This gloomy Bloomberg article, talking of capitalism’s global “winter of discontent”, argues that the current troubles are the first globalized crisis for free enterprise. Well, when an article makes an error in the first paragraph it does rather dim one’s enthusiasm for reading on. Arguably, we have had cross-border crises in markets dozens of times: the recession of 1870s, the Great Crash of the 1930s, the 1970s oil-shocks and stagflations in the US and UK, the early recession of the 1990s in countries as different as far apart as Japan, UK, Germany and US, etc. Maybe the sheer extent of the malaise now is what has struck the Bloomberg writer, but truth be told I think this is a matter of degree. According to this excellent book, markets were in fact more globalised 100 years ago than they are now.
To use one of my least favourite words, there is now a constant “narrative” as to how the recent turmoil somehow proves that unregulated capitalism has failed and too closely interlinked. Quite how anyone can, with a straight face, argue that financial markets have been unregulated in recent years is a joke. Here are some of the regulations financiers have been dealing with, often with counter-productive results:
- Markets in Financial Instruments Directive (known snappily as MiFID). This is designed to make EU financial markets more competitive, but as so often is the case, has been designed to raise barriers to entry in certain fields and has led to a rise in regulatory costs and loss of choice.
- Basel II bank capital adequacy rules. How’s that working for ya?
- Patriot Act – the finance provisions
- Various anti-money laundering laws
- Tax information sharing treaties (various)
- UK capital adequacy regulations of financial advisers
- UK laws banning/controlling certain types of financial advertising. Apparently, we poor saps need protecting from crooks. Shame none of the big banks spotted Bernard Madoff then.
- Restrictions on sell-side analyst research. This is built on the quaint idea that analysts working for banks should be models of Corinthian virtue and not have a bias.
- Sarbanes-Oxley accounting laws – these have been a disaster, encouraging a flight of US businesses offshore, killing IPOs and squeezing new business formation.
- And last but not least: central banks. These are state institutions, issue monopoly money and have been behind much of the current trouble. Sometimes, when reading criticisms of “unregulated” capitalism, you might imagine these banks are purely commercial entities.
I am scratching the surface and I am sure readers can come up with more rules and regulations. Every time any of you good readers hears this canard about “unregulated capitalism”, call them out gently for this and ask them in what field, apart perhaps from security or medicine, are activities more heavily regulated than finance?
Update: oh, I should have mentioned the US federal housing agencies such as Freddie Mac, and their contribution to creating a massive moral hazard problem in the house lending market.
Indeed. One can more convincingly argue that free enterprise (productive free market businesses) have been brought down by unfree state business (the banking system which ultimately controlled by the BoE, Fed, ECB, etc).
The problem, as ever, is in getting our “narrative” heard.
actually it seems like the big banks pretty much all spotted madoff.
Agreed.
The government does have a role in making sure that there are no cartels, collusion, market rigging etc, but nine out of ten ‘bubbles’ are purely down to government intereference in free markets.
Seeing as ‘the government’ always had an indirect financial interest in banks, via the £35k deposit guarantee (now £50k) it’s also right and proper that they supervise banks (as in supervise, not regulate) seeing as of how shareholder and management supervision has been shown to be useless (principal/agent problem).
But that’s about it.
Let them cartelise and collude. Cartels are inherently unstable because every conspirator is constantly looking around the table with shifty eyes knowing he could gain an advantage by outcompeting other members of the cartel; cartels always benefit the least able conspirators, so there is always a pressure for the more able to break ranks.
The dangerous thing for us proles isn’t freely formed cartels, it’s government supported cartels, which can and do hold the members in lockstep. We’d do better from no government intervention at all.
botogol, if they spotted the Madoff fraud, then how come such big banks as Credit Suisse, UBS, Santander, HSBC, etc, got stung for billions from this shyster?
The truth of the matter is that even some of the world’s largest financial institutions did not do basic due diligence checks on this man and were only too happy to ride on the back of his Ponzi scheme. They have now been shafted. For once, I would be supportive of clients in suing their banks for basic negligence and failure to honour their fiduciary responsibilities.
IanB, correct. A good example of how the supposed power of cartels is overblown is OPEC. Four months ago, the price of crude oil was heading towards $150 a barrel. It is now less than $40. That is an incredible shift. OPEC has been hardly able to have any influence on the price movement. Most cartels are unstable because there will always be a vested interest in going against it. A lot of anti-trust laws are pointless and in fact have been used to shake down or damage businessmen deemed too big for their boots, like Bill Gates, Rockefeller, etc.
Regulation under the UK’s FSMA 2000 has been operating as nationalisation lite, or state control by proxy. The Government’s shock troops in this assualt on free markets, the Financial Services Authority are, I can categorically state as I work in FS, clueless. Everything they do is a bureaucratic measure that loads costs onto all the market participants and, as has been shown by the their total failure to identify problems at Northern Rock, a complete waste of time.
We have tried over-regulation and it has failed. Now let’s get back to free markets and freedom and watch them succeed.
It’s about to get a whole shedload worse.
We may all (I do) burble on about the functions of governments. Still we are avoiding a more pervasive context of social organization and the trends amongst “Western” peoples since the two “Enlightenments;” the Scots and the French (or continental).
The French Enlightenment, and its immediate precedents, particularly in Natural Sciences, brought forth the determination that rules (sometimes called “Laws”) must exist, or can be deduced to be constructed [I prefer fabricated] as Hayek noted, for all of human conduct. Hayek referred to “constructivists.” To me such persons are “fabricators” (in all meanings of that word). As noted by some of the more perceptive Scots (and others since), all this has involved enormous conceit as to the application and force of “Reason” to determine the relations of humans with one another and their surroundings (I would use “environments” but for the possible misinterpretation).
The French present us with extreme examples of creating a new “law” whenever economic or social problems arise; legislation as the cure for all ills.
But, they are not alone in the proliferation of “laws.” The statutes of the U.S., the U.K. and other nations where I have worked in the past 55 years have increased exponentially – on all matters civil and criminal (especailly the latter).
The resultant impact on commercial and financial activities (a significant part of human activities in advanced cultures) is not unique or separate, but rather an integral part of the extension of the concept of rules for everything – even if they have to be fabricated rather than evolve from circumstances; and fabricated they are with conceit, errors and consequences.
The swampy morass of fabricated rules has created an environment for predatory creatures and their activities that would not otherwise subsist. The existence of fabricated rules offer no assurance that they will either control or effect human actions as designed or proposed. And yet, the floods of “legislation” “regulations,” “ordinances,” etc. go on and on – but there is not, in most of the “West,” sufficient force to contravene the the conceits generated by the “French” Enlightenment. As yet not enough people realize they are, or find themselves, so obviously adversly impacted to raise that vital question – why?
As a result we now live with a “law” of rules rather than the rule of Law.
The existence of central banks guarantees the existence of banking cartels. When the Federal Reserve was set up in the US, it didn’t have to be forced on the bankers. They were all for it. They wanted it to cartelize high finance.
Not forgetting the costs those regulations create, making it more difficult or impossible for new entrants thereby creating the too big to fail problems.
As for regulations in financial markets, at my very low level, I had to take tests about subjects with absolutely no relevance whatsoever to what I do. The only saving grace was that they were online so I could do them at work. They were such a waste of my time that I would be at a loss to tell you what most of them were about. But somewhere in my firm, a jobsworth was able to tick a box so that another jobsworth at some government agency could tick another box.
That the real cancer.
Johnathan –
I understand your point, although when the Blmbg writer is talking about globalized crisis I think he’s referring to not just the interlinkage of credit markets (which have been linked for quite a long time) but to the globalized linkage of design, raw materials, and finished materials supply and manufacturing operations which are now intertwined in a way they were not in the past. Money has been intertwined for some time, but a country’s manufacturing base used to be housed within its own borders (and when I talk borders I’m including imperial borders). We’ve sent much of our manufacturing base to China and Mexico, and that is very different from the 30’s.
I thought the myth of unregulated global capitalism was the idea that it has ever existed – I guess I have some catching up to do 🙂
… markets were in fact more globalised 100 years ago than they are now.
In labour they certainly were. Migration was physically difficult and expensive, but it was broadly permitted.
i reckon there was a lot market failure to go around. i think banking margins were squeezed and then banks started acting against their owners interests. instead of decapitalizing they started taking on more risk. if i was CEO that’s what i would have done 🙂
and when the banks balance sheets started looking undercapitalized the geniuses on wall st came up with a solution to convert risky debt to less risky debt.
As I have said in other forums, the current problems are the result of a political collapse which has economic symptoms, precisely because it was a political agenda, i.e., that low income people be allowed to buy houses regardless of their credit worthiness under previously accepted standards, that imploded and crashed the game.
The real question, which is understandably avoided like the plague by all the “powers that be” and their media lackeys, is why should any of these alleged “experts” be allowed to have any influence over political or economic policy in the future?
The basic case for limited government is being made right before our eyes, but we are remiss in allowing another, completely opposite and counter-factual, narrative to be trumpeted from the White House to most every small town newspaper, with very little effective reposte from the non-statist side.
This recession/depression originated in the very inbred “upper crust” schools, well connected think tanks, and high powered firms whose members routinely shuttle in and out of government service, allegedly because they are so well informed and knowledgeble.
In fact, as advocates of limited government have been saying for a couple of centuries now, they can’t keep track of the myriad elements of an entire economic system, and their fallability, along with the inevitable corruption and thievery which always accompanies a gravy train, has led us into repeated collapses, bubbles, and recessions just in the last few decades alone.
Statists have very proudly proclaimed all through the 20th century that they were required by the flaws of capitalism to “manage” the economy for the common good.
Well, when the management runs the firm right into bankruptcy court, it’s time for not only new management, but much, much less of it.
Throwing the rascals out has barely started, and we have a long, long way to go before we sleep.
Perhaps the most obvious, if not the most significant:
how did Sarbanes-Oxley, passed specifically to stop accounting fraud with the collusion of a firm’s auditors, fail to stop Madoff from doing exactly that? Will S-O now be repealed on account of being both expensive and useless?
My understanding is that Madoff ran two sets of books, and was very secretive in making the information available. It is possible to run a fund that way *if* you don’t have suspicious investors demanding transparency.
Full disclosure; I work for a hedge fund.
The biggest problem is the SEC as you can imagine is that while ostensibly there should be no conflicts of interest, in practice, there can and often is plenty. Then, you find that all the brighter SEC personnel are ripe for recruitment by the hedge funds themselves, leaving a bunch of dim-bulb jobsworths at least at the foot-soldier level, and sometimes far, far further up the hierarchy.
The very status of hedge funds is such that they can’t solicit for business unless they ‘know’ someone, so many of the firms basically feed off extended social networks and word of mouth. In Madoff’s case, the reason he got away with this was greed on the part of one category of investors (the high-net-worth community) and incompetence by the fund-of-fund, institutional and endowments, who employ expensive ‘risk managers’ and ‘due diligence experts’ who all see what the competition is doing, and follow along (for the most part). Many of these people are utter charlatans. There’s a saying in the business; “You can’t tell who’s swimming naked until the tide goes out”.
To be charitable, this ‘Conventionality Risk’ is the same psychology that used to tell people that nobody ever got fired for buying IBM.
The SEC has a number of terms for investors who may participate in such alternative investments – QEPs (Qualified Eligible Participants) (among other terms). In order to be qualified, there are certain earnings/net worth criteria, which basically rubber stamps you as being ‘big enough’ to be a ‘sophisticated investor’ (one of the truly great oxymorons IMO, much of the time. In practice, it means that your pockets are deep enough to make it worthwhile for an unscrupulous money manager to fleece you.
The SEC’s involvement in regulating and overseeing hedge funds is one of the most compelling examples of how overregulation punishes investors and fund managers alike. No matter how many regulatons are ladled on, any genuine malfeasance within the industry is undertaken by people much, much smarter than the sheepdogs, who are breaking very fundamental laws such as fraud, for which we have quite adequate laws.
The solution to the US economic problems is to abolish the Federal Reserve.
The Federal Reserve is a fascist anti-American and unconstitutional organisation which must be destroyed utterly.
Those who claim to believe in the free market, such as bankers and hedge fund managers, should not come running to the taxpayer when things go bad for them.
These men in suits have been exposed as massive hypocrites, spouting about the evils of government then sponging off the taxpayer.
Wall Street should not be given any taxpayers money.
bod – thanks for your comment; I don’t work in the industry, but what you said confirmed my guesses and suspicions about how it and the SEC operated.
Jonathan – according to the Wall Street Journal list the only one of those banks you mention who seems to have any embarrassment is Santander, who only lost $17m themselves, but whose clients lost money
UBS, CS and HSBC seem to have avoided any losses themselves, and their clients’ losses seem to be limited to indirect exposure through funds-of-funds, or in arrangements where the bank was acting as custodian or administrator, or finance provider not as advisor.
The picture seems to be that anyone with their eye on the ball knew madoff was dodgy
Some people even wrote it up neatly(Link)
and the general approach was to steer clear, but say nothing.
Even in the case of Santander all may not be as it seems(Link).
Bogotol, not true. Santander is being sued for allegedly having more than $3 billion of client money with Madoff.(Link)
UBS is being sued by the French investment house Oddo (great name!) to recover about $40 million; here is a story(Link) itemising many of the losses suffered directly and indirectly by banks and their clients. The fact of the matter is that dozens of financial institutions, such as Credit Suisse(Link), Man Group, UBS, Union Bancaire Privee, Bramdean, etc, got hit. The fine details are irrelevant: the point is that these banks, whether custodians or direct investors themselves, got conned or allowed basic warnings to go unheeded or failed to do basic due diligence.
The moral to draw from this is that with all the rules and regulations in the world, bad things happen and when they do, crooks need to be punished severely. Madoff will probably rot for the rest of his sorry life in jail.
Johnathan’s completely right here – the ‘big boys’ haven’t got off scot free by any means. Many of the private client groups of the large banks have failed spectacularly to protect their customers’ interests.
The biggest failing, on reflection, has been in the fund-of-funds (FoF) business. It’s a tricky business, because what they’re selling is (i) access to managers that individuals themselves can’t get (because a given manager might be closed to new individual investors, or they can’t make the investment minima alone) , and (ii) expertise in manager selection and constructing portfolios of allegedly diversified products. What they get in return is an overlay fee, so that instead of an investor ending up being charged 1% of their assets and 25% of their gains (typical hedge fund fees), there’s a further fee the FoF collects, typically another percentage on top.
In practice, these are the breeding grounds of the types of people I panned in my earlier posting. An FoF analyst putting in a few years at a firm, where nothing blows up, is prime material for the risk team at one of the big banks, reporting to the Chief Risk Manager. Many risk managers who head groups have come from trading-floor or treasury departments and they need subordinates who understand the particular nuances of alternative investments – and that’s one of the big weaknesses – it’s easy for one of these analysts to misrepresent the value they add to the process, when basically, they’ve just been sitting in a chair watching a bunch of investments run.
Aside from individual manager events (Amaranth, LTCM, Madoff etc), very, very few of these individuals experienced or even know about historical events in the alternative investment which can crush the funds they oversee.
The problem therefore, is quite mundane – to paraphrase Dick Cheney – there are things they don’t even know that they don’t know, and these people often lack the imagination to anticipate three- or four-sigma events.
The Cato Institute has a good piece on the statist nonsense of too much deregulation:
http://www.cato.org/pubs/policy_report/v30n6/cpr30n6-1.html
I appreciate Bod’s comments; what he says rings true to my experience in the financial world (although I’ve never worked for a hedge fund).
The only objection I have to Johnathan’s last post is his lumping of custodians together with true advisors for excoriation. By definition, custodians have no duty other than to safeguard the physical securities entrusted to them. They are blameless for any of their customers’ losses.
Except that somehow, this doesn’t apply to unions. The whole point of a labor union is to create a monopolistic labor cartel that eliminates competition and fixes prices. Somehow, these things become virtuous when unions are doing them. And the government not only doesn’t stop the unions, it uses its power to protect them.
The problem wasn’t with unregulated capitalism. It was that the “new capitalism” = “the old socialism” controlled and overregulated by the “Little Lord Fauntleroys” was left unchallenged. Somehow, BRIC was the new religion and everyone had to follow like lemmings. China was allowed to play “Popeye and Wimpy” economics with “I’ll gladly pay you Tuesday for World Domination Today” — let’s not forget they don’t have a convertible currency so what were they paying with? Well, Tuesday came after the Olympics( I still can’t believe people don’t correlate the world collapse with the end of the Olympics) and they told everyone holding IOU’s for the great experiment to go scratch. The credit markets screeched to a halt because they did not assess risk in a totalitarian communist economy — too many people’s supply chain were wholly dependent on one nation. China had to pay full price for commodities instead of sweetheart IMF price controls. Boohoo, commodities came back to historical averages.
Let capitalism work and get rid of the weak hands. Let Western rules of law and commerce work to regauge the system through tried and true mechanisms instead of following the “Bernanke Doctrine”. Instead, the powers that be are just covering the bad debts of the idiot globalists so they can still play their parlor games of a one world society. Hasn’t worked for 7000 years and it definitely isn’t going to work with the current crew of intellectual inbreds.
The government does have a role in making sure that there are no cartels, collusion, market rigging etc
Freedom of association be damned, I guess.
(Hint: the distinction between “economic” and “political” freedom is completely bogus; individual rights do not cease to apply when a dollar is involved. Where do you think the “free” in free markets comes from?)
Personally I hope Madorff walks as long as I get to keep my Glock. Stuffing my cash in the old mattress…
Waking up each day and glad I’m not a Brit…
Included this post in the rebooted Carnival of the Capitalists this week. I’d love to see more stuff get in there that’s on the more philosophical or unabashedly free market side.
Freddie and Fanny were messes. Private.
The biggest messes were the unregulated CDSs.
How many trillions?
If the problem had just been with mortgages, with no securities tied to them, the problem would have been resolved in a matter of months and certainly less money than what it has taken.
Private? They are state creations for goodness sake!