular mandate; and it is the misfortune of modern citizens in any state that they collectively carry responsibility for the accumulation of debts that the elctorate consented to being accumulated.Any Greek could have discovered that their huge salaries, early retirement ages and evasion of taxation were not only exceptional but also blatantly unaffordable when set against national economic data. The typical citizen may have chosen not to take cognisance of the facts: that dereliction alone stimulates fair-minded aliens to inhibit any sypathy for the unfortunate elderly who now have dramatically reduced living standards and no prospect of mitigation in their lifetime.

Economists have been allowed to dominate economic policy with the assertion that 'markets' are efficient. They have handed it down as 'scientific fact' that governments should so arrange affairs that markets are the drivers of the economy. This is utterly ludicrous. Markets are creations of human beings, and only have any life to the extent that human beings take part in them. The people exist under the protection of the state, they can make contracts because the state and its courts-of-law recognise them as legal persons. The companies that exist in markets are licensed to exist by the state. The contracts that people and companies make are only enforcible if the state's courts recognise them to be valid. The state has an unqualified precedence over any business structure and this is an inescapable fact: for Economists and their dupes to presume otherwise is profoundly dangerous.

People have an infinite capacity for cheating, crookery, and fraud; as much as they have the capacity to be creative in the arts and sciences. A few hundred people - mostly science graduates, many with PhDs - have become adepts in black arts that enable them to create derivatives and credit default swaps. They can - and some of them do - set up deals that are designed deliberately to exploit other market participants. They invent and trade in fantastic 'instruments' such as 'shadow shares' that enable a pension fund to put its money into bonds but in parallel with that to buy notional shares, with a promise that if the 'real' bonds fail and the notional shares retain value, then the firm that has sold the shadow share package is contractually obliged to give the pension fund value equivalent to the gap between the value of the bonds that they hold in comparison to the then value of the notional shares. The idea that any financial firm would be able to deliver on such a promise in the event of systemic market failure, without the sort of government support that the banks were given in 2008, is absurd. The contract - and the pension fund with it - would most probably be wiped out. But while the contract is operational [and untested] fees are paid to the conjurers, the pension fund managers get their salaries and the Trustees draw their fees or allowances: only the fund members stand to lose.  The financial services providers have become even more blatant than they were before 2008 in the absurdity of the 'products' that they have offered; and the gullibility of their clientèle seems to be undiminished. The providers made Greek and Irish state debt appear to be sounder investments than they were, by enabling the holders of the bonds to 'hedge' those purchases with derivatives or ghost shares.

Markets that include such cajolery and sheer brass cheek among their trading methods, selling 'products' on which millions of peoples' future incomes depend which have no substance, are profoundly 'imperfect'. It is blatant that knowledge and understanding of the products and of the risks that are inherent in them are not equally understood by purchasers and the people who unknowingly depend on the outcome of the contracts. Essential rules of the system must be defined by the state, the traders must continue to be licensed by the state and the products must be subject to classification by the state. The infantile version of the Tobin Tax that has been proposed in the EU would have no significant impact in regulating the markets as they have evolved in London and New York. It would primarily be a regressive imposition on the day-to-day bank and insurance transactions of the mass of the population. If 'complex products' are to continue to be regulated as financial assets, much more intrusive regulation - more comprehensive than what is currently being proposed by the EU financial regulator - is needed.

But a completely different approach would be more sensible. At the very least, derivatives and most 'swaps'.and many futures and other 'asset classes' should be classified as betting slips; which is the simple truth. As bets, they should be regulated in the UK by the Gambling Commission, not the Financial Services Authorities. They should be subject to gambling tax and not susceptible to regulation by the EU Financial Services Commissioner and his empowering legislation. By trying to exempt Britain - specifically the 'City' - from any new restrictive EU financial services regulation David Cameron has had a Pyrrhic victory. He has not got any significant exemption for British financial services [which he repeatedly points out is 10% of the economy] and he does not have any inkling of the basic fact that much of the 'industry' that he is trying to protect is not finance, but gaming. The appropriate regulatory change should speedily be implemented: then the EU system of financial regulation would not apply.

It would make an amazing positive change to the continentals' perception of Britain and of the activities of the City if the suggested reclassification were to be carried out. If the British Treasury and Cabinet Office will ever be capable of taking this point, they can frame a regulatory regime that will be seen by the rest of the EU as exemplary. Britain's detractors would be wrong-footed and the rehabilitation of the UK would be facilitated. The City need not suffer any great loss of business, insofar as the players can convince their clients that the betting slips that they have been buying to hedge their investments will still serve the same purposes under a more appropriate and honest regulatory regime. I have only a scintilla of doubt that the City lobbies will oppose any reclassification of their 'proprietary' activities because their pride will be offended by their being classified as bookmakers and their greed will baulk at paying higher taxes on a different basis and possibly experiencing some loss of business. But the City and the government have a golden opportunity to escape the very real threat that the new Europe will much more massively deflate the City's income under its tightening and uncomprehending regulatory regime.

Away to the west Dublin has developed huge 'financial services' expertise that is currently underemployed. A swift-footed Irish government - safe within the carapace of the revamped eurozone - can go a significant way to develop a high-level bulk betting regime that could capture a great deal of the market that the City of London stands to loose. That threat [and the possibility that the Swiss may dabble in these markets]  may help to persuade the City that here is a way forward.

Mastering Markets

Media commentators, and the tame Economists who provide them with sound-bites, continue to talk of 'the markets' as independent entities that have the power to undermine national economies and even multinational agencies in their endeavours to stabilise the prices of currencies [against each other] and national debt [quoted in an external currency: e.g. US bonds priced in the Yen or the Euro]. A market is merely a social structure. The dealers in markets are companies that are registered [and taxed] under the laws of specific countries, so the implicit assumption that they somehow exist as agents over which states have no control is a silly outcome from economic theory. Market participants are susceptible to government control at work, no less than they are subject to regulation when they drive home in their cars. If governments opt not to control the behaviour of marketeers, or use arcane and ineffectual methodologies that are concordant with Economists' theorising, any resulting detriment is their responsibility.

Back in the simple world that existed before the Big Bang of 1986, banks [which were then recognisable as a specific group of trading businesses] were subject to the corset. Just as a material corset pinches in the waistline of a person who is embarrassed by obesity, so the banking corset limited the extent to which each bank could expand its business. Banks were told the limits, and they obeyed: sort of, for a time. But then the Bank of England, as the regulator, allowed the rule to be 'bent': the Bank turned a blind eye to window dressing. The banks were required to demonstrate that they were keeping to the rules on one date each month; which allowed them to manage the timing of loans and repayments so that they went significantly about the permitted level for most of the month. It was by making and all-but-breaking such rules as the corset that old-style regulation became discredited. But if the rules and the methodologies had been imposed effectively they need never have become discredited. The supposedly gentlemanly banks of the pre-big-bang era slid around the rules: and their successors have continued to do so.

The present situation in both global finance and in domestic stock markets requires control. History shows that market players ignore rules that are not enforced, and try to manipulate rules and principles that are enforced; so we should be prepared now to treat market participants with firmness - and no exceptions - if rules or precepts are broken.Then new, simple rules can be made and new precepts for the conduct of market operatives can b established.

Within share markets, rules should specify that only registered owners of shares could ever vote on those shares: and company secretaries [or equivalents] should be required to certify compliance [with draconian penalties for breaches].  A corset can be applied to movements in the valuation of shares, such that sales and all other types of transfers of shares are frozen after the price has moved up or down by more than 1% in a day, or 2% in any three-day period. The period of the freeze would then be announced by the regulator, and would not be less than the time necessary for the buyers to pay for the last shares sold and register their new ownership. Exactly similar rules could apply to sales of state bonds and other financial instruments. Derivatives, swaps and other gambling slips that are created and traded as 'hedging' instruments should be subject to gambling tax of at least 10%, and subjected to gambling laws and the regulation of the Gambling Commission. The Commission could establish its own corset on the creation of each class of betting instrument.

Market participants and their conduct can be controlled - and should be controlled. The control need not be complex: just the opposite. The best control would be simple control, and breaches of both the rules and the principles must be punished by both financial levies and penal servitude.

Credibility in Markets

One.

Italy's situation has not notably been improved by the supposed resolution of the Eurozone problem; as interest rates on Italian state debt have continued to rise. The Prime Minister who is regarded outside Italy as a buffoon remains a formidable operator within  the country: he has said that he is willing to stand down later in the year, but most observers are sceptical. Parliamentarians descended to fisticuffs while Berlusconi was in Brussels delivering a long and explicit letter to his Eurozone peers in which none of them placed complete credence.

If the politicians cannot even pretend that the Italian state is credible, how can anyone expect the herd of analysts and traders in international debt to have any faith in it? 'The markets' are just a network of websites: the avatars who inhabit them that reflect the decisions of company representatives who do not have the sort of freedom to take risks that they did in the years 2002 to 2008. Now the boards of their employing companies consciously set the parameters within which the traders can operate, and the terms in which analysts can summarise the data that they select as a basis for comment. As long as Italy is perceived as a public scandal and a rather obsecene private joke, the herd will take its cue from that assessment. Any investor who is contemplating putting money into the 're-engineered' Euro bail-out funds is advised to assess what 'the markets' indicate: and the declining valuation of Greek and Italian debt is a huge inhibiltion on the credibility of the financial engineering that was bodged in Brussels last week, The stock markets had a minor boost from the apparent solution of the problem: because companies based in Germany, France and Finland are trusted and their shares are more widely held than are industrial and bank shares in Italy and Greece, or Spain and Portugal. So over the coming weeks there will almost certainly be a bifurcation between 'northern' shares and 'southern' state stocks. The de facto division of the EU will be consolidated.

Two

Italy will probably eclipse Greece in the analysts' comments and in reports of the markets' behaviour for a few weeks: until the desperate state of Greek politics again demands the prime attention. The Greek people have been so misled by the the state's corruption in ignoring tax obligations, and by its reckless borrowing to pay them pensions and benefits that no economy on earth has ever been able to support from its earnings, that millions of them cannot believe that the austerity package that has been imposed by the Eurozone is either necessary or desirable. They have been told by the media that foreign banks have been induced to write-off half the value of the Greek state securities that they own: so why should not all the state's creditors do the same? And why not 99%, rather than just 50%? What can foreigners do to them, if they simply tell the Eurozone to forget the past and leave their future to them? The failure of CDSs on Greek debt [see Three below] will reinforce the opinion that 'the markets' don't really matter at all.

Three 

There has been a lot of comment on the recent collapse of 'value' in CDSs on Greek debt. The media have glibly described them as 'insurance policies' - which is precisely what they are not: that misrepresentation is wildly misleading. Credit Default Swaps [CDSs] are gambling contracts, of a special type that was invented in US wholesale banks in the nineteen nineties.

The concept was massively oversold by an ill-supervised wholesale-market branch of the greatest US insurance company, AIG, based in London [well away from scrutiny by the Head Office]. This small clique of people earned huge bonuses - and big notional profits for the firm - by selling these bets to banks, who wanted to be able to dress-up their balance sheets with an 'asset' that offset the perceived risk in owning bonds issued by institutions - mostly banks and governments - whose long-term credit worthiness could become questionable. In the credit crunch of 2007-8 holders of CDSs that offset assets that lost their 'value' came for their money, in such numbers that the small funds held by AIG's London office were instantly exhausted. There was a good chance that all the real insurance policies that had been underwritten by AIG would be voided if the company failed, due to the fact that its obligations under CDSs would massively exceed its reserves. One important consideration was that AIG - American International Group - was a huge player in the emergent markets in Asia, If the company failed the reputation of the USA would massively be diminished, especially in China, which had been the main target of the company's long-term Chief Executive 'Hank' Greenberg who had received massive political backing from the US government. Welching on China was considered unthinkable; so the US Administration and Congress agreed to support AIG with as many billion dollars as was needed to settle non-insurance obligations. The AIG case, however, gave credibility to the idiotic misdescription of CDSs as 'insurance policies'.

The really bad story about CDSs began after the bail-out of AIG. Despite that disaster, the players in the wholesale financial markets saw CDSs, alongside 'derivatives', as 'products' that they could sell in massive volume as ephemeral electronic contracts out there in cyberspace. Insurers as such had never been involved in the market: it was ab initio a bankers' creation and so it remained.  Banks bought CDSs - from each other - and reported them as 'assets' that could offset the risk that might exist in holding Greek or Italian government bonds as part of their reported capital reserves. Then they started selling each other CDSs as pure gambling slips, only notionally related to 'real' obligations: and in some cases multiple CDSs were raised in a series of separate contracts which notionally covered the same perceived risks. An increasing proportion of the purported risk-cover held by banks was in this form.

Then came the Irish crisis: where the government saved the situation by accepting all the banks' debts itself, and so the CDSs held against that possible default were not activated. As the Greek crisis approached its first peak even bankers saw it coming, so they mostly sold off the CDSs that they held against Greek debt [at heavily discounted prices] on the crude assumption that it was better to have a tiny asset rather than an undeliverable promise. This made it possible for the club of banks known as the international derivatives association, which was accepted by all the member banks as having authority to say when CDSs should be activated by declaring a 'default' by the issuer of the underlying assets - in this case, Greek government debt - to declare that the 50% write-down of Greek debt was not a default, so the remaining CDSs against Greek debt could not be activated and the balance sheets of the issuers of the CDSs were unimpaired. In the immediate event, the issuing banks were protected: but the longer-term credibility of CDSs as a cover for potential losses was challenged, possibly beyond repair.

There are still trillions of dollarsworth of CDSs in existence: they are still held as balance-sheet cover for the banks' perceived risks; and they may well be useless. Casino Banking has been storming ahead even while the bankers have supposedly been in the pillory and under close examination: so much for regulation, so much for the competency of government.

The more one knows, the less one can believe.

Even if one is irritated by the inarticulate clods who are wasting their time outside Saint Paul's Cathedral, it has to be conceeded that they have a point: if only they understood it.