[R-G] [BillTottenWeblog] This reckless greed of the few ...

[Bill Totten]

... harms the future of the many

The government must act firmly to control an industry that destabilises
all our lives with its naked pursuit of huge profits

by Will Hutton

Observer (January 27 2008)


Never in human affairs have so few been allowed to make so much money by
so many for so little wider benefit. Across the globe, societies and
governments have been hoodwinked by a collection of self-confident
chancers in the guise of investment bankers, hedge and private equity
fund partners and bankers who, in the cause of their monumental
self-enrichment, have taken the world to the brink of a major recession.
It has been economic history's most one-sided bargain.

Last week's financial panic was further evidence of the extreme
foolhardiness with which global finance has been organised and managed.
There was the biggest one-day fall in Wall Street since 11 September,
which spilled over into every world stock market and the largest single
cut in American interest rates for 25 years as an emergency attempt to
stop the rout. A new crisis emerged in an obscure American insurance
business (monoline, it is called). To cap it all, there was the GBP 3.7
billion bank fraud at Societe Generale.

The growing realisation of how exposed the financial system is - and
from transactions that should never have taken place - is reinforcing
the mounting credit crunch, which, in turn, is spooking stock markets.
The US economy is weakening while in Britain new mortgage lending is at
a ten-year low. The staples of a settled life - jobs, pensions and house
prices - are all under threat.

The availability of credit is one of the fundamental pillars of any
economic system. Like the delivery of gas, electricity and water,
finance should be regarded as a utility and after the credit-crunch
disasters of the 1930s, following the free-market 1920s, it was
regulated as one. But Anglo-American financiers have used the theories
of the free-market fundamentalists to argue that it should be liberated
from such regulatory 'shackles' and again run as a business like any other.

Yet finance is not like any other business. When a bank makes a mistake,
the ramifications for the rest of the financial and economic system are
so severe that it has to be bailed out - witness Northern Rock. Because
of this truth, financiers have organised themselves so that actual or
potential losses are picked up by somebody else - if not their clients,
then the state - while profits are kept to themselves. An industry that
socialises losses while privatising profit, and that has the capacity to
create booms and busts alike, has to be as closely regulated as any utility.

I was reminded of the system's proclivities by a consultant friend who
was hired to arbitrate over a performance bonus between a hedge fund and
one of its asset managers. The individual in question was paid a base
salary of some $100,000, but the investment funds he managed had done
well over 2007, rising in value by more than $500 million. His bonus was
$206 million and he felt that to conform to industry norms, his bonus
should be nearer $250 million - the cause of the dispute.

What, I asked, would happen in 2008 if the assets he managed fell in
value? He would get paid his base salary and no bonus came the reply.
And would he be required to repay any of the $250 million he had
pocketed this year? Of course not.

This is the one-way, short-term bet that is endemic in the way the
financial services industry rewards itself and which incentivises
recklessness. Raghuram Rajan, former chief economist of the IMF,
differentiated between two sources of wealth generation in the financial
markets in an insightful article in the Financial Times earlier this
month. There is run-of-the-mill 'beta' value created because stock
markets and the economy are set fair and going up; then there is special
'alpha' value generated by investors such as American billionaire Warren
Buffett who see opportunities others do not.

The problem is that while we know a priori that there are only one or
two Buffetts around who deserve alpha-style pay, this has become the way
the entire financial system's executive class rewards itself - being
paid as if just one year's performance revealed them to be alpha
superstars when, in truth, most are ordinary beta performers. It takes
longer than a year to reveal who is alpha and who is beta, whatever
executives like the hedge-fund manager in dispute over his bonus may claim.

The remuneration structure is a disaster. One of the reasons why rogue
trader Jerome Kerviel faked a stunning GBP 3.7 billion of transactions
at SocGen may have been because he regarded himself as being paid as a
beta when he should have been paid as an alpha like everybody else.
Moreover, he was able to fool the bank by trading in the daffy
instruments that the financial system created to persuade national
governments that it is not running excessive risks, an insurance that
laid off risks to others. Hence the casino character of many new
financial markets, which essentially operate as bookmakers accepting
differing bets on future prices. Underneath their technical names -
monoline insurance, derivatives, debt securitisation - lies little more
than bookie principles and practice.

But selling off bad risks doesn't mean the catastrophe won't occur. And
when the balloon goes up, the financial system screams for government
intervention - to cut interest rates aggressively and to bail out
stricken banks and insurance companies. Indeed, better still for the
financiers, a gullible government can be persuaded to assume the risk,
the exact principles of the Goldman Sachs-devised bail-out of Northern
Rock - lubricated by excessive fees to the partners.

Thirteen years ago, I tried to blow the whistle on financial market
liberalisation in my book The State We're In. It was obvious then what
is even more obvious now: financial market freedom embeds short-termism,
guarantees lower investment, works against business building and
innovation, generates booms and busts, inflates house prices, creates
system-wide risk and excessively rewards those who work in them. I
thought the Germans and Japanese were better than the British and
Americans in the way they organised and regulated finance and that while
Britain and America might look good in the short term, their economies
would eventually come back to earth with a bump.

New Labour threw a protective mantle around the financial markets in a
way it never would for industry and sceptics were patronised as
backward-looking, Old Labour know-nothings. Let's hopes these new crises
will prompt a root-and-branch rethink. Of course, like the Americans,
the British need to respond by aggressively cutting interest rates,
cutting taxes and lifting public spending.

But more, we need to regulate closely how the financial system deploys
its capital, develops its loans and how its people are paid, an
initiative that requires global support. We need the financiers to serve
business and the economy rather than be its master.

This is not a question of helping the financial system better to
understand the risks it runs through more 'transparency', the friendly
diagnosis deployed by both the Governor of the Bank of England and the
Prime Minister in speeches last week. This is about reworking the
one-sided bargain between finance and our economies. Only then can we
lay the foundations for recovery and bring some semblance of fairness
and rationality to the way these plutocrats behave.

Guardian Unlimited (c) Guardian News and Media Limited 2008

http://observer.guardian.co.uk/comment/story/0,,2247583,00.html


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