Christmas Special

Here's a little thought to distract you from the frustration of seemingly insufferable transport delays over the holiday season: might all this grief be a signal to either buy transport companies' shares or short them?

If it's true (as you may bitterly begin to suspect) that transport companies are ultimately profiting from captive UK customers (and the government) by raising fares despite ongoing public subsidy, under-investing in service improvement or snow-clearing and/or saving money by reducing services during difficult weather conditions, then might it not be worthwhile to buy their shares? I mean, if they're engaging in all theses tactics to be more profitable, then why not climb aboard?

Or perhaps you would prefer to bet that, if transport companies are unfairly taking advantage, then sooner or later they'll get rumbled and their stock prices will fall. In which case it may be worth shorting their shares.

In either case, any gains you might make would at least off-set fare increases and other costs. And the consolation that you are personally profiting from disruption might ease your personal discomfort.

Of course, your suspicions may prove to be unfounded or, even if true, may not be material to corporate results or otherwise sound in the market. In which case your investment won't pay off and you're misery may increase. But, hey, at least you'll be able to console yourself that you didn't just sit there simmering helplessly ;-).

Anyhow, safe travels and have a happy Christmas and New Year.


Image from ImpactLab.

German 'Fraudclosure' Issues

Hat-tip to Glen Davis, insolvency and financial services barrister par excellence, for pointing out Dr Philiipp Esser's piece on "Mortgage Foreclosure Turbulence" in Germany.

It seems the US securitisation market is not the only one in which the purchasers of mortgage debt have enforcement problems. German portfolios are similarly vulnerable.

According to Philipp, the Federal Court of Justice of Germany (Bundesgerichtshof, BGH) has ruled (in XI ZR 200/09) that the Risk Limitation Act 2008 requires the loan purchaser to become a party to the original security agreement between the borrower and the original lender before it can lawfully exercise any immediate right of foreclosure in that security agreement. Merely taking an assignment of the agreement from the original lender is not enough. Unlawfully foreclosing will also render the loan purchaser directly liable for any damage suffered by the borrower.

Philipp suggests that "in most transfers of real estate loans for purposes of refinancing the acquirer has not joined the [original] security agreement."

Robo-signers beware!

Policy Fail? Simple Products And The UK Treasury

The UK's regulated financial services providers have failed to co-operate with various government initiatives to encourage the offering of simple financial products, according to a recent report by Professor James Devlin for the UK Treasury. He found that:

"The combination of a relatively low fee cap [1 to 1.5%], free movement in and out of products without penalty and the relatively low level of funds invested by many users together represented a formidable barrier to enthusiasm from the industry for previous “simple products” (Devlin, p.4)

The lack of simple regulated financial products affects virtually the entire UK population. The primary target may be those people earning low to medium incomes, and those with little financial services experience/expertise/interest and/or limited savings (Devlin, p.10). But people earning higher incomes (over £30k) include themselves in the target market because they would most welcome "standards which show when a financial service offers customers a reasonable deal" (Devlin, p.14). The Treasury also notes in the accompanying consultation on simple financial products, that 48% of UK households have less than a month's salary in savings, and 27% have none at all (para 2.13).

When launching the Retail Distribution Review of financial advice in 2006, the FSA claimed that "insufficient consumer trust and confidence in the products and services supplied by the market lie at the root of what we are seeking to address." And while Professor Devlin cites recent research to the effect that trust in financial service providers is "not significantly below" supermarkets, mobile phone providers and the NHS (Devlin, p.16), that's not saying very much. Investments, pensions and securities are the least trusted consumer services across the EU. Only 34% of consumers think they deliver what's promised, 26% of us are as likely to trust investment providers as used car salesmen, yet 76% of us don't bother to switch providers. What would be the point?

Faced with regulated financial services providers' continuing refusal to supply suitable investment, pension and savings products at reasonable prices, you'd think the government would directly question the structure of all the providers and their products. After all, similar proposals for 'vanilla products' are afoot in the US (and meeting strong resistance from providers, of course (Devlin, p.31)). Instead, however, the UK government has meekly decided to avoid simple investments altogether and focus solely on simplifying "deposit savings accounts" and income protection insurance:

"Although the Government believes that the principles of simple products are widely applicable, it also believes that, initially, simple products should focus on products that do not carry risk to capital, i.e. that are not investment products. Risk would add an extra level of complexity to the product design, as the design would have to weigh up how much risk individuals are willing to bear, both in terms of capital risk and risk to gains."

Hello?

This astonishingly narrow focus fails on at least four counts. First, and most obviously, it shies away from the key challenge facing the consumer: the lack of simple investment products. Second, it means the government won't enable us to diversify at a reasonable cost. Third, it encourages us all to put our money in the banks for little or no interest, leaving us exposed to inflation that continues to hover well above base rates. Fourth, given the banks' reluctance to lend their deposits due to capital constraints, these proposals inhibit the efficient allocation of our surplus cash to creditworthy people and businesses.

While initiatives to improve financial advice are helpful, good advice does not equate to simple products. The glacial Retail Distribution Review, launched in 2006, will only alter compensation for financial advisers from the end of 2012. Full advice will be fee-based and beyond most people. While advisers are "considering" developing a simplified advice model that might provide a "limited sales route", they're worried that if the investments do not perform customers may claim they thought they were given full advice which proved to be wrong (Devlin, p.26). I wonder why?!

In response to the sound of dragging feet, the government recently commissioned the Consumer Financial Education Body to develop a "free and impartial national advice service":

"It will not give regulated advice, but it will provide people with information and advice on all major areas of money and personal finance. A key component of the national financial advice service will be a financial healthcheck, that will provide people with a holistic review of their finances, highlight areas to prioritise, and give people a personalised action plan to take forward. The service will move as close to the regulatory boundary as possible to ensure that people have a seamless journey between the national financial advice service and regulated advice, should they need it. To this end, CFEB is exploring the possibility of providing generic product recommendations, for example 'you should consider purchasing home contents insurance'." (HMT, para 4.3; see also Devlin, p.29))

You mean home contents insurance is an investment? In what, burglaries?

That little gem aside, the "Moneymadeclear" web site may help improve the knowledge of someone who already has a basic understanding of the various types of financial service. But it won't help anyone to actually decide on a suitable product, or render products 'simple'. Which is surely the point.

A little sunlight may penetrate via the "key investor information document" introduced at EU level to enable easier comparison of the key terms of multiple products. Professor Devlin also suggests that strong warnings on products that do not meet "simple product" criteria (Devlin, p.5) and a traffic light system to declare the risk associated with products (Devlin, p.27) would help people choose suitable products. He has urged the government to retain rule RU64 that obliges a financial advisor to explain why any alternative product being recommended is at least as suitable as a simple product. He found that this rule led product providers to reduce fees for more complex products to make them at least as suitable (Devlin, p.22).

For now, however, we're stuck with expensive, complex regulated financial products.

Like... the Kickout bond! ;-)

Regulators Ignore Innovations In Lending

Well, surprise, surprise. The latest Bank of England Quarterly Bulletin confirms that banks aren't lending as much as people need, and this is a brake on growth.

Politicians obfuscate by blaming banks for not lending, while insisting banks must conserve capital. Lord Myners has even U-turned into believing it's a good idea to split up the banks in order to create more banks, believing this will mean more competition.

But it's tough to see why more high street banks will mean more competition to provide unsecured loans to people and small businesses, given they're all bound by the same capital rules. We had lots of banks, and they had to consolidate to solve their capital problems. Metro Bank is said to be expanding rapidly, raising more cash to buy old bank branches others have been forced to sell for competition law reasons. But I don't see any truly disruptive difference between them and the other high street operators.

There's also a bigger problem here, as suggested by the finding in the latest British Social Attitudes Survey that only 19% of us think the banks are run well, down from 90% in 1983 and 60% in 1994.

Surely these circumstances demand a new regulatory framework for efficiently directing deposits to where they are needed most. Yet the existing framework prevents regulators from spending any time on this problem. Zopa's request for peer-to-peer lending to be included within the regulatory framework has not produced any joy, even though such platforms enable lending that doesn't tie up a bank's balance sheet and unlent funds remain in the banking system as commercial deposits. Loan volumes at Zopa have exceeded £100 million - 1% of the personal loan market - at a default rate of only 0.7%. Ironically, these numbers do not represent the sort of risk to consumers or the financial system that is claimed to command regulatory attention (which is itself debatable, given the lack of timely attention to the problems in the securitisation market).

In other words, if you have a highly capital-efficient financial innovation that represents a great deal for consumers, expect policy-makers and regulators to ignore you.

You're better off developing Kick-out bonds.

Image from Good Design.

Aged 30 To 34?

Yesterday the National Centre for Social Research published its British Social Attitudes report. More on that later. But I did notice the finding that:

"Those aged between 18-29 years old are more likely to feel discriminated against than any other age group, and are viewed more negatively than older people."

Meanwhile, the Chartered Institute of Personnel and Development also reported that two thirds of new jobs go to under 35's.

So I guess if your aged 30-34, you're golden.

WikiChill: Might Ain't Right

I can't decide which set of DDoS attacks are more mis-guided or counter-productive. Whoever is trying to 'take down' WikiLeaks may as well be jousting at clouds; and those attacking the global payments and cloud computing infrastructure may as well be... well, jousting at clouds. In fact, it's just cloud versus cloud, and both are only succeeding in making innocent crowds angry.

Somewhere in the middle of the WikiLeaks phenomenon is a discussion worth having. But that discussion can't occur while spooks and hackers - the masters of mystery and anonymity - remain the key protagonists, and self-important politicians embark on an arms race of overreaction.

Officials: let the leak thing play out. If WikiLeaks didn't exist, you would have invented it. Focus on changing your protocols to avoid what you really can't cope with. Adopt a decent email policy.

Hackers: focus your energies on inventing something distributed yet productive that will advance the cause of humanity. WikiLeaks does not need your help.


Image from PhysicsBuzz/Wired.

Who Warned Whom About Madoff?

As noted by FTAlphaville, a fascinating aspect to the Madoff Trustee's case against HSBC is that accountants KPMG were asked by the bank to investigate Madoff's operation twice, and issued a damning report on both occasions, in 2006 and 2008 respectively.

This adds to the evidence that suggests Madoff's Ponzi scheme was quite a poorly kept secret from about 2000. Harry Markopolos said it took him four hours to spot the Ponzi scheme in 2000, using publicly available documents. Michael Ocrant published an article after a series of interviews in 2001, as did Barrons (see paras 215-220 of the Trustee's Amended Complaint against HSBC). And according to the Telegraph, Goldman Sachs banned its asset management and brokering divisions from dealing with Madoff's funds about the same time, while "a raft of blue-chip financial institutions have suspected something was wrong for years."

As the Trustee's cases unfold, it will be interesting to discover how far and how fast word spread, and who warned whom.

But the big question is why supposedly sophisticated financial institutions appeared to ignore the warnings? The Trustee claims certain activity occurred with the "intent to hinder, delay, or defraud creditors". But why? He cites the desire for fee income (at para 16). Perhaps the banks and other intermediaries may also have thought that all was fine, so long as their more valued clients got their 'magic' returns paid or their principal out, regardless of the fact that the money came from other participants. They may also have concluded, however unwisely, that it was too late to let go of a balloon that had risen to such lofty heights, and their best chance of recovering their more valued clients' funds was to risk putting more in... If that's the case, then the business of working out where those new funds came from must have been very bloody indeed. Note the Trustee's allegations (at para's 146-148) that Madoff's involvement was deliberately kept out of the 'feeder fund' promotional documentation.

Ugly.

Yet, as is apparent from "Fooling Some of the People All of the Time", investors can remain in denial even in the face of the most dogged attempts to convince them they're being foolish.

WikiLeaks: A Hard Case. Expect Bad Law

Given the enthusiasm with which numerous governments have attempted to thwart WikiLeaks, and their lack of a ready legal basis for doing so, we should keep an eye out for some exceptionally bad legislation.

We cannot expect the politicians to do nothing about this. There is just too much irony involved.

I mean, how galling must it be to claim the Internet is 'lawless' and then find that global commercial service providers seem to have no trouble enforcing their own cross-border terms of service?

And how can one now lay claim to being "diplomatic" when everyone's seen how much care diplomats take when writing to each other?

Never mind that "WikiLeaks" is just a brand name, and the material it publishes has already been leaked by... government officials.

But wait! There's hope yet. I reckon there's a line of official thought that might run something like this:

"We can't possibly have a law that specifically prevents official leaks. How would opposition parties ever get elected? It would be the end of democracy!

Well what about a law approving leaks in certain circumstances, like when they promote democracy? And let's not just make it a national phenomenon. Let's do it by international treaty. We could set up a single, not-for-profit organisation, not controlled by any national government, that would have as its charter the publication of leaked government information that it judges to be in the public interest. All officials could then simply disclose their leaks to it, and impartial editors from around the world could approve disclosure.

We could call it, "WikiLeaks"!"

Image from ThoughtTheater.

The Magic Of Madoff

Ever since the news broke that Bernie had made off with his investors' money (did you see what I did there?), I've been waiting for the forensic accounts of what happened. Well here they are.

Because US courts tolerate relatively florid language in their pleading, these court filings do not disappoint in their sense of outrage. The case against HSBC is the juiciest, complete with a 'smoking gun' email from February 2006 (at para 20 of the Amended Complaint), largely redacted, in which certain unnamed officials reacted to almost a full alphabet of "red flags" (listed at para 18) with the immortal refrain:

"It's the magic of Madoff."

In summary, the trustee alleges that:

"21. Ultimately, as custodians and administrators, the HSBC Defendants oversaw the infusion of no less than $8.9 billion into [Bernard L. Madoff Investment Securities LLC (“BLMIS”)'s fraudulent investment advisory business] through a network of feeder funds. The HSBC Defendants funneled even more money into BLMIS in connection with derivative structured financial products that they issued and sold to their customers.

22. For their efforts, the Defendants received billions of dollars to which they are not entitled. Many of these Defendants received tens, if not hundreds, of millions of dollars by selling, marketing, lending to, and investing in financial instruments designed to substantially assist Madoff by pumping money into BLMIS and prolonging the Ponzi scheme."

Now I can't wait for the hearing - and the movie!

Image from The Memphis Flyer.

Snake Oil And The "Science" Of Liberty

A hat-tip to @rorysutherland, who drew my attention to a paper called "The Science of Liberty" by Paul Zak, self-styled "founder in the field of neuroeconomics" with the following tweet on 1 December :

"http://bit.ly/gMGr06 expect to hear a lot more about Oxytocin in marketing writings going forward. This is a good piece."

The paper purports to provide a basis for lighter financial regulation, but ironically points in the opposite direction. It was funded in part by the John Templeton Foundation, a conservative philanthropic organisation, whose President also supports "Let Freedom Ring", the lobbying outfit that also supports the "Tea Party"; and partly by the Gruter Institute for Law and Behavioural Research.

I hope I don't do Paul's reasoning any injustice, but I understand his thesis to be as follows (italics are mine):

• His research found that "a brain chemical called oxytocin (ox-ee-TOE-sin) is released when a stranger takes money from his or her pocket and intentionally gives it to another person in order to demonstrate trust tangibly... the more money the person receiving the trust-denoting transfer receives, the more his or her brain releases oxytocin. Oxytocin levels, in turn, predict how much the second person will reciprocate the first person; that his, how trustworthy she or he will be."
• This process is "nearly impossible to inhibit".
• However, 2% of those studied did not reciprocate, and "there is a technical word in my lab for these folks: "bastards (sic). Not people you want to have a coffee with... On the other hand, two percent isn't bad. It means most people most of the time are trustworthy, and the others can be identified with a slight bit of investigation."
• Participants go out of their way to punish moral violations in the market "when observers of ethical violations are in a position to punish the violators".
• As a result of these findings, Paul argues that "virtue is in fact the very foundation of trade... The market can be fabulously large if most people, most of the time, behave morally, and if their moral tendencies are supported by a legal system in which property rights are protected and contracts enforced."
• Accordingly, Paul asserts that "Economic systems that provide for freedom and limited oversight recognize human dignity and the desire for self-direction."  Such "economies are complex, adaptive, and evolving systems that need no controller. Just a clear set of rules that are enforced by some independent regulatory body."
• "A number of studies have shown that too much oversight crowds out our innate sense of virtue (Gneezy and Rustichini, 2000). A fine for every violation decouples transgressions from the moral violations to a "greed is good" justification. This is Enron and the like" [includes Ford (Pinto gas tanks) and USSR].
• In other words, the Enron scandal was created by overly intrusive regulation, and therefore we should have less of it.

Certainly at this last point the logical elastic band finally snaps.

Ironically, far from presenting a basis for lighter financial regulation, I'm afraid Paul Zak's research into the effects of Oxytocin shows exactly why people need greater protection from the snake oil salesmen, who understand it's effects only too well. The "bastards" are out there, and even two percent of the population means there are actually a lot of them. They can be tough to challenge, especially once they've generated a bandwagon effect. And other market participants are not always in a position to punish these rogues, at least not in time to prevent them doing significant harm - due diligence does not scale well. Finally, Alan Greenspan, former Chairman of the US Federal Reserve advocated light touch financial regulation for 40 years, and lived to regret it:

"In Congressional testimony on October 23, 2008, Greenspan acknowledged that he was "partially" wrong in opposing regulation and stated "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity — myself especially — are in a state of shocked disbelief." Referring to his free-market ideology, Greenspan said: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.” Rep. Henry Waxman (D-CA) then pressed him to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said. “Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.” Greenspan admitted fault in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected."

As observed in Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism:

"...[T]the unvarnished invisible hand story, although right in a fundamental way, is wrong at the level of detail and approximation that is necessary to explain what we need to know about macroeconomics.

The old story about capitalism is correct: it gives us what we think we want. But capitalism does not act as its own policeman if we fail to watch over it and give it proper directions. It actively, competitively, seeks the most profit-maximising opportunities. Capitalism will follow such opportunities wherever they lead us...

If [we] are willing to pay for real medicine, it will produce real medicine. But if [we] are also willing to pay for snake oil, it will produce snake oil. Indeed, nineteenth century America had a whole industry devoted to fraudulent patent medicine."

Now, I'm no fan of the Nanny State. I don't believe regulation acts as a market catalyst. And I've written often in support of better regulation rather than simply more of it. It's also clear that the financial regulation spawned by the accounting scandals like Enron failed to avert the latest financial crisis, and is unlikely to avert the next without a fundamental change in the importance that we attach to wealth creation.

But this paper perhaps may serve as further evidence that regulation should be aimed at improving transparency at the point when people first engage with a financial service or its promoter. Simplifying products, documentation and disclosures is critical. Another tactic may be to move away from vertical to horizontal models for intermediation.

More limited oversight is not an option.

Relaxing The Rules: Swinegate Returns

The good citizens of Wales must be very afraid.

On the very day the government re-announced the last government's "Equality Strategy", Ann Clwyd, MP for Cynon Valley, apparently rose to her hind legs and said this in support of relaxing the rules recently passed by MPs to curb expenses abuse:

"During my election campaign, someone came up to me and shouted 'Thief!' and if I had been a man I would have run after him and punched him in the face.”

So Ann clearly reckons it would have been okay for ex-MP David Chaytor to lamp his outraged constituents - at least, presumably before this week's guilty plea - and now the Equality Strategy means there's nothing to stop her 'aving a go...

I empathise with MPs who say they are struggling with legislation that they misconceived in their haste to get re-elected. Really I do. Because you could say that about an awful lot of their output, including their appalling attack on the digital economy in the course of the infamous "wash-up".

But we soldier on without being entitled to run people down in the street and punch them in the face, and so must our MPs - male or female.

There must be limits to the extent MPs can relax the rules for themselves.

Where Will Your Tax Money Go? China?

Here is a fabulous tool to show how the UK Government spends our money. Here is a calculator showing where your own personal tax money goes. And, here is a forum to answer your burning questions around low cost government, waste and efficiency. These are all being developed in the course of the Open Knowledge Foundation's excellent Where Does My Money Go? project.

The forum has already settled a burning question of mine:

"What proportion of government revenue comes from personal income tax, as opposed to corporation tax?"

Answer: In 2008/09, the UK government collected £41.8bn in corporation tax and £149.6bn in income tax.

Together, we and the corporations paid about another £180bn in National Insurance (which of course corporations also pay for employing us) and VAT.

The government recently decided to lower the top-line corporate tax rate from 28% to 24%, and there have been protests about how large UK-based corporations like Vodafone minimise their tax. But I don't really begrudge them that. We need to incentivise private sector corporations to start here, and stay here to employ people and otherwise generate income.

I'm more concerned about how to incentivise ourselves. Corporations tax is a sideshow, compared to the fact that we individual taxpayers, who are effectively banned from incorporating, are supposed to aspire to pouring over 50% of our income into a leaky old public sector bucket - and then fund our own education, healthcare and "retirement" to the very considerable extent that the state cannot be relied upon.

The reason the economy struggles to grow is down to the horrific reality that over half of the country's economic output - and of our personal income - goes to support the public sector, which produces absolutely nothing. Civil servants should not feel slighted by that. As taxpayers they are in the private sector with the rest of us. And they have every right to feel just as alarmed as everyone else, if not more so - especially if they are sitting at a desk doing a non-job. Civil servants are citizens who are being overtaxed to pay for their own net incomes. Weird, huh?

Is this supposed to motivate each of us personally to stay in the UK and generate economic growth? Or is our declining share of income better spent on moving the family to, say, Hong Kong - or, indeed, to Singapore or China, as Jaguar advises, where people save half their income?

The reason that the current government's plans for how to stimulate growth are thin is because the government can't grow the economy. Only the private sector produces growth (though of course the government can be supportive... or not).

This coalition government can't and won't explain all this clearly, partly because it wants our taxes to keep rolling in so it can reduce the deficit in time for the next election, and partly because the Liberal Democrats in the ranks are almost as wedded to 'tax and spend' as their cousins in the Labour Party. Those people think that cutting taxes is "taking money out of the economy". But, of course, lower taxes merely leaves money in the hands of individuals - the private sector of the economy - where the public sector can't get at it.

Here's a growth hypothesis for you: If low income earners were to pay no tax, and others no more than 20% personal income tax/National Insurance plus 10% of income to a UK sovereign wealth fund that invested the money long term; and the administration functions in the public sector were halved, the UK would be growing faster by the next general election than under the current plan.

Discuss.

Image from Joystiq's coverage of tax relief campaign for UK games developers.

Anatomy Of A Dodgy AAA Rating?

Can't wait for a judgment in Cassa di Risparmio della Repubblica di San Marino SpA v. Barclays Bank Plc (Case No. 08-757, High Court, Queen’s Bench Division).

According to Bloomberg, CRSM claims that "Barclays Plc deliberately designed structured notes that would have a much higher risk of default than their triple-A rating suggested" - i.e. "25% or more" instead of “a fraction of 1 percent.”

With any luck, the case won't settle, and we'll have some more forensic insight into the relationship between investment banks and ratings agencies, as well as due diligence and the ratings methodologies...

Lifting The Lid On The EU's Finances

Congratulations to the Financial Times and the Bureau of Investigative Journalism on their exposé on the gross fraud, waste and ineptitude inherent in the EU's €347 billion 'structural and cohesion' funds.

Even putting fraud and waste aside, it's hard to understand how this approach is sustainable if Greece, Ireland, Portugal and Spain are anything to go by. Public sector largesse eventually seems to generate the need for public bail-outs, especially when local governments borrow to match the free money that's available. No wonder the new UK government has put an end to direct local authority funding through this mechanism.

Certainly all this porkbarrelling has done little for 'cohesion'. A recent poll found that only 42% of Europeans trust the European Union - reflecting a general disenchantment with EU institutions over the past few decades.

The seven year budget cycle and lack of provision for returning unspent funds to donor states also makes the scheme incapable of flexing to meet changing economic circumstances. The fact that a large proportion of this money is lying around simply unclaimed in the current environment is scandalous, and another blow to economic confidence.

It's a travesty that this money was raised in national taxes in the first place, let alone handed over to Brussels on the terms of this scheme.

The EU's budget for this nonsense should be slashed next time around.

Image from Forest's Fine Foods.