Showing posts with label audit. Show all posts
Showing posts with label audit. Show all posts
Monday, 21 February 2022
Saturday, 4 July 2020
After Wirecard: is it time to audit the auditors?
The industry’s failure to spot holes in the accounts of several collapsed companies has led to clamour for reform writes Jonathan Ford and Tabby Kinder in The FT
At the end of 2003, the Italian dairy company Parmalat descended into bankruptcy in an eye-catchingly abrupt manner. A routine bank reconciliation revealed that €3.9bn of cash which Parmalat was supposed to have at Bank of America did not actually exist.
At the end of 2003, the Italian dairy company Parmalat descended into bankruptcy in an eye-catchingly abrupt manner. A routine bank reconciliation revealed that €3.9bn of cash which Parmalat was supposed to have at Bank of America did not actually exist.
The scam that emerged duly blew apart one of Italy’s best-known entrepreneurial companies, and sent its founder, Calisto Tanzi, to prison for fraud. Dubbed Europe’s Enron, it humiliated two large auditing firms, Deloitte and Grant Thornton, and ended up costing the former $149m in damages.
Yet it rested on an apparently simple deception: the reconciliation letter on which the auditors were relying had been forged.
There were shades of Parmalat’s collapse again last week when, nearly two decades later, another fast-growing European entrepreneurial company blew up in strikingly similar circumstances.
After years of public questions about the reliability of its accounts, primarily from the FT, the German electronic payments giant, Wirecard, was forced to admit to a massive hole in its balance sheet.
Rattled by the failure of an independent probe by KPMG to verify transactions underpinning “the lion’s share” of its reported profits between 2016 and 2018, and unable to publish its results due to issues eventually raised by its longstanding auditors EY, Wirecard finally capitulated. It announced that purported €1.9bn cash balances at banks in the Philippines probably did “not exist” and parted company with its chief executive Markus Braun. Evidence relied on by EY had been bogus.
It remains unclear exactly how the crucial confirmation slipped through the cracks. According to one EY partner: “The general view internally is that confirming historic cash balances is auditing 101, and [that] ordinary auditing processes were followed, including third party verification, in which case the fraud was sophisticated in its use of false documents.”
Others, however, take a less charitable view of such slip-ups, especially when, as with both Wirecard and Parmalat, they were preceded by so many questions about the reliability of the figures.
“The integrity of the cash account [which records cash and should reconcile to all the other items in the accounts] is totally central to the whole system of double-entry bookkeeping,” says Karthik Ramanna, professor of business and public policy at Oxford’s Blavatnik School of Government. “If there is no integrity to the cash account, then the whole system is just a joke.”
Shareholder support
Wirecard’s collapse is the latest in a wave of accounting scandals that has swept through the corporate world, including UK outsourcing group Carillion and Abu Dhabi-based hospital group NMC Health, as well as alleged frauds at the mini-bond firm London Capital & Finance (LCF) and the café chain Patisserie Valerie.
Many fear a further surge as the Covid-19 lockdown washes away those companies with weakened balance sheets or business models in the coming months.
Questions about “softball” auditing have dogged many recent high-profile insolvencies. Carillion’s enthusiasm for buying companies with few tangible assets for high prices led it to build up £1.5bn of goodwill on its balance sheet. Despite vast losses at some of those subsidiaries, it had written down the value of just £134m of that goodwill when the whole edifice caved in.
Similar questions hang over LCF, where close reading of the notes in the last accounts it published show how the estimated fair value of its liabilities far exceeded that of its assets in 2017, making it technically insolvent roughly 18 months before it collapsed taking with it more than £200m of savers’ cash. Yet EY gave the accounts a clean bill of health.
Such cases have raised concerns about the independence of auditors, and their willingness to challenge the wishes of management at the client, who are often driven by their own desire for self-enrichment or survival.
“It’s so important if you want to keep the relationship to have a rapport with the finance director,” says a financier who once worked at a Big Four auditing firm. “It is basically sometimes easier to swallow what you are told.”
It is a problem that has deepened with the adoption of modern accounting standards. Over the past three decades, these have progressively dismantled the traditional system of historical cost accounting with its emphasis on the verifiability of evidence and using prudent judgment, replacing it with one based on the idea that the primary purpose of accounts is to present information that is “useful to users”.
This process has allowed managers to pull forward anticipated profits and unrealised gains, and write them up as today’s surpluses. Many company bonus schemes depend on the delivery of the “right” accounting numbers.
In theory, shareholders are supposed to provide a check on the influence of self-interested bosses. They choose the auditors and set the terms of the engagement. But in practice, investors tend not to assert themselves in the relationship. Scandals rarely lead to the ejection of auditors.
So after UK telecoms group BT announced a £530m writedown in 2017 because of accounting misstatements at its Italian business, the auditors, PwC, were not sanctioned by investors. Far from it, the firm was reappointed with more than 75 per cent support. And when EY came up for re-election at Wirecard in the summer of 2018, despite rumblings about the numbers, it was voted back by more than 99 per cent.
Tight budgets and timetables
It is not only an auditor’s desire for an easy life that can drain audits of that all important culture of challenge. There are practical issues too. Tight budgets and timetables limit the scope for investigation.
Audit fees in Europe are far below those in the US. Audits of Russell 3000 index companies in the US cost 0.39 per cent of company turnover on average. Those in Europe average just 0.13 per cent, while for German companies it is a feeble 0.09 per cent.
With fees low, auditing teams are often stretched thin, with only limited support from a partner out of a desire to limit costs and maximise the number of audits done. Audit is traditionally the junior partner in a big accountancy firm, with around four-fifths of the Big Four’s profits coming from the non-audit consultancy side.
Take the last audit of BHS under the ownership of Philip Green, who sold the failing UK retailer to a little known entrepreneur, Dominic Chappell, in 2015. The chain subsequently collapsed the following year.
The PwC partner, Steve Denison, recorded only two hours of work auditing the financial statements. The number two, an auditor with just one year’s post-qualification experience, recorded 29.25 hours, and the more junior team members 114.6 hours. Mr Denison was later fined for misconduct and effectively banned by the audit regulator.
According to Tim Bush, head of governance and financial analysis at the Pensions & Investment Research Consultants, a shareholder advisory group, this reliance on juniors tends to result in “box checking” rather than an investigative approach to audit processes. “Audit teams are less likely to have a feel for the company’s business model,” he says.
This in turn can open the door to abuse. Scams often hinge on faith in some implausible business activity. Parmalat’s €3.9bn cash pile, for instance, was supposed to have come from selling milk powder to Cuba. But an analysis of the volumes claimed suggested that if the company’s numbers were accurate, each of the island’s inhabitants would have needed to be consuming 60 gallons a year.
As the author Richard Brooks noted in his book The Bean Counters: “It shouldn’t have been difficult for a half-competent audit firm to spot.”
No ‘golden age’
The academic Prem Sikka rejects the idea that auditing has gone downhill in the past few decades. “Go back into history and you will find there was never a golden age,” he says.
He argues that most of the weaknesses are of longstanding vintage, and are down to a lack of accountability. “On the audit side, there is no transparency. You have no idea as a reader of accounts how much time the auditors spent on the task and whether that was reasonable,” says the professor of accounting at the University of Sheffield.
While there are signs that the UK regulator is getting tougher, it is down to shareholders to provide stronger governance, Prof Sikka says. If they won’t do it, the government should consider setting up a state agency to commission audits of firms and set fees. “It wouldn’t have to be everyone. You could just do large companies and banks.”
Britain has recently been through a comprehensive review of audit, including how it is regulated and competition in the market, plus a review by the businessman Donald Brydon of its purpose. This devoted many pages to establishing it as a distinct new profession and coming up with new statements to include in already groaning company reports.
Far from creating new tasks, many observers think that audit should reconnect with its original purpose. This is to assure investors that companies’ capital is not being abused by over-optimistic or fraudulent managers. “At their heart, audits are about protecting capital, and thereby ensuring responsible stewardship of capital,” says Natasha Landell-Mills, head of stewardship at the asset manager Sarasin & Partners.
Yet modern accounting practice has made audits more complicated while watering down the legal requirement to exercise the judgment needed to ensure the numbers are “true and fair”. Despite the endless mushrooming of numbers, it is no easier to know if the capital is really present and can thus justify the payment of dividends and bonuses.
Michael Izza, chief executive of the Institute of Chartered Accountants in England and Wales says auditors need a “renewed focus on internal controls, going concern and fraud. The vast majority of business failures are not the fault of the auditor, but when audit quality is a contributory factor, the problem generally involves these three fundamental areas.”
Mr Bush thinks a radical simplification is in order. “Without clarity there is never going to be proper accountability,” he says. “What we have is a recipe for weak auditing, and ever more Wirecards and Parmalats. In the extreme it facilitates Ponzi schemes. Stay on that route and it won’t be long before you come unstuck.”
Thursday, 19 September 2019
Why rigged capitalism is damaging liberal democracy
Economies are not delivering for most citizens because of weak competition, feeble productivity growth and tax loopholes writes Martin Wolf in The FT
“While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.”
With this sentence, the US Business Roundtable, which represents the chief executives of 181 of the world’s largest companies, abandoned their longstanding view that “corporations exist principally to serve their shareholders”.
This is certainly a moment. But what does — and should — that moment mean? The answer needs to start with acknowledgment of the fact that something has gone very wrong. Over the past four decades, and especially in the US, the most important country of all, we have observed an unholy trinity of slowing productivity growth, soaring inequality and huge financial shocks.
As Jason Furman of Harvard University and Peter Orszag of Lazard Frères noted in a paper last year: “From 1948 to 1973, real median family income in the US rose 3 per cent annually. At this rate . . . there was a 96 per cent chance that a child would have a higher income than his or her parents. Since 1973, the median family has seen its real income grow only 0.4 per cent annually . . . As a result, 28 per cent of children have lower income than their parents did.”
So why is the economy not delivering? The answer lies, in large part, with the rise of rentier capitalism. In this case “rent” means rewards over and above those required to induce the desired supply of goods, services, land or labour. “Rentier capitalism” means an economy in which market and political power allows privileged individuals and businesses to extract a great deal of such rent from everybody else.
That does not explain every disappointment. As Robert Gordon, professor of social sciences at Northwestern University, argues, fundamental innovation slowed after the mid-20th century. Technology has also created greater reliance on graduates and raised their relative wages, explaining part of the rise of inequality. But the share of the top 1 per cent of US earners in pre-tax income jumped from 11 per cent in 1980 to 20 per cent in 2014. This was not mainly the result of such skill-biased technological change.
If one listens to the political debates in many countries, notably the US and UK, one would conclude that the disappointment is mainly the fault of imports from China or low-wage immigrants, or both. Foreigners are ideal scapegoats. But the notion that rising inequality and slow productivity growth are due to foreigners is simply false.
Every western high-income country trades more with emerging and developing countries today than it did four decades ago. Yet increases in inequality have varied substantially. The outcome depended on how the institutions of the market economy behaved and on domestic policy choices.
Harvard economist Elhanan Helpman ends his overview of a huge academic literature on the topic with the conclusion that “globalisation in the form of foreign trade and offshoring has not been a large contributor to rising inequality. Multiple studies of different events around the world point to this conclusion.”
The shift in the location of much manufacturing, principally to China, may have lowered investment in high-income economies a little. But this effect cannot have been powerful enough to reduce productivity growth significantly. To the contrary, the shift in the global division of labour induced high-income economies to specialise in skill-intensive sectors, where there was more potential for fast productivity growth.
Donald Trump, a naive mercantilist, focuses, instead, on bilateral trade imbalances as a cause of job losses. These deficits reflect bad trade deals, the American president insists. It is true that the US has overall trade deficits, while the EU has surpluses. But their trade policies are quite similar. Trade policies do not explain bilateral balances. Bilateral balances, in turn, do not explain overall balances. The latter are macroeconomic phenomena. Both theory and evidence concur on this.
The economic impact of immigration has also been small, however big the political and cultural “shock of the foreigner” may be. Research strongly suggests that the effect of immigration on the real earnings of the native population and on receiving countries’ fiscal position has been small and frequently positive.
Far more productive than this politically rewarding, but mistaken, focus on the damage done by trade and migration is an examination of contemporary rentier capitalism itself.
Finance plays a key role, with several dimensions. Liberalised finance tends to metastasise, like a cancer. Thus, the financial sector’s ability to create credit and money finances its own activities, incomes and (often illusory) profits.
A 2015 study by Stephen Cecchetti and Enisse Kharroubi for the Bank for International Settlements said “the level of financial development is good only up to a point, after which it becomes a drag on growth, and that a fast-growing financial sector is detrimental to aggregate productivity growth”. When the financial sector grows quickly, they argue, it hires talented people. These then lend against property, because it generates collateral. This is a diversion of talented human resources in unproductive, useless directions.
Again, excessive growth of credit almost always leads to crises, as Carmen Reinhart and Kenneth Rogoff showed in This Time is Different. This is why no modern government dares let the supposedly market-driven financial sector operate unaided and unguided. But that in turn creates huge opportunities to gain from irresponsibility: heads, they win; tails, the rest of us lose. Further crises are guaranteed.
Finance also creates rising inequality. Thomas Philippon of the Stern School of Business and Ariell Reshef of the Paris School of Economics showed that the relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector.
This explosion of financial activity since 1980 has not raised the growth of productivity. If anything, it has lowered it, especially since the crisis. The same is true of the explosion in pay of corporate management, yet another form of rent extraction. As Deborah Hargreaves, founder of the High Pay Centre, notes, in the UK the ratio of average chief executive pay to that of average workers rose from 48 to one in 1998 to 129 to one in 2016. In the US, the same ratio rose from 42 to one in 1980 to 347 to one in 2017.
As the US essayist HL Mencken wrote: “For every complex problem, there is an answer that is clear, simple and wrong.” Pay linked to the share price gave management a huge incentive to raise that price, by manipulating earnings or borrowing money to buy the shares. Neither adds value to the company. But they can add a great deal of wealth to management. A related problem with governance is conflicts of interest, notably over independence of auditors.
In sum, personal financial considerations permeate corporate decision-making. As the independent economist Andrew Smithers argues in Productivity and the Bonus Culture, this comes at the expense of corporate investment and so of long-run productivity growth.
A possibly still more fundamental issue is the decline of competition. Mr Furman and Mr Orszag say there is evidence of increased market concentration in the US, a lower rate of entry of new firms and a lower share of young firms in the economy compared with three or four decades ago. Work by the OECD and Oxford Martin School also notes widening gaps in productivity and profit mark-ups between the leading businesses and the rest. This suggests weakening competition and rising monopoly rent. Moreover, a great deal of the increase in inequality arises from radically different rewards for workers with similar skills in different firms: this, too, is a form of rent extraction.
A part of the explanation for weaker competition is “winner-takes-almost-all” markets: superstar individuals and their companies earn monopoly rents, because they can now serve global markets so cheaply. The network externalities — benefits of using a network that others are using — and zero marginal costs of platform monopolies (Facebook, Google, Amazon, Alibaba and Tencent) are the dominant examples.
Another such natural force is the network externalities of agglomerations, stressed by Paul Collier in The Future of Capitalism. Successful metropolitan areas — London, New York, the Bay Area in California — generate powerful feedback loops, attracting and rewarding talented people. This disadvantages businesses and people trapped in left-behind towns. Agglomerations, too, create rents, not just in property prices, but also in earnings.
Yet monopoly rent is not just the product of such natural — albeit worrying — economic forces. It is also the result of policy. In the US, Yale University law professor Robert Bork argued in the 1970s that “consumer welfare” should be the sole objective of antitrust policy. As with shareholder value maximisation, this oversimplified highly complex issues. In this case, it led to complacency about monopoly power, provided prices stayed low. Yet tall trees deprive saplings of the light they need to grow. So, too, may giant companies.
Some might argue, complacently, that the “monopoly rent” we now see in leading economies is largely a sign of the “creative destruction” lauded by the Austrian economist Joseph Schumpeter. In fact, we are not seeing enough creation, destruction or productivity growth to support that view convincingly.
A disreputable aspect of rent-seeking is radical tax avoidance. Corporations (and so also shareholders) benefit from the public goods — security, legal systems, infrastructure, educated workforces and sociopolitical stability — provided by the world’s most powerful liberal democracies. Yet they are also in a perfect position to exploit tax loopholes, especially those companies whose location of production or innovation is difficult to determine.
The biggest challenges within the corporate tax system are tax competition and base erosion and profit shifting. We see the former in falling tax rates. We see the latter in the location of intellectual property in tax havens, in charging tax-deductible debt against profits accruing in higher-tax jurisdictions and in rigging transfer prices within firms.
A 2015 study by the IMF calculated that base erosion and profit shifting reduced long-run annual revenue in OECD countries by about $450bn (1 per cent of gross domestic product) and in non-OECD countries by slightly over $200bn (1.3 per cent of GDP). These are significant figures in the context of a tax that raised an average of only 2.9 per cent of GDP in 2016 in OECD countries and just 2 per cent in the US.
Brad Setser of the Council on Foreign Relations shows that US corporations report seven times as much profit in small tax havens (Bermuda, the British Caribbean, Ireland, Luxembourg, Netherlands, Singapore and Switzerland) as in six big economies (China, France, Germany, India, Italy and Japan). This is ludicrous. The tax reform under Mr Trump changed essentially nothing. Needless to say, not only US corporations benefit from such loopholes.
In such cases, rents are not merely being exploited. They are being created, through lobbying for distorting and unfair tax loopholes and against needed regulation of mergers, anti-competitive practices, financial misbehaviour, the environment and labour markets. Corporate lobbying overwhelms the interests of ordinary citizens. Indeed, some studies suggest that the wishes of ordinary people count for next to nothing in policymaking.
Not least, as some western economies have become more Latin American in their distribution of incomes, their politics have also become more Latin American. Some of the new populists are considering radical, but necessary, changes in competition, regulatory and tax policies. But others rely on xenophobic dog whistles while continuing to promote a capitalism rigged to favour a small elite. Such activities could well end up with the death of liberal democracy itself.
Members of the Business Roundtable and their peers have tough questions to ask themselves. They are right: seeking to maximise shareholder value has proved a doubtful guide to managing corporations. But that realisation is the beginning, not the end. They need to ask themselves what this understanding means for how they set their own pay and how they exploit — indeed actively create — tax and regulatory loopholes.
They must, not least, consider their activities in the public arena. What are they doing to ensure better laws governing the structure of the corporation, a fair and effective tax system, a safety net for those afflicted by economic forces beyond their control, a healthy local and global environment and a democracy responsive to the wishes of a broad majority?
We need a dynamic capitalist economy that gives everybody a justified belief that they can share in the benefits. What we increasingly seem to have instead is an unstable rentier capitalism, weakened competition, feeble productivity growth, high inequality and, not coincidentally, an increasingly degraded democracy. Fixing this is a challenge for us all, but especially for those who run the world’s most important businesses. The way our economic and political systems work must change, or they will perish.
“While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.”
With this sentence, the US Business Roundtable, which represents the chief executives of 181 of the world’s largest companies, abandoned their longstanding view that “corporations exist principally to serve their shareholders”.
This is certainly a moment. But what does — and should — that moment mean? The answer needs to start with acknowledgment of the fact that something has gone very wrong. Over the past four decades, and especially in the US, the most important country of all, we have observed an unholy trinity of slowing productivity growth, soaring inequality and huge financial shocks.
As Jason Furman of Harvard University and Peter Orszag of Lazard Frères noted in a paper last year: “From 1948 to 1973, real median family income in the US rose 3 per cent annually. At this rate . . . there was a 96 per cent chance that a child would have a higher income than his or her parents. Since 1973, the median family has seen its real income grow only 0.4 per cent annually . . . As a result, 28 per cent of children have lower income than their parents did.”
So why is the economy not delivering? The answer lies, in large part, with the rise of rentier capitalism. In this case “rent” means rewards over and above those required to induce the desired supply of goods, services, land or labour. “Rentier capitalism” means an economy in which market and political power allows privileged individuals and businesses to extract a great deal of such rent from everybody else.
That does not explain every disappointment. As Robert Gordon, professor of social sciences at Northwestern University, argues, fundamental innovation slowed after the mid-20th century. Technology has also created greater reliance on graduates and raised their relative wages, explaining part of the rise of inequality. But the share of the top 1 per cent of US earners in pre-tax income jumped from 11 per cent in 1980 to 20 per cent in 2014. This was not mainly the result of such skill-biased technological change.
If one listens to the political debates in many countries, notably the US and UK, one would conclude that the disappointment is mainly the fault of imports from China or low-wage immigrants, or both. Foreigners are ideal scapegoats. But the notion that rising inequality and slow productivity growth are due to foreigners is simply false.
Every western high-income country trades more with emerging and developing countries today than it did four decades ago. Yet increases in inequality have varied substantially. The outcome depended on how the institutions of the market economy behaved and on domestic policy choices.
Harvard economist Elhanan Helpman ends his overview of a huge academic literature on the topic with the conclusion that “globalisation in the form of foreign trade and offshoring has not been a large contributor to rising inequality. Multiple studies of different events around the world point to this conclusion.”
The shift in the location of much manufacturing, principally to China, may have lowered investment in high-income economies a little. But this effect cannot have been powerful enough to reduce productivity growth significantly. To the contrary, the shift in the global division of labour induced high-income economies to specialise in skill-intensive sectors, where there was more potential for fast productivity growth.
Donald Trump, a naive mercantilist, focuses, instead, on bilateral trade imbalances as a cause of job losses. These deficits reflect bad trade deals, the American president insists. It is true that the US has overall trade deficits, while the EU has surpluses. But their trade policies are quite similar. Trade policies do not explain bilateral balances. Bilateral balances, in turn, do not explain overall balances. The latter are macroeconomic phenomena. Both theory and evidence concur on this.
The economic impact of immigration has also been small, however big the political and cultural “shock of the foreigner” may be. Research strongly suggests that the effect of immigration on the real earnings of the native population and on receiving countries’ fiscal position has been small and frequently positive.
Far more productive than this politically rewarding, but mistaken, focus on the damage done by trade and migration is an examination of contemporary rentier capitalism itself.
Finance plays a key role, with several dimensions. Liberalised finance tends to metastasise, like a cancer. Thus, the financial sector’s ability to create credit and money finances its own activities, incomes and (often illusory) profits.
A 2015 study by Stephen Cecchetti and Enisse Kharroubi for the Bank for International Settlements said “the level of financial development is good only up to a point, after which it becomes a drag on growth, and that a fast-growing financial sector is detrimental to aggregate productivity growth”. When the financial sector grows quickly, they argue, it hires talented people. These then lend against property, because it generates collateral. This is a diversion of talented human resources in unproductive, useless directions.
Again, excessive growth of credit almost always leads to crises, as Carmen Reinhart and Kenneth Rogoff showed in This Time is Different. This is why no modern government dares let the supposedly market-driven financial sector operate unaided and unguided. But that in turn creates huge opportunities to gain from irresponsibility: heads, they win; tails, the rest of us lose. Further crises are guaranteed.
Finance also creates rising inequality. Thomas Philippon of the Stern School of Business and Ariell Reshef of the Paris School of Economics showed that the relative earnings of finance professionals exploded upwards in the 1980s with the deregulation of finance. They estimated that “rents” — earnings over and above those needed to attract people into the industry — accounted for 30-50 per cent of the pay differential between finance professionals and the rest of the private sector.
This explosion of financial activity since 1980 has not raised the growth of productivity. If anything, it has lowered it, especially since the crisis. The same is true of the explosion in pay of corporate management, yet another form of rent extraction. As Deborah Hargreaves, founder of the High Pay Centre, notes, in the UK the ratio of average chief executive pay to that of average workers rose from 48 to one in 1998 to 129 to one in 2016. In the US, the same ratio rose from 42 to one in 1980 to 347 to one in 2017.
As the US essayist HL Mencken wrote: “For every complex problem, there is an answer that is clear, simple and wrong.” Pay linked to the share price gave management a huge incentive to raise that price, by manipulating earnings or borrowing money to buy the shares. Neither adds value to the company. But they can add a great deal of wealth to management. A related problem with governance is conflicts of interest, notably over independence of auditors.
In sum, personal financial considerations permeate corporate decision-making. As the independent economist Andrew Smithers argues in Productivity and the Bonus Culture, this comes at the expense of corporate investment and so of long-run productivity growth.
A possibly still more fundamental issue is the decline of competition. Mr Furman and Mr Orszag say there is evidence of increased market concentration in the US, a lower rate of entry of new firms and a lower share of young firms in the economy compared with three or four decades ago. Work by the OECD and Oxford Martin School also notes widening gaps in productivity and profit mark-ups between the leading businesses and the rest. This suggests weakening competition and rising monopoly rent. Moreover, a great deal of the increase in inequality arises from radically different rewards for workers with similar skills in different firms: this, too, is a form of rent extraction.
A part of the explanation for weaker competition is “winner-takes-almost-all” markets: superstar individuals and their companies earn monopoly rents, because they can now serve global markets so cheaply. The network externalities — benefits of using a network that others are using — and zero marginal costs of platform monopolies (Facebook, Google, Amazon, Alibaba and Tencent) are the dominant examples.
Another such natural force is the network externalities of agglomerations, stressed by Paul Collier in The Future of Capitalism. Successful metropolitan areas — London, New York, the Bay Area in California — generate powerful feedback loops, attracting and rewarding talented people. This disadvantages businesses and people trapped in left-behind towns. Agglomerations, too, create rents, not just in property prices, but also in earnings.
Yet monopoly rent is not just the product of such natural — albeit worrying — economic forces. It is also the result of policy. In the US, Yale University law professor Robert Bork argued in the 1970s that “consumer welfare” should be the sole objective of antitrust policy. As with shareholder value maximisation, this oversimplified highly complex issues. In this case, it led to complacency about monopoly power, provided prices stayed low. Yet tall trees deprive saplings of the light they need to grow. So, too, may giant companies.
Some might argue, complacently, that the “monopoly rent” we now see in leading economies is largely a sign of the “creative destruction” lauded by the Austrian economist Joseph Schumpeter. In fact, we are not seeing enough creation, destruction or productivity growth to support that view convincingly.
A disreputable aspect of rent-seeking is radical tax avoidance. Corporations (and so also shareholders) benefit from the public goods — security, legal systems, infrastructure, educated workforces and sociopolitical stability — provided by the world’s most powerful liberal democracies. Yet they are also in a perfect position to exploit tax loopholes, especially those companies whose location of production or innovation is difficult to determine.
The biggest challenges within the corporate tax system are tax competition and base erosion and profit shifting. We see the former in falling tax rates. We see the latter in the location of intellectual property in tax havens, in charging tax-deductible debt against profits accruing in higher-tax jurisdictions and in rigging transfer prices within firms.
A 2015 study by the IMF calculated that base erosion and profit shifting reduced long-run annual revenue in OECD countries by about $450bn (1 per cent of gross domestic product) and in non-OECD countries by slightly over $200bn (1.3 per cent of GDP). These are significant figures in the context of a tax that raised an average of only 2.9 per cent of GDP in 2016 in OECD countries and just 2 per cent in the US.
Brad Setser of the Council on Foreign Relations shows that US corporations report seven times as much profit in small tax havens (Bermuda, the British Caribbean, Ireland, Luxembourg, Netherlands, Singapore and Switzerland) as in six big economies (China, France, Germany, India, Italy and Japan). This is ludicrous. The tax reform under Mr Trump changed essentially nothing. Needless to say, not only US corporations benefit from such loopholes.
In such cases, rents are not merely being exploited. They are being created, through lobbying for distorting and unfair tax loopholes and against needed regulation of mergers, anti-competitive practices, financial misbehaviour, the environment and labour markets. Corporate lobbying overwhelms the interests of ordinary citizens. Indeed, some studies suggest that the wishes of ordinary people count for next to nothing in policymaking.
Not least, as some western economies have become more Latin American in their distribution of incomes, their politics have also become more Latin American. Some of the new populists are considering radical, but necessary, changes in competition, regulatory and tax policies. But others rely on xenophobic dog whistles while continuing to promote a capitalism rigged to favour a small elite. Such activities could well end up with the death of liberal democracy itself.
Members of the Business Roundtable and their peers have tough questions to ask themselves. They are right: seeking to maximise shareholder value has proved a doubtful guide to managing corporations. But that realisation is the beginning, not the end. They need to ask themselves what this understanding means for how they set their own pay and how they exploit — indeed actively create — tax and regulatory loopholes.
They must, not least, consider their activities in the public arena. What are they doing to ensure better laws governing the structure of the corporation, a fair and effective tax system, a safety net for those afflicted by economic forces beyond their control, a healthy local and global environment and a democracy responsive to the wishes of a broad majority?
We need a dynamic capitalist economy that gives everybody a justified belief that they can share in the benefits. What we increasingly seem to have instead is an unstable rentier capitalism, weakened competition, feeble productivity growth, high inequality and, not coincidentally, an increasingly degraded democracy. Fixing this is a challenge for us all, but especially for those who run the world’s most important businesses. The way our economic and political systems work must change, or they will perish.
Thursday, 28 June 2018
How to get away with financial fraud
Dan Davies in The Guardian
Guys, you’ve got to hear this,” I said. I was sitting in front of my computer one day in July 2012, with one eye on a screen of share prices and the other on a live stream of the House of Commons Treasury select committee hearings. As the Barclays share price took a graceful swan dive, I pulled my headphones out of the socket and turned up the volume so everyone could hear. My colleagues left their terminals and came around to watch BBC Parliament with me.
It didn’t take long to realise what was happening. “Bob’s getting murdered,” someone said.
Bob Diamond, the swashbuckling chief executive of Barclays, had been called before the committee to explain exactly what his bank had been playing at in regards to the Libor rate-fixing scandal. The day before his appearance, he had made things very much worse by seeming to accuse the deputy governor of the Bank of England of ordering him to fiddle an important benchmark, then walking back the accusation as soon as it was challenged. He was trying to turn on his legendary charm in front of a committee of angry MPs, and it wasn’t working. On our trading floor, in Mayfair, calls were coming in from all over the City. Investors needed to know what was happening and whether the damage was reparable.
A couple of weeks later, the damage was done. The money was gone, Diamond was out of a job and the market, as it always does, had moved on. We were left asking ourselves: How did we get it so wrong?
At the time I was working for a French stockbroking firm, on the team responsible for the banking sector. I was the team’s regulation specialist. I had been aware of “the Libor affair”, and had written about it on several occasions during the previous months. My colleagues and I had assumed that it would be the typical kind of regulatory risk for the banks – a slap on the wrist, a few hundred million dollars of fines, no more than that.
The first puzzle was that, to start with, it looked like we were right. By the time it caught the attention of the mainstream media, the Libor scandal had reached what would usually be the end of the story – the announcement, on 27 June 2012, of a regulatory sanction. Barclays had admitted a set of facts, made undertakings not to do anything similar again, and agreed to pay finesof £59.5m to the UK’s Financial Services Authority, $200m to the US Commodity Futures Trading Commission and a further $160m to the US Department of Justice. That’s how these things are usually dealt with. If anything, it was considered quite a tough penalty.
But the Libor case marked the beginning of a new process for the regulators. As well as publishing their judgment, they gave a long summary of the evidence and reasoning that led to their decision. In the case of the Libor fines, the majority of that evidence took the form of transcripts of emails and Bloomberg chat. Bloomberg’s trading terminals – the $50,000-a-year news and financial-data servers that every trader uses – have an instant-messaging function in addition to supplying prices and transmitting news. Financial market professionals are vastly more addicted to this chat than teen girls are to Instagram, and many of them failed to realise that if you discussed illegal activity on this medium, you were making things easy for the authorities.
The transcripts left no room for doubt.
Trader C: “The big day [has] arrived … My NYK are screaming at me about an unchanged 3m libor. As always, any help wd be greatly appreciated. What do you think you’ll go for 3m?”
Submitter: “I am going 90 altho 91 is what I should be posting.”
Trader C: “[…] when I retire and write a book about this business your name will be written in golden letters […]”.
Submitter: “I would prefer this [to] not be in any book!”
Perhaps it’s unfair to judge the Libor conspirators on their chat records; few of the journalists who covered the story would like to see their own Twitter direct-message history paraded in front of an angry public. Trading, for all its bluster, is basically a service industry, and there is no service industry anywhere in the world whose employees don’t blow off steam by acting out or insulting the customers behind their backs. But traders tend to have more than the usual level of self-confidence, bordering on arrogance. And in a general climate in which the public was both unhappy with the banking industry and unimpressed with casual banter about ostentatious displays of wealth, the Libor transcripts appeared crass beyond belief. Every single popular stereotype about traders was confirmed. An abstruse and technical set of regulatory breaches suddenly became a morality play, a story of swaggering villains who fixed the market as if it was a horse race. The politicians could hardly have failed to get involved.
It is not a pleasant thing to see your industry subjected to criticism that is at once overheated, ill-informed and entirely justified. In 2012, the financial sector finally got the kind of enemies it deserved. The popular version of events might have been oversimplified and wrong in lots of technical detail, but in the broad sweep, it was right. The nuanced and technical version of events which the specialists obsessed over might have been right on the detail, but it missed one utterly crucial point: a massive crime of dishonesty had taken place. There was a word for what had happened, and that word was fraud. For a period of months, it seemed to me as if the more you knew about the Libor scandal, the less you understood it.
That’s how we got it so wrong. We were looking for incidental breaches of technical regulations, not systematic crime. And the thing is, that’s normal. The nature of fraud is that it works outside your field of vision, subverting the normal checks and balances so that the world changes while the picture stays the same. People in financial markets have been missing the wood for the trees for as long as there have been markets.
Some places in the world are what they call “low-trust societies”. The political institutions are fragile and corrupt, business practices are dodgy, debts are rarely repaid and people rightly fear being ripped off on any transaction. In the “high-trust societies”, conversely, businesses are honest, laws are fair and consistently enforced, and the majority of people can go about their day in the knowledge that the overall level of integrity in economic life is very high. With that in mind, and given what we know about the following two countries, why is it that the Canadian financial sector is so fraud-ridden that Joe Queenan, writing in Forbes magazine in 1989, nicknamed Vancouver the “Scam Capital of the World”, while shipowners in Greece will regularly do multimillion-dollar deals on a handshake?
We might call this the “Canadian paradox”. There are different kinds of dishonesty in the world. The most profitable kind is commercial fraud, and commercial fraud is parasitical on the overall health of the business sector on which it preys. It is much more difficult to be a fraudster in a society in which people only do business with relatives, or where commerce is based on family networks going back centuries. It is much easier to carry out a securities fraud in a market where dishonesty is the rare exception rather than the everyday rule.
Guys, you’ve got to hear this,” I said. I was sitting in front of my computer one day in July 2012, with one eye on a screen of share prices and the other on a live stream of the House of Commons Treasury select committee hearings. As the Barclays share price took a graceful swan dive, I pulled my headphones out of the socket and turned up the volume so everyone could hear. My colleagues left their terminals and came around to watch BBC Parliament with me.
It didn’t take long to realise what was happening. “Bob’s getting murdered,” someone said.
Bob Diamond, the swashbuckling chief executive of Barclays, had been called before the committee to explain exactly what his bank had been playing at in regards to the Libor rate-fixing scandal. The day before his appearance, he had made things very much worse by seeming to accuse the deputy governor of the Bank of England of ordering him to fiddle an important benchmark, then walking back the accusation as soon as it was challenged. He was trying to turn on his legendary charm in front of a committee of angry MPs, and it wasn’t working. On our trading floor, in Mayfair, calls were coming in from all over the City. Investors needed to know what was happening and whether the damage was reparable.
A couple of weeks later, the damage was done. The money was gone, Diamond was out of a job and the market, as it always does, had moved on. We were left asking ourselves: How did we get it so wrong?
At the time I was working for a French stockbroking firm, on the team responsible for the banking sector. I was the team’s regulation specialist. I had been aware of “the Libor affair”, and had written about it on several occasions during the previous months. My colleagues and I had assumed that it would be the typical kind of regulatory risk for the banks – a slap on the wrist, a few hundred million dollars of fines, no more than that.
The first puzzle was that, to start with, it looked like we were right. By the time it caught the attention of the mainstream media, the Libor scandal had reached what would usually be the end of the story – the announcement, on 27 June 2012, of a regulatory sanction. Barclays had admitted a set of facts, made undertakings not to do anything similar again, and agreed to pay finesof £59.5m to the UK’s Financial Services Authority, $200m to the US Commodity Futures Trading Commission and a further $160m to the US Department of Justice. That’s how these things are usually dealt with. If anything, it was considered quite a tough penalty.
But the Libor case marked the beginning of a new process for the regulators. As well as publishing their judgment, they gave a long summary of the evidence and reasoning that led to their decision. In the case of the Libor fines, the majority of that evidence took the form of transcripts of emails and Bloomberg chat. Bloomberg’s trading terminals – the $50,000-a-year news and financial-data servers that every trader uses – have an instant-messaging function in addition to supplying prices and transmitting news. Financial market professionals are vastly more addicted to this chat than teen girls are to Instagram, and many of them failed to realise that if you discussed illegal activity on this medium, you were making things easy for the authorities.
The transcripts left no room for doubt.
Trader C: “The big day [has] arrived … My NYK are screaming at me about an unchanged 3m libor. As always, any help wd be greatly appreciated. What do you think you’ll go for 3m?”
Submitter: “I am going 90 altho 91 is what I should be posting.”
Trader C: “[…] when I retire and write a book about this business your name will be written in golden letters […]”.
Submitter: “I would prefer this [to] not be in any book!”
Perhaps it’s unfair to judge the Libor conspirators on their chat records; few of the journalists who covered the story would like to see their own Twitter direct-message history paraded in front of an angry public. Trading, for all its bluster, is basically a service industry, and there is no service industry anywhere in the world whose employees don’t blow off steam by acting out or insulting the customers behind their backs. But traders tend to have more than the usual level of self-confidence, bordering on arrogance. And in a general climate in which the public was both unhappy with the banking industry and unimpressed with casual banter about ostentatious displays of wealth, the Libor transcripts appeared crass beyond belief. Every single popular stereotype about traders was confirmed. An abstruse and technical set of regulatory breaches suddenly became a morality play, a story of swaggering villains who fixed the market as if it was a horse race. The politicians could hardly have failed to get involved.
It is not a pleasant thing to see your industry subjected to criticism that is at once overheated, ill-informed and entirely justified. In 2012, the financial sector finally got the kind of enemies it deserved. The popular version of events might have been oversimplified and wrong in lots of technical detail, but in the broad sweep, it was right. The nuanced and technical version of events which the specialists obsessed over might have been right on the detail, but it missed one utterly crucial point: a massive crime of dishonesty had taken place. There was a word for what had happened, and that word was fraud. For a period of months, it seemed to me as if the more you knew about the Libor scandal, the less you understood it.
That’s how we got it so wrong. We were looking for incidental breaches of technical regulations, not systematic crime. And the thing is, that’s normal. The nature of fraud is that it works outside your field of vision, subverting the normal checks and balances so that the world changes while the picture stays the same. People in financial markets have been missing the wood for the trees for as long as there have been markets.
Some places in the world are what they call “low-trust societies”. The political institutions are fragile and corrupt, business practices are dodgy, debts are rarely repaid and people rightly fear being ripped off on any transaction. In the “high-trust societies”, conversely, businesses are honest, laws are fair and consistently enforced, and the majority of people can go about their day in the knowledge that the overall level of integrity in economic life is very high. With that in mind, and given what we know about the following two countries, why is it that the Canadian financial sector is so fraud-ridden that Joe Queenan, writing in Forbes magazine in 1989, nicknamed Vancouver the “Scam Capital of the World”, while shipowners in Greece will regularly do multimillion-dollar deals on a handshake?
We might call this the “Canadian paradox”. There are different kinds of dishonesty in the world. The most profitable kind is commercial fraud, and commercial fraud is parasitical on the overall health of the business sector on which it preys. It is much more difficult to be a fraudster in a society in which people only do business with relatives, or where commerce is based on family networks going back centuries. It is much easier to carry out a securities fraud in a market where dishonesty is the rare exception rather than the everyday rule.
Traders at Bloomberg terminals on the floor of the New York stock exchange, 2013. Photograph: Brendan McDermid / Reuters/REUTERS
The existence of the Canadian paradox suggests that there is a specifically economic dimension to a certain kind of crime of dishonesty. Trust – particularly between complete strangers, with no interactions beside relatively anonymous market transactions – is the basis of the modern industrial economy. And the story of the development of the modern economy is in large part the story of the invention and improvement of technologies and institutions for managing that trust.
And as industrial society develops, it becomes easier to be a victim. In The Wealth of Nations, Adam Smith described how prosperity derived from the division of labour – the 18 distinct operations that went into the manufacture of a pin, for example. While this was going on, the modern world also saw a growing division of trust. The more a society benefits from the division of labour in checking up on things, the further you can go into a con game before you realise that you’re in one. In the case of several dealers in the Libor market, by the time anyone realised something was crooked, they were several billions of dollars in over their heads.
In hindsight, the Libor system was always a shoddy piece of work. Some not-very-well-paid clerks from the British Bankers’ Association would call up a few dozen banks and ask: “If you were to borrow, say, a million dollars in [a given currency] for a 30-day deposit, what would you expect to pay?” A deposit, in this context, is a short-term loan from one bank to another. Due to customers’ inconvenient habit of borrowing from one bank and putting the money in an account at another, banks are constantly left with either surplus customer deposits, or a shortage of funds. The “London inter-bank offered-rate” (Libor) market is where they sort this out by borrowing from and lending to each other, at the “offered rate” of interest.
Once they had their answers, the clerks would throw away the highest and lowest outliers and calculate the average of the rest, which would be recorded as “30-day Libor” for that currency. The process would be repeated for three-month loans, six-month loans and any other periods of interest, and the rates would be published. You would then have a little table recording the state of the market on that day – you could decide which currency you wanted to borrow in, and how long you wanted the use of the money, and the Libor panel would give you a good sense of what high-quality banks were paying to do the same.
Compared with the amount of time and effort that goes into the systems for nearly everything else that banks do, not very much trouble was taken over this process. Other markets rose and fell, stock exchanges mutated and were taken over by super-fast robots, but the Libor rate for the day was still determined by a process that could be termed “a quick ring-around”. Nobody noticed until it was too late that hundreds of trillions of dollars of the world economy rested on a number compiled by the few dozen people in the world with the greatest incentive to fiddle it.
It started to fall apart with the onset of the global financial crisis in 2007, and all the more so after the collapse of Lehman Brothers in 2008, when banks were so scared that they effectively stopped lending to each other. Although the market was completely frozen, the daily Libor ring-around still took place, and banks still gave, almost entirely speculatively, answers to the question “If you were to borrow a reasonable sum, what would you expect to pay?”
But the daily quotes were published, and that meant everyone could see what everyone else was saying about their funding costs. And one of the telltale signs that a bank in trouble is when its funding costs start to rise. If your Libor submission is taken as an indicator of whether you’re in trouble or not, you really don’t want to be the highest number on the daily list. Naturally, then, quite a few banks started using the Libor submission process as a form of false advertising, putting in a lowballed quote in order to make it look like they were still obtaining money easily when, in fact, they could hardly borrow at all. And so it came to pass that several banks created internal message trails saying, in effect, “Dear Lowly Employee, for the benefit of the bank and its shareholders, please start submitting a lower Libor quote, signed Senior Executive”. This turned out to be a silly thing to do.
All this was known at the time. There was an article in the Wall Street Journal about it. I used to prepare PowerPoint slides with charts on them that had gaps for the year 2008 because the data was “somewhat hypothetical”. Even earlier, in late 2007, the Bank of England held a “liaison group” meeting so that representatives from the banks could discuss the issue of Libor reporting. What nobody seemed to realise is that an ongoing fraud was being committed. There was a conspiracy to tell a lie (to the Libor phone panel, about a bank’s true cost of funding) in order to induce someone to enter into a bargain at a disadvantage to themselves. The general public caught on to all this a lot quicker than the experts did, which put the last nail in the coffin of the already weakened trust in the financial system. You could make a case that a lot of the populist politics of the subsequent decade can be traced back to the Libor affair.
Libor teaches us a valuable lesson about commercial fraud – that unlike other crimes, it has a problem of denial as well as one of detection. There are very few other criminal acts where the victim not only consents to the criminal act, but voluntarily transfers the money or valuable goods to the criminal. And the hierarchies, status distinctions and networks that make up a modern economy also create powerful psychological barriers against seeing fraud when it is happening. White-collar crime is partly defined by the kind of person who commits it: a person of high status in the community, the kind of person who is always given the benefit of the doubt.
In popular culture, the fraudster is the “confidence man”, somewhere between a stage magician and the trickster gods of mythology. In films such as The Sting and Dirty Rotten Scoundrels, they are master psychologists, exploiting the greed and myopia of their victims, and creating a world of illusion. People like this do exist (albeit rarely). But they are not typical of white-collar criminals.
The interesting questions are never about individual psychology. There are plenty of larger-than-life characters. But there are also plenty of people like Enron’s Jeff Skilling and Baring’s Nick Leeson: aggressively dull clerks and managers whose only interest derives from the disasters they caused. And even for the real craftsmen, the actual work is, of necessity, incredibly prosaic.
The way most white-collar crime works is by manipulating institutional psychology. That means creating something that looks as much as possible like a normal set of transactions. The drama comes later, when it all unwinds.
Fraudsters don’t play on moral weaknesses, greed or fear; they play on weaknesses in the system of checks and balances – the audit processes that are meant to supplement an overall environment of trust. One point that comes up again and again when looking at famous and large-scale frauds is that, in many cases, everything could have been brought to a halt at a very early stage if anyone had taken care to confirm all the facts. But nobody does confirm all the facts. There are just too bloody many of them. Even after the financial rubble has settled and the arrests been made, this is a huge problem.
The existence of the Canadian paradox suggests that there is a specifically economic dimension to a certain kind of crime of dishonesty. Trust – particularly between complete strangers, with no interactions beside relatively anonymous market transactions – is the basis of the modern industrial economy. And the story of the development of the modern economy is in large part the story of the invention and improvement of technologies and institutions for managing that trust.
And as industrial society develops, it becomes easier to be a victim. In The Wealth of Nations, Adam Smith described how prosperity derived from the division of labour – the 18 distinct operations that went into the manufacture of a pin, for example. While this was going on, the modern world also saw a growing division of trust. The more a society benefits from the division of labour in checking up on things, the further you can go into a con game before you realise that you’re in one. In the case of several dealers in the Libor market, by the time anyone realised something was crooked, they were several billions of dollars in over their heads.
In hindsight, the Libor system was always a shoddy piece of work. Some not-very-well-paid clerks from the British Bankers’ Association would call up a few dozen banks and ask: “If you were to borrow, say, a million dollars in [a given currency] for a 30-day deposit, what would you expect to pay?” A deposit, in this context, is a short-term loan from one bank to another. Due to customers’ inconvenient habit of borrowing from one bank and putting the money in an account at another, banks are constantly left with either surplus customer deposits, or a shortage of funds. The “London inter-bank offered-rate” (Libor) market is where they sort this out by borrowing from and lending to each other, at the “offered rate” of interest.
Once they had their answers, the clerks would throw away the highest and lowest outliers and calculate the average of the rest, which would be recorded as “30-day Libor” for that currency. The process would be repeated for three-month loans, six-month loans and any other periods of interest, and the rates would be published. You would then have a little table recording the state of the market on that day – you could decide which currency you wanted to borrow in, and how long you wanted the use of the money, and the Libor panel would give you a good sense of what high-quality banks were paying to do the same.
Compared with the amount of time and effort that goes into the systems for nearly everything else that banks do, not very much trouble was taken over this process. Other markets rose and fell, stock exchanges mutated and were taken over by super-fast robots, but the Libor rate for the day was still determined by a process that could be termed “a quick ring-around”. Nobody noticed until it was too late that hundreds of trillions of dollars of the world economy rested on a number compiled by the few dozen people in the world with the greatest incentive to fiddle it.
It started to fall apart with the onset of the global financial crisis in 2007, and all the more so after the collapse of Lehman Brothers in 2008, when banks were so scared that they effectively stopped lending to each other. Although the market was completely frozen, the daily Libor ring-around still took place, and banks still gave, almost entirely speculatively, answers to the question “If you were to borrow a reasonable sum, what would you expect to pay?”
But the daily quotes were published, and that meant everyone could see what everyone else was saying about their funding costs. And one of the telltale signs that a bank in trouble is when its funding costs start to rise. If your Libor submission is taken as an indicator of whether you’re in trouble or not, you really don’t want to be the highest number on the daily list. Naturally, then, quite a few banks started using the Libor submission process as a form of false advertising, putting in a lowballed quote in order to make it look like they were still obtaining money easily when, in fact, they could hardly borrow at all. And so it came to pass that several banks created internal message trails saying, in effect, “Dear Lowly Employee, for the benefit of the bank and its shareholders, please start submitting a lower Libor quote, signed Senior Executive”. This turned out to be a silly thing to do.
All this was known at the time. There was an article in the Wall Street Journal about it. I used to prepare PowerPoint slides with charts on them that had gaps for the year 2008 because the data was “somewhat hypothetical”. Even earlier, in late 2007, the Bank of England held a “liaison group” meeting so that representatives from the banks could discuss the issue of Libor reporting. What nobody seemed to realise is that an ongoing fraud was being committed. There was a conspiracy to tell a lie (to the Libor phone panel, about a bank’s true cost of funding) in order to induce someone to enter into a bargain at a disadvantage to themselves. The general public caught on to all this a lot quicker than the experts did, which put the last nail in the coffin of the already weakened trust in the financial system. You could make a case that a lot of the populist politics of the subsequent decade can be traced back to the Libor affair.
Libor teaches us a valuable lesson about commercial fraud – that unlike other crimes, it has a problem of denial as well as one of detection. There are very few other criminal acts where the victim not only consents to the criminal act, but voluntarily transfers the money or valuable goods to the criminal. And the hierarchies, status distinctions and networks that make up a modern economy also create powerful psychological barriers against seeing fraud when it is happening. White-collar crime is partly defined by the kind of person who commits it: a person of high status in the community, the kind of person who is always given the benefit of the doubt.
In popular culture, the fraudster is the “confidence man”, somewhere between a stage magician and the trickster gods of mythology. In films such as The Sting and Dirty Rotten Scoundrels, they are master psychologists, exploiting the greed and myopia of their victims, and creating a world of illusion. People like this do exist (albeit rarely). But they are not typical of white-collar criminals.
The interesting questions are never about individual psychology. There are plenty of larger-than-life characters. But there are also plenty of people like Enron’s Jeff Skilling and Baring’s Nick Leeson: aggressively dull clerks and managers whose only interest derives from the disasters they caused. And even for the real craftsmen, the actual work is, of necessity, incredibly prosaic.
The way most white-collar crime works is by manipulating institutional psychology. That means creating something that looks as much as possible like a normal set of transactions. The drama comes later, when it all unwinds.
Fraudsters don’t play on moral weaknesses, greed or fear; they play on weaknesses in the system of checks and balances – the audit processes that are meant to supplement an overall environment of trust. One point that comes up again and again when looking at famous and large-scale frauds is that, in many cases, everything could have been brought to a halt at a very early stage if anyone had taken care to confirm all the facts. But nobody does confirm all the facts. There are just too bloody many of them. Even after the financial rubble has settled and the arrests been made, this is a huge problem.
Jeffrey Skilling and Sherron Watkins of Enron at a Senate commerce committee hearing in 2002. Photograph: Ron Edmonds/AP
It is a commonplace of law enforcement that commercial frauds are difficult to prosecute. In many countries, proposals have been made, and sometimes passed into law, to remove juries from complex fraud trials, or to move the task of dealing with them out of the criminal justice system and into regulatory or other non-judicial processes. Such moves are understandable. There is a need to be seen to get prosecutions and to maintain confidence in the whole system. However, taking the opinions of the general public out of the question seems to me to be a counsel of despair.
When analysed properly, there isn’t much that is truly difficult about the proverbial “complex fraud trial”. The underlying crime is often surprisingly crude: someone did something dishonest and enriched themselves at the expense of others. What makes white-collar trials so arduous for jurors is really their length, and the amount of detail that needs to be brought for a successful conviction. Such trials are not long and detailed because there is anything difficult to understand. They are long and difficult because so many liars are involved, and when a case has a lot of liars, it takes time and evidence to establish that they are lying.
This state of affairs is actually quite uncommon in the criminal justice system. Most trials only have a couple of liars in the witness box, and the question is a simple one of whether the accused did it or not. In a fraud trial, rather than denying responsibility for the actions involved, the defendant is often insisting that no crime was committed at all, that there is an innocent interpretation for everything.
In January this year, the construction giant Carillion collapsed. Although they had issued a profits warning last summer, they continued to land government contracts. It was assumed that, since they had been audited by KPMG, one of the big-four accounting firms, any serious problems would have been spotted.
At the time of writing, nobody has been prosecuted over the collapse of Carillion. Maybe nobody will and maybe nobody should. It’s possible, after all, for a big firm to go bust, even really suddenly, without it being a result of anything culpable. But the accounting looks weird – at the very least, they seem to have recognised revenue a long time before it actually arrived. It’s not surprising that the accounting standards bodies are asking some questions. So are the Treasury select committee: one MP told a partner at KPMG that “I would not hire you to do an audit of the contents of my fridge.”
In general, cases of major fraud should have been prevented by auditors, whose specific job it is to review every set of accounts as a neutral outside party, and certify that they are a true and fair view of the business. But they don’t always do this. Why not? The answer is simple: some auditors are willing to bend the rules, and some are too easily fooled. And whatever reforms are made to the accounting standards and to the rules governing the profession, the same problems have cropped up again and again.
First, there is the problem that the vast majority of auditors are both honest and competent. This is a good thing, of course, but the bad thing about it is that it means that most people have never met a crooked or incompetent auditor, and therefore have no real understanding that such people exist.
To find a really bad guy at a big-four accountancy firm, you have to be quite unlucky (or quite lucky if that was what you were looking for). But as a crooked manager of a company, churning around your auditors until you find a bad ’un is exactly what you do – and when you find one, you hang on to them. This means that the bad auditors are gravitationally drawn into auditing the bad companies, while the majority of the profession has an unrepresentative view of how likely that could be.
Second, there is the problem that even if an auditor is both honest and competent, he has to have a spine, or he might as well not be. Fraudsters can be both persistent and overbearing, and not all the people who went into accountancy firms out of university did so because they were commanding, alpha-type personalities.
Added to this, fraudsters are really keen on going over auditors’ heads and complaining to their bosses at the accounting firm, claiming that the auditor is being unhelpful and bureaucratic, not allowing the CEO to use his legitimate judgment in presenting the results of his own business.
Partly because auditors are often awful stick-in-the-muds and arse-coverers, and partly because auditing is a surprisingly competitive and unprofitable business that is typically used as a loss-leader to sell more remunerative consulting and IT work, you can’t assume that the auditor’s boss will support their employee, even though the employee is the one placing their signature (and the reputation of the whole practice) on the set of accounts. As with several other patterns of behaviour that tend to generate frauds, the dynamic by which a difficult audit partner gets overruled or removed happens so often, and reproduces itself so exactly, that it must reflect a fairly deep and ubiquitous incentive problem that will be very difficult to remove.
By way of a second line of defence, investors and brokerage firms often employ their own “analysts” to critically read sets of published accounts. The analyst is meant to be an industry expert, with enough financial training to read company accounts and to carry out valuations of companies and other assets. Although their primary job is to identify profitable opportunities in securities trading – shares or bonds that are either very undervalued or very overvalued – it would surely seem to be the case that part of this job would involve the identification of companies that are very overvalued because they are frauds.
Well, sometimes it works. A set of fraudulent accounts will often generate “tells”. In particular, fraudsters in a hurry, or with limited ability to browbeat the auditors, will not be able to fake the balance sheet to match the way they have faked the profits. Inflated sales might show up as having been carried out without need for inventories, and without any trace of the cash they should have generated. Analysts are also often good at spotting practices such as “channel stuffing”, when a company (usually one with a highly motivated and target-oriented sales force) sells a lot of product to wholesalers and intermediaries towards the end of the quarter, booking sales and moving inventory off its books. This makes growth look good in the short term, at the expense of future sales.
Often, an honest auditor who has buckled under pressure will include a cryptic-looking passage of legalese, buried in the notes to the accounts, explaining what accounting treatment has been used, and hoping that someone will read it and understand that the significance of this note is that all of the headline numbers are fake. Nearly all of the fraudulent accounting policies adopted by Enron could have been deduced from its public filings if you knew where to look.
More common is the situation that prevailed in the period immediately preceding the global financial crisis.Analysts occasionally noticed that some things didn’t add up, and said so, and one or two of them wrote reports that, if taken seriously, could have been seen as prescient warnings. The problem is that spotting frauds is difficult and, for the majority of investors, not worth expending the effort on. That means it is not worth it for most analysts, either. Frauds are rare. Frauds that can be spotted by careful analysis are even rarer. And frauds that are also large enough to offer serious rewards for betting against them come along roughly once every business cycle, in waves.
Analysts are also subject to very similar pressures to those that cause auditors to compromise their principles. Anyone accusing a company publicly of being a fraud is taking a big risk, and can expect significant retaliation. It is well to remember that frauds generally look like very successful companies, and there are sound accounting reasons for this. It is not just that once you have decided to fiddle the accounts you might as well make them look great rather than mediocre.
If you are extracting cash fraudulently, you usually need to be growing the fake earnings at a higher rate. So people who are correctly identifying frauds can often look like they are jealously attacking success. Frauds also tend to carry out lots of financial transactions and pay large commissions to investment banks, all the while making investors believe they are rich. The psychological barriers against questioning a successful CEO are not quite as powerful as those against questioning the honesty of a doctor or lawyer, but they are substantial.
And finally, most analysts’ opinions are not read. A fraudster does not have to fool everyone; he just needs to fool enough people to get his money.
If you are looking to the financial system to protect investors, you are going to end up being disappointed. But this is inevitable. Investors don’t want to be protected from fraud; they want to invest. Since the invention of stock markets, there has been surprisingly little correlation between the amount of fraud in a market and the return to investors. It’s been credibly estimated that in the Victorian era, one in six companies floated on the London Stock Exchange was a fraud. But people got rich. It’s the Canadian paradox. Although in the short term, you save your money by checking everything out, in the long term, success goes to those who trust.
It is a commonplace of law enforcement that commercial frauds are difficult to prosecute. In many countries, proposals have been made, and sometimes passed into law, to remove juries from complex fraud trials, or to move the task of dealing with them out of the criminal justice system and into regulatory or other non-judicial processes. Such moves are understandable. There is a need to be seen to get prosecutions and to maintain confidence in the whole system. However, taking the opinions of the general public out of the question seems to me to be a counsel of despair.
When analysed properly, there isn’t much that is truly difficult about the proverbial “complex fraud trial”. The underlying crime is often surprisingly crude: someone did something dishonest and enriched themselves at the expense of others. What makes white-collar trials so arduous for jurors is really their length, and the amount of detail that needs to be brought for a successful conviction. Such trials are not long and detailed because there is anything difficult to understand. They are long and difficult because so many liars are involved, and when a case has a lot of liars, it takes time and evidence to establish that they are lying.
This state of affairs is actually quite uncommon in the criminal justice system. Most trials only have a couple of liars in the witness box, and the question is a simple one of whether the accused did it or not. In a fraud trial, rather than denying responsibility for the actions involved, the defendant is often insisting that no crime was committed at all, that there is an innocent interpretation for everything.
In January this year, the construction giant Carillion collapsed. Although they had issued a profits warning last summer, they continued to land government contracts. It was assumed that, since they had been audited by KPMG, one of the big-four accounting firms, any serious problems would have been spotted.
At the time of writing, nobody has been prosecuted over the collapse of Carillion. Maybe nobody will and maybe nobody should. It’s possible, after all, for a big firm to go bust, even really suddenly, without it being a result of anything culpable. But the accounting looks weird – at the very least, they seem to have recognised revenue a long time before it actually arrived. It’s not surprising that the accounting standards bodies are asking some questions. So are the Treasury select committee: one MP told a partner at KPMG that “I would not hire you to do an audit of the contents of my fridge.”
In general, cases of major fraud should have been prevented by auditors, whose specific job it is to review every set of accounts as a neutral outside party, and certify that they are a true and fair view of the business. But they don’t always do this. Why not? The answer is simple: some auditors are willing to bend the rules, and some are too easily fooled. And whatever reforms are made to the accounting standards and to the rules governing the profession, the same problems have cropped up again and again.
First, there is the problem that the vast majority of auditors are both honest and competent. This is a good thing, of course, but the bad thing about it is that it means that most people have never met a crooked or incompetent auditor, and therefore have no real understanding that such people exist.
To find a really bad guy at a big-four accountancy firm, you have to be quite unlucky (or quite lucky if that was what you were looking for). But as a crooked manager of a company, churning around your auditors until you find a bad ’un is exactly what you do – and when you find one, you hang on to them. This means that the bad auditors are gravitationally drawn into auditing the bad companies, while the majority of the profession has an unrepresentative view of how likely that could be.
Second, there is the problem that even if an auditor is both honest and competent, he has to have a spine, or he might as well not be. Fraudsters can be both persistent and overbearing, and not all the people who went into accountancy firms out of university did so because they were commanding, alpha-type personalities.
Added to this, fraudsters are really keen on going over auditors’ heads and complaining to their bosses at the accounting firm, claiming that the auditor is being unhelpful and bureaucratic, not allowing the CEO to use his legitimate judgment in presenting the results of his own business.
Partly because auditors are often awful stick-in-the-muds and arse-coverers, and partly because auditing is a surprisingly competitive and unprofitable business that is typically used as a loss-leader to sell more remunerative consulting and IT work, you can’t assume that the auditor’s boss will support their employee, even though the employee is the one placing their signature (and the reputation of the whole practice) on the set of accounts. As with several other patterns of behaviour that tend to generate frauds, the dynamic by which a difficult audit partner gets overruled or removed happens so often, and reproduces itself so exactly, that it must reflect a fairly deep and ubiquitous incentive problem that will be very difficult to remove.
By way of a second line of defence, investors and brokerage firms often employ their own “analysts” to critically read sets of published accounts. The analyst is meant to be an industry expert, with enough financial training to read company accounts and to carry out valuations of companies and other assets. Although their primary job is to identify profitable opportunities in securities trading – shares or bonds that are either very undervalued or very overvalued – it would surely seem to be the case that part of this job would involve the identification of companies that are very overvalued because they are frauds.
Well, sometimes it works. A set of fraudulent accounts will often generate “tells”. In particular, fraudsters in a hurry, or with limited ability to browbeat the auditors, will not be able to fake the balance sheet to match the way they have faked the profits. Inflated sales might show up as having been carried out without need for inventories, and without any trace of the cash they should have generated. Analysts are also often good at spotting practices such as “channel stuffing”, when a company (usually one with a highly motivated and target-oriented sales force) sells a lot of product to wholesalers and intermediaries towards the end of the quarter, booking sales and moving inventory off its books. This makes growth look good in the short term, at the expense of future sales.
Often, an honest auditor who has buckled under pressure will include a cryptic-looking passage of legalese, buried in the notes to the accounts, explaining what accounting treatment has been used, and hoping that someone will read it and understand that the significance of this note is that all of the headline numbers are fake. Nearly all of the fraudulent accounting policies adopted by Enron could have been deduced from its public filings if you knew where to look.
More common is the situation that prevailed in the period immediately preceding the global financial crisis.Analysts occasionally noticed that some things didn’t add up, and said so, and one or two of them wrote reports that, if taken seriously, could have been seen as prescient warnings. The problem is that spotting frauds is difficult and, for the majority of investors, not worth expending the effort on. That means it is not worth it for most analysts, either. Frauds are rare. Frauds that can be spotted by careful analysis are even rarer. And frauds that are also large enough to offer serious rewards for betting against them come along roughly once every business cycle, in waves.
Analysts are also subject to very similar pressures to those that cause auditors to compromise their principles. Anyone accusing a company publicly of being a fraud is taking a big risk, and can expect significant retaliation. It is well to remember that frauds generally look like very successful companies, and there are sound accounting reasons for this. It is not just that once you have decided to fiddle the accounts you might as well make them look great rather than mediocre.
If you are extracting cash fraudulently, you usually need to be growing the fake earnings at a higher rate. So people who are correctly identifying frauds can often look like they are jealously attacking success. Frauds also tend to carry out lots of financial transactions and pay large commissions to investment banks, all the while making investors believe they are rich. The psychological barriers against questioning a successful CEO are not quite as powerful as those against questioning the honesty of a doctor or lawyer, but they are substantial.
And finally, most analysts’ opinions are not read. A fraudster does not have to fool everyone; he just needs to fool enough people to get his money.
If you are looking to the financial system to protect investors, you are going to end up being disappointed. But this is inevitable. Investors don’t want to be protected from fraud; they want to invest. Since the invention of stock markets, there has been surprisingly little correlation between the amount of fraud in a market and the return to investors. It’s been credibly estimated that in the Victorian era, one in six companies floated on the London Stock Exchange was a fraud. But people got rich. It’s the Canadian paradox. Although in the short term, you save your money by checking everything out, in the long term, success goes to those who trust.
Monday, 12 March 2018
Accounting watchdogs find ‘serious problems’ at 40% of audits
Madison Marriage in The Financial Times
Global accounting watchdogs identified serious problems at 40 per cent of the audits they inspected last year, raising fresh concerns about the quality of work being carried out by the world’s largest accounting firms.
Global accounting watchdogs identified serious problems at 40 per cent of the audits they inspected last year, raising fresh concerns about the quality of work being carried out by the world’s largest accounting firms.
According to the International Forum of Independent Audit Regulators, accounting lapses were identified at two-fifths of the 918 audits of listed public interest entities they inspected last year.
The audit inspections focused on organisations in riskier or complex situations such as mergers or acquisitions, according to the IFIAR, whose members include 52 audit regulators around the world.
The most common issue identified by these regulators was a failure among auditors to “assess the reasonableness of assumptions”.
The second biggest problem was a failure among auditors to “sufficiently test the accuracy and completeness of data or reports produced by management”.
The findings have intensified concerns about weaknesses in the auditing process, an issue that has been thrust into the spotlight over the past 12 months following a string of high profile accounting failures.
These include the collapse of BHS and Carillion in the UK, a corruption scandal involving oil company Petrobras in Brazil, and the share price collapse of South Africa’s Steinhoff after the retail conglomerate admitted to a series of accounting irregularities last year.
Prem Sikka, an accounting expert and emeritus professor at Essex University, said the frequency of problems identified by the IFIAR was “terrible”.
“There are a whole range of issues and there is no simple fix. There is a huge knowledge failure in the audit industry which is not being looked at. The whole industry is ripe for reform. The question is where is the political will for this?”
The accounting industry has faced significant reputational problems in the UK in particular. KPMG came under heavy criticism from politicians last year for giving HBOS a clean bill of health shortly before the UK bank collapsed during the financial crisis. KPMG has also been criticised for declaring Carillion a going concern last March, 10 months before the construction company went into liquidation.
The report showed that 41 per cent of the problems identified by audit regulators last year related to independence and ethics. These included accounting firms failing to maintain their independence due to financial relationships with clients, and failing to evaluate the extent of non-audit and audit services provided to clients.
Many firms also failed “to implement a reliable system for tracking business relationships, audit firm financial interests, and corporate family trees”, the IFIAR said. Its research was based on feedback from 33 audit regulators who inspected the work done by 120 audit firms.
Karthik Ramanna, a professor at Oxford university’s Blavatnik School of Government, said the number of firms with issues around independence and ethics was “absurdly high”. He added that the research would reinforce concerns about a lack of competition in the audit market, which is widely viewed as being dominated by the ‘Big Four’: EY, Deloitte, KPMG and PwC.
“The auditing industry is so concentrated, once the largest firms set the standard for poor conduct, the whole industry is dragged down,” he said.
Brian Hunt, chairman of the IFIAR, told the FT: “We would like the firms to focus on getting better. We need them to think about how they come at this a bit differently. The firms are making progress — we would like to see it happen a bit faster.”
Deloitte said: “We remain focused on continually improving the quality of services we provide to our clients. We look forward to continuing our constructive engagement with our audit regulators.”
Sunday, 15 October 2017
Big data prove it is possible for a society to be riddled with racism in the complete absence of racists.
The government audit shows racism can be endemic even in the absence of racists
Trevor Phillips in The Financial Times
If Theresa May’s challenge to her own government on race equality does nothing else, it should take some of the terror out of talking about racial difference. Her government’s compendium of data about ethnic minorities’ experience across 130 public service areas, published this week, confronts us with a baffling puzzle: in a society demonstrably more open-minded than a generation ago, why do race and ethnicity remain such powerful pointers to an individual’s place in society?
You do not have to be a specialist in race relations to know that your doctor is more likely to be a Sikh than a Somali. Most of us can see that people from certain backgrounds — South Asians, Chinese — are more likely than others — African Caribbeans, Pakistani Muslims — to wind up as chief financial officers of big companies.
Sir John Parker, in a review that concluded this week, called out the paucity of non-white leaders in Britain’s top companies, confirming what most business leaders know: there are many available candidates but black and brown faces still do not turn up in the boardroom — except perhaps when they come to clean.
White Britons remain cautious about making such observations, for fear of being held personal responsible for racial inequalities. People of colour stay silent because nobody wants to sound like a grievance-monger. The race audit could be the best chance in years to break the silence.
Ministers have anticipated the charge of stirring up minority resentment by releasing a flood of data, some of which show that whites too can be at a disadvantage. White boys, for example, are far less likely to get in to a good university than the proverbial hijab-wearing Bangladeshi-heritage girl. By acknowledging that some differences might turn out to be intractable, Mrs May’s injunction that disparities should either be explained or eliminated could encourage a more open debate.
Some critics suggest that the audit will undermine minorities’ faith in public services. This underestimates the common sense of most people of colour. We do not live to complain about racism. On the contrary, we factor it into our daily lives, shrugging off discourtesies. But forbearance should not be confused with compliance. The data show that people of colour are right to have low expectations of their treatment by the healthcare system, the police or the courts. Their resentment should not be a surprise.
The audit is far from complete. Crucially, it tells us nothing about the UK’s most important economic issue — low productivity. Yet race relations can have a profound impact on the workplace.
A US survey shows that more than a third of white-collar employees think discussing race is off limits in the office, even though staff of all races think it affects their prospects. Blacks and Latinos believe their ethnicity holds them back; whites fear a word out of place will torpedo their careers. Annual appraisals have become stilted affairs: white bosses worry that too critical an assessment will land them in the dock for bigotry. Poor performance goes unchallenged and mediocrity protected.
The data released this week have all been available before. But together they could revolutionise our understanding of racism. Since the 1999 Macpherson Report into the death of Stephen Lawrence, the official doctrine has been that pretty much everyone everywhere was wrapped up in a racist conspiracy, even if they did not know it.
If that is true, how can we explain the fact that every measure of racial hostility has declined steadily over the past 40 years but there has been no corresponding fall in racial disadvantage? The answer is that most racial disadvantage is not the product of individual attitudes. Even if we were to adopt the widest definition of a racial incident, including online insults, and attribute every one of those acts to a prejudiced white person, it remains statistically demonstrable that the average person of colour will encounter such hostility once in their lifetime — not enough to produce the persistent patterns revealed by the audit.
So if Britons are individually better people what is preventing us becoming a better nation? Part of the answer is inertia: racial patterns we inherited and have not dealt with effectively. An example would be ethnic segregation in cities, baked into the geography because of settlement patterns generations ago.
A new source of racial disparities stems from what may be called techno-racism. Online decision systems use apparently neutral data: names, addresses, place of education. But these data carry racial markers that machines can read as reasons to reject minority applications for jobs, loans or insurance. In the US, companies are rewriting mortgage-lending programmes, having seen fines in excess of $100m for discriminating against African-American borrowers. Big data prove it is possible for a society to be riddled with racism in the complete absence of racists.
Mrs May says that government departments will have “nowhere to hide” in future. Unfortunately, her own privacy legislation will protect ministers from scrutiny. Data protection means that neither public bodies nor private corporations are allowed to keep ethnic data about individuals. A prime ministerial decision to allow companies, particularly recruitment firms, to hold ethnic data could be transformative.
Mrs May’s audit has opened a Pandora’s box. But when the first woman in the legend unleashed evils on humanity, Hope sat gleaming at the bottom. Our modern Pandora, lifting the lid on racism, is betting the facts may be the best way to solve our most toxic social problem. In this, at least, she has to be right.
Trevor Phillips in The Financial Times
If Theresa May’s challenge to her own government on race equality does nothing else, it should take some of the terror out of talking about racial difference. Her government’s compendium of data about ethnic minorities’ experience across 130 public service areas, published this week, confronts us with a baffling puzzle: in a society demonstrably more open-minded than a generation ago, why do race and ethnicity remain such powerful pointers to an individual’s place in society?
You do not have to be a specialist in race relations to know that your doctor is more likely to be a Sikh than a Somali. Most of us can see that people from certain backgrounds — South Asians, Chinese — are more likely than others — African Caribbeans, Pakistani Muslims — to wind up as chief financial officers of big companies.
Sir John Parker, in a review that concluded this week, called out the paucity of non-white leaders in Britain’s top companies, confirming what most business leaders know: there are many available candidates but black and brown faces still do not turn up in the boardroom — except perhaps when they come to clean.
White Britons remain cautious about making such observations, for fear of being held personal responsible for racial inequalities. People of colour stay silent because nobody wants to sound like a grievance-monger. The race audit could be the best chance in years to break the silence.
Ministers have anticipated the charge of stirring up minority resentment by releasing a flood of data, some of which show that whites too can be at a disadvantage. White boys, for example, are far less likely to get in to a good university than the proverbial hijab-wearing Bangladeshi-heritage girl. By acknowledging that some differences might turn out to be intractable, Mrs May’s injunction that disparities should either be explained or eliminated could encourage a more open debate.
Some critics suggest that the audit will undermine minorities’ faith in public services. This underestimates the common sense of most people of colour. We do not live to complain about racism. On the contrary, we factor it into our daily lives, shrugging off discourtesies. But forbearance should not be confused with compliance. The data show that people of colour are right to have low expectations of their treatment by the healthcare system, the police or the courts. Their resentment should not be a surprise.
The audit is far from complete. Crucially, it tells us nothing about the UK’s most important economic issue — low productivity. Yet race relations can have a profound impact on the workplace.
A US survey shows that more than a third of white-collar employees think discussing race is off limits in the office, even though staff of all races think it affects their prospects. Blacks and Latinos believe their ethnicity holds them back; whites fear a word out of place will torpedo their careers. Annual appraisals have become stilted affairs: white bosses worry that too critical an assessment will land them in the dock for bigotry. Poor performance goes unchallenged and mediocrity protected.
The data released this week have all been available before. But together they could revolutionise our understanding of racism. Since the 1999 Macpherson Report into the death of Stephen Lawrence, the official doctrine has been that pretty much everyone everywhere was wrapped up in a racist conspiracy, even if they did not know it.
If that is true, how can we explain the fact that every measure of racial hostility has declined steadily over the past 40 years but there has been no corresponding fall in racial disadvantage? The answer is that most racial disadvantage is not the product of individual attitudes. Even if we were to adopt the widest definition of a racial incident, including online insults, and attribute every one of those acts to a prejudiced white person, it remains statistically demonstrable that the average person of colour will encounter such hostility once in their lifetime — not enough to produce the persistent patterns revealed by the audit.
So if Britons are individually better people what is preventing us becoming a better nation? Part of the answer is inertia: racial patterns we inherited and have not dealt with effectively. An example would be ethnic segregation in cities, baked into the geography because of settlement patterns generations ago.
A new source of racial disparities stems from what may be called techno-racism. Online decision systems use apparently neutral data: names, addresses, place of education. But these data carry racial markers that machines can read as reasons to reject minority applications for jobs, loans or insurance. In the US, companies are rewriting mortgage-lending programmes, having seen fines in excess of $100m for discriminating against African-American borrowers. Big data prove it is possible for a society to be riddled with racism in the complete absence of racists.
Mrs May says that government departments will have “nowhere to hide” in future. Unfortunately, her own privacy legislation will protect ministers from scrutiny. Data protection means that neither public bodies nor private corporations are allowed to keep ethnic data about individuals. A prime ministerial decision to allow companies, particularly recruitment firms, to hold ethnic data could be transformative.
Mrs May’s audit has opened a Pandora’s box. But when the first woman in the legend unleashed evils on humanity, Hope sat gleaming at the bottom. Our modern Pandora, lifting the lid on racism, is betting the facts may be the best way to solve our most toxic social problem. In this, at least, she has to be right.
Monday, 25 April 2016
Pakistan Army Accounts - No Audit permitted
Accountability without exception Friday Night with Hamid Bashani Ep48 (in Urdu)
History of Pakistan's Foreign Policy - AApas ki Baat with Najam Sethi and Muneeb Farooq
Politician & Military in Pakistan Part II
Tuesday, 26 August 2014
The barefoot government
Bunker Roy in The Indian Express
Since 1947, Indians have not spoken out so strongly and clearly for a completely new brand of people running government. Mercifully, there are no ministers educated abroad. Thankfully, none of them has been brainwashed at Harvard, Stanford, Cambridge, the World Bank or the IMF, subtly forcing expensive Western solutions on typically Indian problems at the cost of the poor. Look what the high-powered, foreign-returned degree-wallahs have reduced this country to. They wasted opportunities to show the inner strength of what is essentially Indian because they never really knew their own people living in Bharat. In the eyes of the world, we have lost our self-respect, dignity and identity.
All the ministers now have gone through average government schools. Some have never been to college. Many have experienced poverty, exploitation, injustice and discrimination at some point of time in their lives. It is truly the first barefoot government ever to be voted into power in independent India. Where else in the world would you have a one-time tea-seller on a railway station becoming prime minister, shaping the destiny of more than one billion people?
The first example the Modi government must set is by drastically reducing the perks and privileges of MPs. Free power, food, housing, travel to those whose personal assets run into crores and a Rs 2 crore annual fund for development (read patronage) for over 500 MPs is costing the exchequer nearly Rs 2,000 crore. Only the prime minister will be able to make it happen and, at the same time, stifle any dissent from BJP MPs. The time is now.
No other government in the world has a Class 12-pass woman minister speaking as an equal to almost 120 heavily qualified, on paper, vice chancellors (90 per cent male). Today, as we judge them, the VCs are all too intellectually and morally fatigued. There is something dreadfully wrong with an education system that produces graduates from even private, expensive, snobbish schools and colleges who are still prejudiced about caste, class, religion, sex and colour. These “graduates”, who roam the streets of small towns and cities by the thousands, call themselves “educated”, practice the worst forms of cruelty, slavery and crimes against humanity, against society and in their own families. Indeed, some of them rose to the level of their incompetence by becoming ministers in previous governments, reinforcing the status quo, wasting vast public resources by implementing silly Western ideas, listening to foreign-returned “experts” and making a hopeless mess of this country. The tragedy is that they cannot see the colossal damage they have done to the very fabric of this country.
Now they will call me a “namak haram” because I went to Doon School and St Stephen’s College and I am trashing my own kind. They deserve it. Their snobbish elitist education has made them arrogant, inaccessible, insensitive and devoid of any humanity or humility. Just because they received a Western education, they think they know their country. Superficially, they may know urban India but they are clueless about rural Bharat.
Alvin Toffler, in his book Future Shock, said, “The illiterate of the 21st century will not be someone who cannot read or write. It will be someone who is not prepared to learn, unlearn and relearn.” In the 40 years that I have lived and worked with the rural poor in Rajasthan, what have I learnt that I did not manage to make my own kind “unlearn and relearn”?
It was not for want of trying. What did the prime minister, the deputy chairman of the Planning Commission and finance minister of the decimated UPA government have in common? They were all “educated” abroad. They were all for subsidising the rich and cutting subsidies for the poor. They had no idea about real poverty and hunger and how the rural poor survived, expecting the whole country to be gullible enough to believe that the rural poor today could survive on Rs 27 per day.
Out of sheer ignorance of rural realities and showing extremely poor political judgement, the three of them almost managed to strangle the MGNREGA. The MGNREGA prevented migration by the millions into cities. The bungling and corruption by village officials notwithstanding, the rural poor now have more money to spend on food, clothing, housing and essentials. So, of course, prices will go up.
The prime minister is evidently serious about improving the quality of life of the rural poor, as he eloquently stated in his speech on Independence Day. So what are the out of the box solutions that need to be considered urgently?
The MGNREGA should stay with “Modi-fications”. Pay minimum wages, which the Congress’s three armchair foreign-returned economists so stubbornly and unethically refused to do, in spite of a high court order. Make it more transparent and accountable, take action against corrupt officials exposed in social audits to set an example. Pass the public grievance bill in Parliament as soon as possible. Call a meeting of respected grassroot practitioners across political ideologies who know the MGNREGA from the village level and follow up on their recommendations.
The focus has to be on innovative job creation in the rural areas. Provide 100 days of employment at minimum wages to construct low-cost toilets for girls and rooftop rainwater harvesting tanks for drinking water, tree plantations and flush toilets in rural schools by the thousands. Construct rural godowns to store food grains instead of letting nearly 5 million tonnes of grain just rot in the open. Start community colleges on Gandhian lines instead of sending delegations of “experts” on education to study the American model. There are enough indigenous examples to replicate and scale up.
Civil society is riddled with defeated politicians and retired bureaucrats who, having lost their power, influence and privileges, have started NGOs. While they were in power, they did not lift a finger to help them. When these has-beens have nothing better to do, they start NGOs. They give genuine small civil society organisations a bad name. Maybe it is time to revive the debate of the 1980s on the need for a code of conduct for NGOs. The code would expect them to have a simple lifestyle, take a living wage instead of a market wage and observe the laws of the country.
If we are fighting against crony capitalism, we should also fight against cronyism in NGOs. When the Council for Advancement of People’s Action and Rural Technology (CAPART) was closed down and replaced by a Bharat Rural Livelihood Foundation (BRLF) in September 2013, it was done in complete secrecy. The BRLF was never widely publicised and civil society was never invited to contribute to its formation. It is designed to benefit a handful of select organisations — cronyism of the worst kind. It was so much in contrast to the open debate that galvanised the voluntary sector over the code of conduct and which preceded the merger of the People’s Action for Development India (PADI) and the Council for Advancement of Rural Technology (CART) to form CAPART in 1986.
What needs to be done? Replace the national advisory council (NAC) with a voluntary action commission (VAC). The mandate of the VAC should be to identify the thousands of genuine grassroots groups who have an FCRA registration and submit their report to the home ministry. It is not the job of the home ministry to judge the incredible work of community-based organisations. A lot of effort has gone into the formulation of the BRLF. Let it remain. But demand of the existing management if they have the self-respect to resign en masse and let the new government bring in new members.
Monday, 9 June 2014
The French are right: tear up public debt – most of it is illegitimate anyway
Debt audits show that austerity is politically motivated to favour social elites. Is a new working-class internationalism in the air?
Contracts for Chilean student loans worth $500m go up in flames – the 'imaginative auditing' of the artist Francisco Tapia, commonly known as Papas Fritas (Fried Potatoes). Photograph: David von Blohn/REX
As history has shown, France is capable of the best and the worst, and often in short periods of time.
On the day following Marine Le Pen's Front National victory in the European elections, however, France made a decisive contribution to the reinvention of a radical politics for the 21st century. On that day, the committee for a citizen's audit on the public debt issued a 30-page report on French public debt, its origins and evolution in the past decades. The report was written by a group of experts in public finances under the coordination of Michel Husson, one of France's finest critical economists. Its conclusion is straightforward: 60% of French public debt is illegitimate.
Anyone who has read a newspaper in recent years knows how important debt is to contemporary politics. As David Graeber among others has shown, we live in debtocracies, not democracies. Debt, rather than popular will, is the governing principle of our societies, through the devastating austerity policies implemented in the name of debt reduction. Debt was also a triggering cause of the most innovative social movements in recent years, the Occupy movement.
If it were shown that public debts were somehow illegitimate, that citizens had a right to demand a moratorium – and even the cancellation of part of these debts – the political implications would be huge. It is hard to think of an event that would transform social life as profoundly and rapidly as the emancipation of societies from the constraints of debt. And yet this is precisely what the French report aims to do.
The audit is part of a wider movement of popular debt audits in more than 18 countries.Ecuador and Brazil have had theirs, the former at the initiative of Rafael Correa's government, the latter organised by civil society. European social movements have also put in place debt audits, especially in countries hardly hit by the sovereign debt crisis, such as Greece and Spain. In Tunisia, the post-revolutionary government declared the debt taken out during Ben Ali's dictatorship an "odious" debt: one that served to enrich the clique in power, rather than improving the living conditions of the people.
The report on French debt contains several key findings. Primarily, the rise in the state's debt in the past decades cannot be explained by an increase in public spending. The neoliberal argument in favour of austerity policies claims that debt is due to unreasonable public spending levels; that societies in general, and popular classes in particular, live above their means.
This is plain false. In the past 30 years, from 1978 to 2012 more precisely, French public spending has in fact decreased by two GDP points. What, then, explains the rise in public debt? First, a fall in the tax revenues of the state. Massive tax reductions for the wealthy and big corporations have been carried out since 1980. In line with the neoliberal mantra, the purpose of these reductions was to favour investment and employment. Well, unemployment is at its highest today, whereas tax revenues have decreased by five points of GDP.
The second factor is the increase in interest rates, especially in the 1990s. This increase favoured creditors and speculators, to the detriment of debtors. Instead of borrowing on financial markets at prohibitive interest rates, had the state financed itself by appealing to household savings and banks, and borrowed at historically normal rates, the public debt would be inferior to current levels by 29 GDP points.
Tax reductions for the wealthy and interest rates increases are political decisions. What the audit shows is that public deficits do not just grow naturally out of the normal course of social life. They are deliberately inflicted on society by the dominant classes, to legitimise austerity policies that will allow the transfer of value from the working classes to the wealthy ones.
A sit-in called by Occupy France at La Défense business district in Paris. Photograph: Afp/AFP/Getty Images
A stunning finding of the report is that no one actually knows who holds the French debt. To finance its debt, the French state, like any other state, issues bonds, which are bought by a set of authorised banks. These banks then sell the bonds on the global financial markets. Who owns these titles is one of the world's best kept secrets. The state pays interests to the holders, so technically it could know who owns them. Yet a legally organised ignorance forbids the disclosure of the identity of the bond holders.
This deliberate organisation of ignorance – agnotology – in neoliberal economies intentionally renders the state powerless, even when it could have the means to know and act. This is what permits tax evasion in its various forms – which last year cost about €50bn to European societies, and €17bn to France alone.
Hence, the audit on the debt concludes, some 60% of the French public debt is illegitimate.
An illegitimate debt is one that grew in the service of private interests, and not the well being of the people. Therefore the French people have a right to demand a moratorium on the payment of the debt, and the cancellation of at least part of it. There is precedent for this: in 2008 Ecuador declared 70% of its debt illegitimate.
The nascent global movement for debt audits may well contain the seeds of a new internationalism – an internationalism for today – in the working classes throughout the world. This is, among other things, a consequence of financialisation. Thus debt audits might provide a fertile ground for renewed forms of international mobilisations and solidarity.
This new internationalism could start with three easy steps.
1) Debt audits in all countries
The crucial point is to demonstrate, as the French audit did, that debt is a political construction, that it doesn't just happen to societies when they supposedly live above their means. This is what justifies calling it illegitimate, and may lead to cancellation procedures. Audits on private debts are also possible, as the Chilean artist Francisco Tapia has recently shown by auditing student loans in an imaginative way.
2) The disclosure of the identity of debt holders
A directory of creditors at national and international levels could be assembled. Not only would such a directory help fight tax evasion, it would also reveal that while the living conditions of the majority are worsening, a small group of individuals and financial institutions has consistently taken advantage of high levels of public indebtedness. Hence, it would reveal the political nature of debt.
3) The socialisation of the banking system
The state should cease to borrow on financial markets, instead financing itself through households and banks at reasonable and controllable interest rates. The banks themselves should be put under the supervision of citizens' committees, hence rendering the audit on the debt permanent. In short, debt should be democratised. This, of course, is the harder part, where elements of socialism are introduced at the very core of the system. Yet, to counter the tyranny of debt on every aspect of our lives, there is no alternative.
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