by Francis Lee for the Saker Blog
Moral Hazard: Circumstances that increase the probability of loss because of an applicant’s personal habits or morals. For example, if the applicant is a known criminal or engages in suspect financial dealings. (Dictionary of Business Terms)
Economic Rent: Payments and remuneration over and above normal profits which arise from a monopolistic market position. (Cf. David Ricardo – Theory of Ground Rent).
For our purposes, we can substitute the word criminal with speculator, trader, banker, or financier.
In light of the events of the past few years in the development of capitalism (particularly finance capitalism) it appears self-evident that the banks and financial sector have been given a state-backed guarantee that whatever losses they incur will be underwritten by the government of the day.
Of course such bail-outs only serve to increase the problem of moral hazard (see above). Knowing that they are ‘too big to fail’ these institutions are able to indulge in risky trading (with other peoples’ money – OPM) in the sure knowledge that they are virtually immune from any of the negative consequences of this gambling. If it were their own money, they were gambling with they might be somewhat more circumspect in their actions. Free market capitalism should mean that, for better or worse, you should get what is coming to you. These gilded gentlemen, are, their protestations notwithstanding, not in fact the inhabitants of a free market; they would never have survived in that particular environment.
Thus assured of their invulnerability banks on both sides of the Atlantic have resumed their cocky, business-as-usual trading activities and obscene bonus payouts; and incredibly this even included the nominally nationalised banks in the UK such as Royal Bank of Scotland (RBS).
But where are the new credit-rating agencies, the accountancy firms or big banks in this particular scenario? Are there enough of them, and do they act with due diligence? In fact there are just four significant accountancy firms. As far as I know, all British. The Big Four is the nickname used to refer collectively to the four largest professional accounting services networks in the world, these consisted of the global accounting networks Deloitte, Ernst & Young, KPMG and Price Waterhouse Cooper who are supposed to audit critically. It’s the same with the three New York based credit-rating agencies, Standard and Poor, Moody’s and Fitch’s who dominate the market. In 2008/09 this latter trio was involved in dishing out triple-A ratings to all and sundry.(1)
Sad to say that it actually gets worse. Hypothetically, imagine that a restaurant in your neighbourhood made the kind of money paid to top employees in banking, credit-rating and accountancy firms. You’d expect people rushing to open more restaurants, and with that increased competition you’d expect wages and prices to come down. Again, this is how competition works, or at least is supposed to work. There are thousands and thousands of young graduates aching to get into investment banking, so no shortage of prospective chefs. So where are the unpractised players in high finance? Where indeed.
One of the problems in this situation already alluded to is that the banking and financial industry is a de facto cartel; it is not alone in this respect; it is a closed monopolistic market structure protected from competitive pressures. This is not how it is supposed to work. In theory and assuming free market conditions, most importantly freedom of entry into the market is blocked. In the modern world there are significant barriers to entry, competition is therefore nullified and surplus remuneration and profits (economic rent being the technical term) become the norm. Moreover, there are of course huge entry-cost barriers in this industry, so much so, that payment levels are completely distorted. Remuneration committees perform a back-scratching exercise setting, where members of the committee set each other’s salaries, bonuses and stock options. All very chummy.
The reality is that global high finance is a skewed set of interlocking cartels that divide the market among themselves and use their advantages to keep out competitors. Cartels can and do extract huge premiums over what would be regarded as normal profits in a functioning market, and part of those profits go to keeping the cartel intact: huge PR efforts, a permanent recruiting circus drawing in top academic talent; clever sponsoring of, say, an ambitious politician’s re-cycling scheme; vast lobbying efforts behind the scenes; and highly lucrative second careers for ex-politicians and ex high-ranking soldiers. There is also plenty of money to offer talented regulators three or four times their salary.
Additionally, the flagrant rent-seeking, monopolistic abuse is protected by the government from failure. They are apparently so vital to our well-being and their personnel so intrinsically gifted that they must be supported no matter what the cost. So much for the free market!
Of course it will be argued that banks perform a vital function of supplying credit and loans to households and businesses, and as such may be compared to other public utilities such as energy and railways. But recognised public utilities are, unlike banks, tightly controlled or even nationalised, although this is unfortunately changing; but the rewards in these industries are nowhere near those prevalent in the financial sphere. Nor do we allow these industries to play the derivatives markets with tax-payers’ money. This point is particularly important and goes right to the heart of the matter.
The question is whether the Countrywide’s (Countrywide Financial, a US mortgage lender bailed out in the US after reckless lending) of this world are risk-taking enterprises or public utilities. You can’t be both. If the government is going to be on the hook by means of deposit insurance … or implicit federal insurance or other forms of taxpayer guarantees far too important to fail institutions, bank risk-taking has to be tightly controlled. Cautious, risk-aversion, public-utility style banks need intelligent credit and balance sheet managers, not envelope pushing high-rollers with eight-figure pay-checks.
It could be plausibly argued, therefore, that this specially privileged position of finance and its institutions rests upon the regulatory capture of the political apparatus of policy and decision making by this same interest group. There can be no other explanation. Trans-national corporations, global finance and the bond markets seem to be calling all the shots. Governments around the world to date have been seemingly subservient to both their power and their values. Nowhere is this more the case than in the US/UK.
This hegemony of finance and the privileging of financial interests in the UK has been a long-term problem. Taken as a case study, nothing could demonstrate this more graphically than the sell-off of Cadburys, a long-established British confectionary-manufacturing company dating back to the 18th century, to the US food multi-national, Kraft. Of course Cadbury’s is not the first successful British company to be subject to a takeover. We can list the long line of pillage. British Airport Authorities (BAA) various Energy and Water companies, P&O-Ferries (purchased by DP World – Nasdeq-Dubai) Pilkington’s Glass (now owned by the Japanese) Alliance and Leicester Building Society (now absorbed by the Spanish Giant – Santander) Abbey National (another Santander takeover), Rolls-Royce, Aston Martin, Boots (a pharmacy company bought out and owned by a US company in Illinois) KitKat chocolate company, Harrods, The Savoy hotel, even the football (soccer) team Manchester United? Typhoo tea or HP Sauce. This list is by no means exhaustive, and it grows year on year.
Of course, this policy is predicated upon the nonsensical notion that ownership does not matter. This statement is, to use Keynes apt description, ‘of a featherbrained order.’ It should be relegated to the other egregious platitudes such as ‘deficits don’t matter’ (Dick Cheney) or ‘an end to boom and bust.’ Of course, ownership matters. Foreign ownership of domestic assets means a negative outflow of income streams, this is the whole purpose of overseas ownership. It also means a loss of sovereignty of economic ownership, policy and decision making, on the part of the firm which is being bought out, and as well as a loss for the nation.
Of course, the City (of London) loves it. They make much of their money by charging consultancy and brokerage fees and organizing Mergers and Acquisitions (M&A) activity. It has been estimated that:
‘’There are also nearly $1.3bn of reorganisation costs and $390m of fees to advisers, prompting Kraft shareholder Warren Buffett, the legendary US entrepreneur, to describe it as a “bad deal”.
It should also be borne in mind that the Kraft bid was based upon leveraged (that is to say, borrowed) capital. And where did Kraft borrow the funds to buy out Cadbury? Well from no less a source than the Royal Bank of Scotland! It beggars’ belief that an overwhelmingly publicly owned UK bank is underwriting a hostile bid from a foreign multinational for a long-standing UK company.
Well, the CEO of Cadbury’s Todd Stitzer walked away from the takeover with an estimated £12 million. Okay for him. For the hapless workers at the Cadbury’s plant closures and redundancies loom. Industry concentration also increases as there is one less competitor in the field which in its turn means more opportunities for price-fixing and general anti-competitive behaviour.
It would appear that the City of London has not and will not learn from the error of its ways, but then why should they! They have an exceptionally good racket going forward. They will continue in the same manner, who, like the Bourbons ‘’have learnt nothing and forgotten nothing. ‘’ But of course, it pays them to learn nothing and forget nothing.
Of course, this state of mind has been engendered by the certainty of bailouts when their ‘trading’ activities go awry. If the government of the day continues to subsidize failure, failure is what it will continue to get. As a consequence of this Britain will continue to be denuded of its vital companies and increasingly dependent on its waning financial activities – a cosmopolitan group who basically have no interest in the UK economy since their activities are directed to international capital flows and speculation. In this situation it makes no sense to talk about a UK economy or a UK product.
When companies become so disconnected from their home base what happens to the national economy? How can it be expected to perform well when the profitability of its corporations no longer depends on the national economy for the best investment opportunities? In what sense will the UK be a society when it has no national economy? And for the UK read for the national economies of the West in general, with the possible exception of Germany. However, according to the now retired doyen of the present order, the world is actually going in the right direction. Consider ‘’… we are fortunate that, thanks to globalization, policy decisions in the US have been largely replaced by global markets … It hardly makes any difference as to who the next President will be. The world is governed by market forces.’’(2) Thank you for that pearl of wisdom Mr. Greenspan. Now everything can be hunky-dory!
Governments around the world must regain control of their economies. This must happen at least at a regional level. Otherwise, globalization and the forces pushing globalization – The Enemy Within – will simply mean the world functioning as an oyster for the activities of multinational corporations and the race to the bottom which they impose on the recipients of their investment, or short-term speculative flows of ‘hot money’ with the usual destructive impacts, particularly in the developing world.
So far there has been much talk – meaning the usual sweet-talk which comes from the authorities and which goes nowhere – but little concrete action. Returning to the main theme of this article, it seems that little short of outright nationalisation of bankrupt industries will be sufficient to concentrate the minds of the banking and financial fraternity. Secondly there should be a much stricter and draconian code of the public interest when independent companies are threatened with hostile takeovers.
But is it conceivable that any government in the developed world would do this? That is anyone’s guess and there’s the rub. In the short to medium term the answer is almost certainly no. These people are frankly incorrigible and a new generation of politicians and businesspersons with vision and a will to fundamentally reconfigure the world is what is needed. Whether this leadership emerges or not is a moot point, however.
(1) In the 2008 blowout the ratings agencies played a critical role in the marketing of risky mortgage-backed securities, such as collateralized debt obligations, which helped bring the U.S. financial system to its knees.
Investment banks had bundled collections of individual mortgages, which by themselves can be hard to trade, into baskets that could be bought and sold like any bonds. These financial instruments were then sold to investors. But in order to sell them, the investment banks counted on them receiving stellar ratings from the agencies to tempt investors starved for return.
(2) Quoted in Wolfgang Streeck, – Buying Time: The Delayed Crisis of Democratic Capitalism. – 2014 – p.13