Much of the year gone by bore out the truth of Edward Heath's famed expression.
Edward Heath, the UK Conservative Prime Minister in the 1970s, used the expression “the unacceptable face of capitalism” to describe his abhorrence of the way a British multinational had bribed many African governments, and engineered coups, to get mining concessions. It could as well be applied to Siemens, recently fined $800 million in a bribery investigation in the United States; the Securities Exchange Commission has alleged that Siemens made more than 4,000 payments, totaling $1.4 billion, to foreign government officials to win business contracts earlier this decade; and that bribery was a “widespread and systematic practice” at the German company. Siemens also recently settled a parallel investigation by the German authorities, paying a fine.
Heath was defeated in the General Election in 1974, which brought Labour into power, and also in the following election for leadership of the Conservative Party, by Thatcher. Helped by the backlash against an arrogant and irresponsible trade union movement used to holding the country to ransom, Thatcher became Prime Minister in 1979, smashed the power of the trade unions, and embarked on a market fundamentalist policy. Her ideological twin, Reagan, became the US President in 1980. Since then, for almost three decades, marauding finance capital has dominated western economies. Much of the year about to end has been parading what could well be called the unacceptable face of finance capital, connived at by an incompetent regulatory regime. The proximate cause for the trillions of dollars being spent by the western governments to shore up the banking and financial system, and a world facing a global recession, was the crisis in the sub-prime mortgage market created by greedy bankers, rating agencies, brokers and salesmen. The year is fittingly ending with the exposure of a $50 billion Ponzi scheme practiced by Bernard Madoff, a pillar of the Wall Street establishment for decades.
For a long time Madoff was a major figure in the National Association of Securities Dealers, a self regulatory agency, chairman of the NASDAQ stock market and the trading committee of the Securities Industry Association, and was member of an advisory committee of the SEC itself. Several aspects of l'affaire Madoff have amazed me, raising questions about the assumed sophistication of the financial services industry in the west and its regulators:
* There were several obvious pointers which should have raised questions in the minds of at least the sophisticated investor. The accounting firm was a very small, non-descript one, for the scale of operations Madoff was conducting. There was also a lack of clarity about the investment strategy and investments. The investors relied on Madoff’s own brokerage for information.
* Still, investors of the standing of HSBC, Banco Santander, BBVA (Spain’s second largest bank), AXA, Royal Bank of Scotland, BNP Paribas, Nomura, et al had invested in Madoff’s funds. This apart, several funds of hedge funds, whose managers are paid by the investor to select the fund, had invested with Madoff and have lost billions. (One investment manager, with $1.4 billion at stake, committed suicide last week.)
* Bloomberg has reported that the Securities and Exchange Commission missed several signals starting from 1992, which should have led to an alert regulator to investigate Madoff well before the fraud reached the scale it did. The Wall Street Journal has reported that Harry Markopolos, an investment professional in Boston, had aired his suspicions about Madoff to an SEC official as far back as 2000, and more formally in 2006, but nothing happened. Ultimately, it was only when Madoff confessed what he was doing to his sons, and they blew the whistle, that the fraud came to light.
* The sheer steadiness of the returns, 13 to 15 per cent p.a, and that too from risky, non-bond, investments should itself have raised questions (remember US 64?), but the Ponzi scheme continued for decades.
Discussing more generally what has happened in financial services, Paul Krugman, the recently crowned economics Nobel Laureate, wrote in a recent article that, “there’s an innate tendency on the part of even the elite to idolize men who are making a lot of money, and assume that they know what they are doing.” So true: an old Sanskrit subhasit said the same thing: “sarve gunah kanchanam ashrayante (All virtues are assumed to be attached to somebody having gold, perhaps the only form of money then existing).”
Madoff apart, most hedge funds have incurred huge losses in the recent turmoil and even the reputed ones have suspended redemptions; many have closed. The industry justified its 20 per cent of profit fees as it promised “absolute” returns to investors, i.e. irrespective of the state of the market. Recent experience evidences how hollow those claims were.
Tailpiece: Well before the current crisis, Emilio Botin, head of Banco Santander, had advised investors: “never buy a product you do not understand, and don’t sell a product you would not buy yourself.” While the advice remains extremely relevant and valid, Santander itself has been one of the victims of Madoff.
This is wishing all my readers ‘A Very Happy and Prosperous New Year’. May they follow Botin’s advice even if his own bank did not!
