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.