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.
Showing posts with label swaps. Show all posts
Showing posts with label swaps. Show all posts
Friday, 2 November 2012
Monday, 2 July 2012
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.
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.
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.
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.
Friday, 9 December 2011
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.
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.
Tuesday, 8 November 2011
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.
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.
Subscribe to:
Posts (Atom)