Our banks are not merely out of control. They're beyond control

Jailing reckless bankers is a dangerously incomplete solution. The market is bust. Institutions that are too big to fail are too big to exist

• 
• • Joris Luyendijk
  • The Guardian, Wednesday 19 June 2013 20.35 BST

'The banking system is highly dysfunctional, deeply entrenched, and enormously abusive, both to its own workers and the society it operates in.' Photograph: Adrian Dennis/AFP/Getty

Seeing the British establishment struggle with the financial sector is like watching an alcoholic who still resists the idea that something drastic needs to happen for him to turn his life around. Until 2008 there was denial over what finance had become. When a series of bank failures made this impossible, there was widespread anger, leading to the public humiliation of symbolic figures. But the scandals kept coming, and so we entered stage three – what therapists call "bargaining". A broad section of the political class now recognises the need for change but remains unable to see the necessity of a fundamental overhaul. Instead it offers fixes and patches, from tiny increases in leverage ratios tobonus clawbacks and "electrified ring fences".

Today's report by the parliamentary commission on banking standards (to which I gave evidence) is a perfect example of this tendency to fight the symptoms while keeping the dysfunctional system itself intact. The commission, set up after last year's Libor scandal, identifies all the structural problems and nails the fundamental flaw in finance today: "Too many bankers, especially at the most senior levels, have operated in an environment with insufficient personal responsibility." Indeed, as they like to say in the City, running a mega-bank these days is like "Catholicism without a hell", or "playing russian roulette with someone else's head".

In response, the commission proposes jailing reckless bankers. Restoring the link between risk, reward and responsibility is a crucial step towards a robust and stable financial sector. But the report's focus on individual responsibility is also dangerously incomplete because it implies that the sector is merely out of control. This plays into the narrative that things can be fixed by tweaking rules and realigning incentives; in other words, by bargaining.

In reality the financial sector is not out of control. It's beyond control. During the past two years I have interviewed almost 200 people working in finance in London: "front office" bankers with telephone-number bonuses as well as those in "risk and compliance" who are meant to stop them being reckless. I have also spoken to many internal and external accountants, lawyers and consultants.

The picture emerging from those interviews is of big banks not as coherent units run by top bankers who know what they are doing. Instead these banks seem, in the words of Manchester University anthropologist Karel Williams, "loose federations of money-making franchises". One risk analyst talked about her bank as "a nation engaged in perpetual civil war", while a trader said, "You have to understand, it's us against the bank."

I could give 50 similar quotes. Taken together, they leave but one conclusion: employees at the big banks themselves do not believe their top people know what's going on; the big banks have simply become too complex and too big to manage. If this is true, the solution is not so much to jail the top bankers when something goes wrong, it is to break up the banks into manageable parts. But the British establishment still seems incapable of accepting the notion that a bank that is too big to fail or manage is a also bank that is too big to exist.

The same seems to apply to the need to restore market forces in the financial sector: the second source of structural dysfunctionality. Imagine a restaurant had served up product as toxic as that which big banks, credit rating agencies and accountancy firms were churning out until 2008. You would expect that restaurant to have closed. You would also expect new restaurants to have opened up in the area. This is how a free market should work: competition drives out bad practices.

But where are the new credit-rating agencies, accountancy firms or big banks? Even worse, not only are there just four major accountancy firms, they are also financially dependent on the very banks they are supposed to audit critically. It's the same with thethree credit-rating agencies dominating the market.

And it gets worse. Imagine that a restaurant in your neighbourhood made the kind of money paid to top employees in banking, credit-rating and accountancy firms. You'd expect people rushing to open more restaurants, and with that increased competition you'd expect wages to come down. Again, this is how competition works. There are thousands and thousands of young graduates aching to get into investment banking, so no shortage of prospective chefs. So where are the new players in high finance?

The reality is that global high finance is de facto a set of interlocking cartels that divide the market among themselves and use their advantages to keep out competitors. Cartels can extract huge premiums over what would be normal profits in a functioning market, and part of those profits go to keeping the cartel intact: huge PR efforts, a permanent recruiting circus drawing in top academic talent; clever sponsoring of, say, an ambitious politician's cycling scheme; vast lobbying efforts behind the scenes; and highly lucrative second careers for ex-politicians. There is also plenty of money to offer talented regulators three or four times their salary.

Capitalists have an expression for this, and it's "market failure". Here is the source of so many of the perversities in modern finance, and the solution is not only to denounce those who can't resist its temptations, it's to take away those temptations. That probably means smaller banks, smaller and independent accountancy firms and credit-rating agencies, simpler financial products, and much higher capital requirements.

Before studying bankers I spent many years researching Islam and Muslims. I set out with images in my mind of angry bearded men burning American flags, but as the years went by I became more and more optimistic: beyond the frightening rhetoric and sensationalist television footage, ordinary Muslim people go about their day like all other human beings. The problem of radical Islam is smaller and more containable than Islamophobes believe.

With bankers I have experienced an opposite trajectory. I started with the reassuring images in my mind of well-dressed bankers and their lobbyists; surely at some basic level these people knew what they were doing? But after two years I feel myself becoming deeply pessimistic and genuinely terrified. This system is highly dysfunctional, deeply entrenched, and enormously abusive, both to its own workers and the society it operates in. The problem really is exactly as bad as the "banker bashers" believe.

JP Morgan et al - Not a decent banker around

By Martin Hutchinson in Asia Times Online

In the past week, the detailed revelations from JP Morgan's grilling in the US Senate have combined with the Cyprus rescue blunder to generate one inescapable conclusion: public or private sector, European or American, there isn't a decent, competent banker among them. Truly almost 20 years of funny money and 30-40 years of misguided deregulation have drained the financial sector of the quiet competence it used to exhibit. 

I wrote about JP Morgan's "London Whale" derivatives insanities of early 2012 a few weeks ago. It demonstrated two failings that appear to me unforgivable. First, in spite of the experience of 2007-08 Morgan was still using value-at-risk as a major element of its risk management. 

Kevin Dowd and I pointed out the irretrievable flaws in this methodology in Alchemists of Loss, published in June 2010 - and we were by no means alone in doing so, though we may have had a "better mousetrap" than others in terms of an alternative risk management approach. A bank of Morgan's stature has a duty to keep up with the literature; it's as simple as that. 

The second failing is even more fundamental, because it rests on what Morgan thinks a bank should be doing. Bruno Iksil, the London Whale, was attempting to "corner the market" in an obscure and artificial credit default swap (CDS) contract. 

First, credit default swaps are not solidly based, because their settlement procedure can very easily be "gamed" - rather than the current procedure it would make more sense to select a random number between 1 and 100 as the percentage of the contract that was paid out on default. Second, index CDS contracts are doubly artificial, because the index itself is constructed as a basket of credit default swaps, none of which themselves trade with any liquidity; thus the index itself can be "gamed." Third, Iksil was trading in an "off the run" index, constructed five years previously, whose liquidity was even more restricted and whose relationship to any underlying reality was even more attenuated. 

JP Morgan would have done better to put their capital on red in Las Vegas. The CDS index Iksil was trading was so far removed from reality it was a mere gambling chip, with no underlying economic meaning. His trading volumes were so large that he controlled the market, which enabled him to report spurious profits until the beginnings of responsible risk management forced him to begin unwinding the position. His activity bore no relationship to true banking; it served no legitimate financial purpose, nor did it serve the financing or risk management needs of any client. 

This is the real problem of derivatives markets in general; the genuine client service they provide is minor, in some cases infinitesimal, compared with the gambling and manipulation activities they enable. If you are JP Morgan, and privy to a great deal of information about market movements to which less exalted institutions do not have access, you can make good money by exploiting others' ignorance. But make no mistake, the immense profits made in these markets are not secured by providing genuine service to clients, any more than Las Vegas casinos make money by providing investment opportunities to their foolish punters. In the final analysis, both activities are almost purely parasitic, and should be severely discouraged if not prohibited altogether. 

The only problem with prohibiting these activities is that the prohibition would have to be designed and enforced by public sector regulators. Public choice theory suggests that they are not capable of performing this function adequately and the Cyprus imbroglio shows just how inept and conflicted they are in reality. 

Legally, if US$7.2 billion was required for the Cyprus bailout beyond the European Union loan (the accuracy of that calculation is of course unverifiable), then the Cypriot banks' subordinated loans should have been wiped out, and the necessary amount taken from the banks' senior debt and uninsured depositors. (Any amount taken from insured depositors would have had to be made up by the Cyprus government, so would have added to the bailout need.) 

Instead, the proposed bailout took a 9.9% tax from depositors above 100,000 euros (the deposit insurance limit) and a 6.7% tax from deposits below 100,000 euros, which were theoretically insured, while leaving the modest amount of senior debt untouched. 

The Cyprus government rejected these terms, not because of the taxes' effect on small Cypriot depositors or on the Cypriot deposit insurance system, but because of their effect on the Russian mafia thugs who contribute about a third of the Cypriot banking system's deposits. One can only guess what inducements, positive and negative, the big depositors gave to the Cyprus legislature to take that position. 

Legality seems to have been utterly irrelevant to those arranging the bailout. Instead, by arranging a "tax" that fell so heavily on small depositors, they blew a hole in deposit insurance schemes worldwide. Depositors in banks elsewhere in the EU, or indeed the United States, can no longer believe that the first $100,000 (or whatever figure is "insured") of their savings is secure. 

Inevitably, calls upon the deposit insurance scheme will be made in times of financial stress, and at those times governments can use the depositors' funds to recapitalize the banks or indeed themselves. In 2008, depositors in Western Europe and the US could be reasonably confident that their governments were in decent financial shape, so would have no need to raid their citizens' piggy banks. In the next financial crisis, thanks to years of foolish, indeed evil, monetary and fiscal "stimulus" there will be no such assurance. 

I wrote some months ago about the problems involved in going back to a world in which government bonds are no longer a reliable store of value, and suggested that such a change would reverse 350 years of financial history, taking us back to the time before the establishment of the Bank of England in 1694. 

A world in which neither government bonds nor banks are to be trusted takes us back about 400 years further. After all, Samuel Pepys only occasionally buried his money in the back garden; most of the time he entrusted it to a reliable goldsmith, the precursors to the London merchant banks. The goldsmith-bankers were new in Restoration England, but as Edward, Earl of Clarendon wrote in his memoirs around 1670, before their time, the scriveners had been available for "money business''. A world without banks takes us back before the scriveners, before the first Italian banks (Monti dei Paschi di Siena, 1472) and even before the Lombard moneylenders of the fourteenth century. 

Needless to say, pushing our financial system back close to the Dark Ages will do nothing whatever for global economic well-being. A world without banks is a world in which all trade must be financed by merchants themselves, in which investments must be financed entirely out of equity or ad hoc loans from those with money. 

While much of Silicon Valley currently finances itself on close to this basis, it is unimaginable that business as a whole can do so; the needs of fixed assets, inventory and receivables are simply too great. A world with 13th century finance is more a less a world with 13th century living standards - and for only a 13th century world population. 

We thus live in a world in which neither the managers of JP Morgan nor the financial wizards of the European Union have the slightest awareness of the basic needs of a sound financial system. 

Admittedly the two problems cancel each other out: provided governments remain solvent both the need for deposit insurance and the speculative games of the trading desks can be eliminated by going back, not to the Dark Ages, but only to 1914. At that time, banks did not have deposit insurance, so depositors were forced to assure themselves that deposit institutions were soundly managed. 

This pretty well put paid to speculative games: the Knickerbocker Trust of New York went bankrupt in 1907 through speculation in the copper market, and for at least the next two decades it was accepted that speculation had no place in a soundly run deposit-taking bank. (Investment banks existed, but they were separately capitalized and did not rely on the bank's depositors for funding.) 

Without deposit insurance, banks would have to be properly capitalized, with a tangible capital base of no less than 20% of assets - calculated not on a "Basel" formula in which some assets are defined as "low risk" and discounted accordingly, but in which all assets and liabilities are fully reflected in the balance sheet. Only with such a heavy capitalization could depositors be sure the banks would stay in business. 

What's more, derivatives, securitization and other off-balance sheet risks would have to be undertaken by separate companies that did not themselves take deposits; bank depositors would insist that all such risks be taken onto the bank's balance sheet, which would make them impossibly costly. 

In order to discourage speculative activity further, it would also be necessary to return to a strict gold standard (or other commodity standard). The 1920s gold exchange standard, with the Federal Reserve able to increase credit at will, proved impossibly dangerous to the banking system after 1929, so a banking system with an active Fed would over time prove unable to attract depositors because of its risk. 

I'm quite certain that both the management of JP Morgan and the EU bureaucracy would regard such an alternative as wholly unacceptable - it would, for one thing, restrict sharply the ability for self-remuneration of both bankers and bureaucracies (which would have to finance themselves in a bond market without bank lenders, strong intermediaries or fiat money). 

However, by their ineffable folly, they have brought such a world (or the much worse dystopia where we lose 750 years of financial progress altogether) very much closer. 

Martin Hutchinson is the author of Great Conservatives(Academica Press, 2005) - details can be found on the website www.greatconservatives.com - and co-author with Professor Kevin Dowd of Alchemists of Loss (Wiley, 2010). 

If bankers leave the country, it would be no loss

Ignore their howls of protest. 

They took home unheard of sums. Only in Britain do ministers dance to their tune. But public fury cannot be defied for ever

• 
• • Simon Jenkins
  • The Guardian, Wednesday 6 March 2013

Illustration by Belle Mellor

The peasants are revolting across Europe. They want bankers' blood and mean to get it. Until now, public response to the credit crunch has been one of general bafflement and wrist-slapping. The banks persuaded the world it was all an act of fate. As it was, they were too big to fail and their leaders too saintly to atone for it. For four years, British banks were showered with nearly half a trillion pounds of public and printed money. They duly recovered and stayed rich, while everyone else went poor.

The worm has turned. The banks and government alike have failed to deliver recovery. The people want revenge, and have found it – of all places – in the European parliament. It has declared that EU bankers cannot get bonuses bigger than their salaries, or twice as big if shareholders approve. This applies wherever EU bankers work, and to any overseas banker working in the EU.

Meanwhile, a Swiss referendum now requires top executives to seek explicit shareholder approval for their pay, with a ban on golden hellos and goodbyes. The Netherlands is talking of a tighter 20% cap on bonuses. Even laissez-faire Britain has seen the National Association of Pension Funds demand that boards keep executive pay rises down to inflation.

Europe's once omnipotent banking lobby has been all but neutered by the scale of scandal. The German government caved in to the EU parliament under pressure from the opposition Social Democrats. This was after the Libor scandal revealed Deutsche Bank cutting one trader's bonus by £34m, thus implying a staggering original sum. The Swiss campaign was kicked into life by the drugs firm Novartis giving its departing chairman a $76m gift. Some 68% of Swiss voted for the new curb.

Only in Britain do ministers still dance to the bankers' tune. Last month RBS executives brushed aside their state shareholder and paid themselves £600m in bonuses after posting a £5bn loss. Loss-making Lloyds dipped into its till and gave senior staff an extra £365m. Money-laundering HSBC announced 78 of its London executives would take home more than £1m each. They all say bonuses were unrelated to fines or losses, but they always say that. George Osborne was humiliated in Brussels on Tuesday by having to plead their fruitless cause.

Last year the City of London's much-heralded "shareholder spring" got nowhere. Revolts against executive pay at WPP, Barclays, Trinity Mirror and elsewhere had little noticeable impact. While overall pay stagnated, that of top executives rose 12%. Opinion polls showed the public overwhelmingly hostile to top pay. Only the government and the London mayor stand between the very rich and a furious public. The peasants' revolt means that even British ministers cannot defy opinion for ever.

The reality is that the banking community has allowed this thirst for revenge to build up for over four years, and it just did not care. Ever since the 1980s and financial deregulation, the profession took home sums of money unheard of in any other line of work.

This had nothing to do with free markets, except within a tight group of high-rolling traders. Modern bankers derive "economic rent" from exploiting oligopolistic cartels in financial services, with shareholders kept at one remove. The astronomical traders' bonuses are asymmetric returns on cash that properly belongs to depositors and shareholders whose money bears the risk. In any other business such bonuses would be regarded as theft from the firm.

For four years the British government – Labour and the coalition – huffed and puffed but was too terrified of the banks to act. Regulators were suborned by lobbyists and ministers, their offices packed with seconded bankers, and did as they were told. They gave huge sums to the banks in the belief that this was benefiting the demand economy. In Britain, some £400bn of cash was "pumped into the economy" via the banks. They merely traded or hoarded it, to their ever greater enrichment. The money vanished. A thousand pounds handed to every British citizen would have had more impact on the economy.

Last year, as if learning nothing, the Treasury gave the banks another £80bn to boost business and mortgage lending. This week it was predictably revealed that lending to small businesses actually fell as result. It was like giving money to a drunk and telling him to support his children. Never in the history of money can policy have been so glaringly inept. The banks laughed.

No trade unions are fiercer in defending their interests than the rich professions. As we saw this week with lawyers, cut their largesse and they threaten to take it out on the poor, the economy, the government, everyone. The banks howl that the bonus cap means their greed will go "offshore". This seems exaggerated. But the EU curbs could possibly see the start of the high-rollers moving out of over-regulated Europe towards the Americas and Asia.

This would not be wholly good news for Britain: finance has been the boom industry of the past quarter-century. But more likely is that the more toxic activities will go, and that is no loss. Either way, the banks have themselves to blame. They flew their golden wings too near the sun, and rage has melted them. They have only one plea on their side. The culture of greed in the City was nothing to the culture of ineptitude at the Bank of England and the Treasury. They pumped out the money. Never in British economic history can so much have been so wasted on so fruitless a cause. And still no hint of remorse.

What's the point of wealth beyond utility?

DJ TAYLOR

Sunday 17 February 2013

Why stinking rich bankers can't imagine why there's an almighty stink when the public finds out.  

Reading the remarks uttered by Sir Philip Hampton, chairman of the Royal Bank of Scotland, in defence of his chief executive's "modest" £7.8m annual pay package, I was irresistibly reminded of Martin Amis's short story "Career Move". The piece – one of Amis's very best – is a variation on the "world turned upside down" motif, in this case examining a futuristic entertainment industry where poetry commands the attention of Hollywood ("We really think Sonnet is going to work, Luke"), while screenplays are written by desperate men in bedsits and printed in obscure magazines for little or no payment.

This wholesale role-reversal prompts a fascinating question. If the really serious and important jobs, of guaranteed practical value to humanity – social work, for instance, or school teaching – attracted stratospherically high salaries, while investment banking and currency dealing were only averagely remunerated, would Sir Philip and Stephen Hester – the beneficiary of that £7.8m-worth of largesse – suddenly itch to work with disadvantaged children? In other words, do they like doing their jobs for the satisfaction that the work affords, or do they merely want to wallow in the filthy lucre that comes with them?

Clearly, this question in unanswerable. But there is a second, associated, puzzle that the disinterested observer may be able to solve. Why does Mr Hester think that he needs to be paid £7.8m a year, other than as a rather bizarre testimony to his caste and status? What is the point of having wealth beyond utility? The explanation, alas, is that Mr Hester, and perhaps Sir Philip, altogether lack what used in bygone eras to be an absolutely vital part of the nation's moral repertoire – a puritan conscience. This may be defined as having the sort of mind that impels its owner, if taken to an expensive restaurant, automatically to order the cheapest thing on the menu.

Naturally, the puritan conscience has much to be said against it. After all, it brought us Shakespeare's Malvolio, Mrs Whitehouse and the Lady Chatterley trial (and also, ironically enough, D H Lawrence himself). On the other hand, its absence means more people like Sir Philip Hampton, who not only wants to offer his chief executive £7.8m a year, but can't imagine why there should be such an almighty stink when the public finds out.

Cheating isn’t cheating if you don’t think it is

Luis Suárez's handball: Cheating isn’t cheating if you don’t think it is

Football is only a reflection of that society - and that doesn't say much about us

Mark Steel in The Independent

Luis Suárez should be given a job in the Cabinet. He’s the footballer who’s been called a cheat, after he handled the ball just before scoring a goal for Liverpool in the FA Cup, and experts are undecided as to how he should be dealt with. And you can see the difficulty, because with such a brazen attitude towards cheating, he ought to be running one of our major institutions.

Suárez appears to have grasped how society’s rules have changed. Under the old system, if you cheated you hoped you weren’t caught. Now you don’t mind getting caught, you just announce that cheating isn’t really breaking any rules, and carry on. Football is only a reflection of that society.

So in his next match, Suárez could place the ball in a Sherman tank and drive it through the goal, flanked by marines who assassinate the opposing goalkeeper. His manager would say, “I can’t comment as I didn’t see the incident, but his first touch was astounding”. Match of the Day would debate whether the commandos were interfering with play. And after he’d scored 60 goals this way, the Football Association would set up an inquiry, in which Suárez would say he couldn’t recall ever playing football in his life. The inquiry would propose a limit on the number of tanks in each half but this wouldn’t be implemented as Suárez would be outraged at the restrictions on his freedom.

Or he could learn from the Deputy Prime Minister, by pledging to abolish handball at all times in every way, including by the goalkeeper, with fines for anyone who even carries the ball to the ground. And then spend the next match throwing balls in the goal, before announcing: “I’m really, really sorry to have made such a foolish promise. I’m sure you’ll understand that from now on I’m going to do this in every match.”

Maybe the first part of each footballer’s training now is to study the banks. The coach says: “This lot were caught bringing the whole economic system down, but did they bother looking sheepish? No, they insisted on an extra bonus as it would be even harder clearing up the mess than it was causing it. If they can do that after causing a global recession, you can do it after diving in the box.”

As the attitude towards cheating is so similar in different fields, football pundits should be regular guests on the news. So Alan Shearer could say: “You can see from this angle, the police have definitely falsified 116 documents, but the ref hasn’t blown the whistle so they’ve got away with it.”

Some commentators suggested that Suárez should have owned up to his foul, but with the modern rules, even if he’d announced on the Tannoy, “I punched that ball in the goal ha ha ha”, the referee would have let it stand, but suggested at some point in the future someone should set up a self-regulating body made up of prominent figures from the handballing community.

Unlimited Liability for Speculative Bankers

Bankers must be made to bear the cost of their reckless risk-taking

Separating retail and investment banking is not enough. Speculative banking needs to have unlimited liability

• 
• • Prem Sikka
  • guardian.co.uk, Sunday 4 November 2012 13.10 GMT

Lehman Brothers employees leaving the Canary Wharf building in London, carrying their possessions in boxes, aftert the bank collapsed in 2008. Photograph: Graeme Robertson

 

Hot on the heels of the Libor scandal and money-laundering at HSBC and Standard Chartered Bank comes the allegation that Barclays Bank attempted to manipulate the US energy markets to make profits. Of course, Barclays has no direct interest in buying or selling oil, gas or electricity. Its aim is to make profits by betting on the price changes, a process that often drives up the price of the underlying commodity and forces ordinary people to pay sky-high prices.

This speculative activity is facilitated by complex financial instruments known as derivatives, described by investment guru Warren Buffett as "financial weapons of mass destruction". Behind the technical jargon lies a giant gambling machine, which bets on anything that can be priced. The hard cash needed to settle the outcome of the bets is always highly uncertain until the contracts mature, which could be 10 to 15 years in the future. And, like other bets, derivatives don't always pay off – as the cases of Nick Leeson at Barings and more recently Jérôme Kerviel at Société Générale exemplify.
The UK government claims that speculation will be curbed by a separation of investment banking from the retail side. This, it is claimed, will protect savers and taxpayers from the toxic effects of risky positions adopted by bankers. This policy will not work. Even after separation, investment banks will continue to use funds from retail banks, pension funds and insurance companies for their speculative activities. The speculators will continue to shelter behind limited liability and dump losses on to innocent bystanders. Unless the benefit of limited liability is removed from investment banks, their losses and reckless risks will inevitably be transferred to other sectors. The separation between retail and speculative operations needs to be accompanied by unlimited liability for investment banking, ensuring that those who take excessive risks are 100% liable for their mistakes.

Derivatives are central to the current economic crisis. In 2008, Lehman Brothers collapsed with 1.2 million derivatives contracts, which had a face value of nearly $39 trillion, though the economic exposure was considerably less. For nearly six years before its demise, almost all of the pre-tax profits at Bear Stearns came from speculative activities. It could not continue to pick winners indefinitely, and collapsed in 2008. It had shareholder funds of $11.8bn, debts of $384bn and a derivatives portfolio with a face value of $13.4 trillion. The derivatives gambles also brought down American International Group (AIG) – the world's largest insurer – and Washington Mutual. Then in October 2011, MF Global, a US brokerage firm that specialised in delivering trading and hedging solutions, filed for bankruptcy. It had nearly 3 million derivatives contracts with a notional value of more than $100bn.

Despite these high-profile casualties, risk-hungry investment bankers remain undeterred. The face value of the global derivatives trade is about $1,200 trillion (£749 trillion). With a global GDP of $65-70 trillion, the world economy is not in a position to absorb even 0.1% ($1.2 trillion) of losses.
The UK's GDP is about £1.5 trillion. Just three UK banks – Barclays, HSBC and Royal Bank of Scotland (RBS) – alone have a derivatives portfolio, with a face value totalling nearly £100 trillion. Barclays leads the way with £43 trillion. It has recently reported a third-quarter loss of £47 million, but its balance sheet points to a more serious position. Barclays' last full-year accounts show assets of £1.56 trillion and capital of only £65bn, meaning that its gross leverage is nearly 24 times its capital base. A decline of just 4% in asset values would wipe out its entire capital. Barclays' balance sheet shows gross exposure to derivatives of £539bn, though the bank could argue that this is offset by hedges of £528bn, leaving a net exposure of £11bn. The difficulty is that the hedges, as Lehman Brothers, Bear Stearns and Northern Rock have learnt, do not necessarily work in the desired way and always depend on the position of the counter parties in a highly unpredictable environment.

Merely separating retail and investment banking will neither choke off nor contain the effects of toxic gambles, because speculative activities will affect other sectors of the economy. For any possibility of containing the crisis, speculative banking needs to have unlimited liability. Thus, if the bets go bad, bankers will personally need to bear the negative consequences. One of the tasks of the banking regulator should be to ensure that the size of the bets bears a reasonable relationship to the assets of the gamblers, so that cavalier bankers are not able to gamble more than they can lose. No retail bank, pension fund, insurance company or pension fund should be able to provide money to any investment bank without specific approval from its stakeholders.

The above reforms will help to reduce speculative activity and quarantine the negative effects of reckless gambling. They will also remind neoliberals that the freedom to speculate needs to be accompanied by responsibilities.

£1m buys foreign investors right to live in Britain

Foreign millionaires are flocking to use a little-known immigration scheme that allows wealthy individuals to jump to the top of the queue for permanent residency.

The most recent figures from the Home Office show that more than 400 people applied to use the investor visa scheme in the 12 months to the end of June. This compares with a total of 331 people in 2011 and fewer than 200 in 2009. Photo: PA

By Harry Wilson

9:30PM BST 06 Oct 2012

Rich Russians and Chinese are increasingly using "investor visas" that allow wealthy foreigners to effectively buy the right to live in the UK in return for buying at least £1m of gilts or shares and bonds in British companies.

Top London private bankers have expressed concerns at the number of people using the scheme to gain permanent resident status, arguing that the authorities should consider raising the amount of money needed to gain residency.

"The £1m threshold was put in place more than 20 years ago and is not the obstacle it once was. We have seen a huge increase in demand from Russians, Chinese and people from the Middle East wanting to move to London and it is clear that given the unlimited demand the time may have come to charge more for entry," said on senior London banker.

The most recent figures from the Home Office show that more than 400 people applied to use the investor visa scheme in the 12 months to the end of June. This compares with a total of 331 people in 2011 and fewer than 200 in 2009.

Mark Pihlens, chief executive of Invest UK, which advises wealthy foreigners on investing in Britain, said political instability in the Middle East as well as China and Russia had driven the spike. "People want to take out a second option on where they and their children can live," he said. 2012

Wealthy foreign nationals can speed up the process by investing greater amounts. Investments of more than £5m and £10m mean permanent residency could be gained within as little as two years.

Banking keeps getting away with it, just as the unions did

Heads will probably roll for the Libor scandal, but this crisis won't end until the profession's link with politicians is severed

• 
• • Simon Jenkins
  • guardian.co.uk, Thursday 28 June 2012 20.30 BST

Banking first refused regulation and now welcomes it, because only thus can it be protected from the consequences of its own greed. Illustration: Simon Pemberton

 

Too big to fail … now too big to jail? There seems no end to the immunity – moral, political, fiscal and possibly legal – claimed by the present masters of the universe, the bankers. In a side-splitting, coffee-spluttering radio interview today, Sir Martin Taylor, the former chief executive of Barclays, mused that his old board might consider the best person to "turn the page" on the bank's latest scandal might be none other than its author and present chief executive, Bob Diamond. That is presumably despite the bank being fined £290m and pending possible charges of fraud.

Diamond has "taken responsibility" for the division that from 2005 onwards manipulated inter-bank loans so as to disguise the bank's vulnerability in the runup to the 2008 credit crunch. The clear intention was to mislead the market and enrich bank staff with bonuses. Responsibility apparently means Diamond "giving up" a bonus which, surely, he has yet to earn.

A year ago the Barclays chief dazzled the BBC into letting him give a lecture on banking and citizenship, a lecture now sodden with irony. He spoke of the importance of an organisation's culture, of "how people behave when no one is watching", and how "our culture must be one where the interests of customers and clients are at the very heart of every decision we make". Bankers must be good citizens, said Diamond,, or there would be social unrest.

At the time Diamond was demanding his own shareholders pay him not just a salary, but the tax on that salary and then the tax on that taxable benefit. It is not clear who paid the tax in this spiral of greed. Diamond must also have known his colleagues were then being investigated by the Financial Services Authority for irregularities in the bank's trading. Diamond's entire reputation was built on his banking culture, one of bonus-hunting, offshore tax avoidance and killer-takes-all rivalry. For him to give a lecture on ethics invited cliches about Jack the Ripper and door-to-door salesmanship.
The Barclays affair should be a sideshow to our present discontents. The world currently faces the greatest collapse in western statecraft since the second world war. Economists, officials, politicians, even commentators, seem gripped by professional and intellectual rigor mortis, one horribly reminiscent of the 1930s. All experience tells them that a collapse in global demand needs monetary injection, not contraction. Yet they deny it, and bankers lie about it. In Britain we all parrot that £325bn has been "pumped into the economy" by the Bank of England. It has not. The money is nowhere to be seen. It is a device, a headline, a sick joke.

At such times it is comforting to turn from the murky failures of the present to the clear ones of the past. The snoozing Commons Treasury committee is yet again "to call Mr Diamond the account", so it can show off its interrogatory machismo. Lord Myners, formerly of the Guardian, won himself plaudits today by calling Barclays "the most corrosive failure of moral behaviour that I have seen in a major financial institution". But he was a worldly banker himself, and City minister in 2008-9, when the whole house of cards was collapsing amid media reports of "something fishy" in the Libor market. Labour was putty in the hands of the bankers.

From the credit crisis to the present day, the one profession with open access to Downing Street is banking. It lobbies successfully on everything from bailouts to bonuses, non-doms to Tobin taxes, euro regulation to "quantitative easing". When told to lend to small businesses, it refuses. When given money to do so, it buries the money. When ministers plead for lower salaries, it increases them. The government takes over a bank, RBS, and its computers crash. Bankers get ribbed in the press – but so what, when the bonus is in the safe and few are ever called to account, banned from trading, or sent to jail?

Banking gets away with all this because it enjoys the same unaccounted access to power that trade unions enjoyed in the bad old days. It first refused regulation and now welcomes it, because only thus can it be protected from the consequences of its own greed. It preaches the nobility of the markets and then rigs them. We should listen every day to Adam Smith's maxim, that "people of the same trade seldom meet together … but the conversation ends in a conspiracy against the public or in some contrivance to raise prices".

Most running controversies today reflect deep confusion in corporate ethics and accountability. Barclays traders, News of the World reporters, immigration office officials, even drone bombers, turn instinctively to the excuse that they were "just obeying orders". Thus is moral responsibility dispersed and blame passed upwards to the boss, the board, the regulator, the government, ultimately democracy. The great let-out is that "we are all to blame". As the philosopher Reinhold Niebuhr remarked, moral individuals can still constitute an immoral society. Guilt is diffused in a crowd.
Failure of regulation has become a catch-all to sanitise personal and corporate misbehaviour in large organisations. This merely means that, when an outrage has been detected, and a feeding frenzy begins there are howls for heads to roll. Certainly at Barclays public decency, if nothing else, demands some sacrifice. But the real fault lies in bigness, in the ease with which corporations can fall victim to ethical compromise and pretend it is not their fault but the regulator's.

There must surely be a reckoning one day for the loss and agony that the credit crunch has inflicted – and is still inflicting – on millions of innocent victims. But as we seek out the guilty men, we should know that as long as banking retains its stranglehold on policy, the disaster will continue.

Why do bankers get to decide who pays for the mess Europe is in?

There were summits about how much misery would be imposed on the Greeks – and no trade unions got a say

• 
• • Aditya Chakrabortty
  • guardian.co.uk, Monday 2 April 2012 20.00 BST

What you're about to read does, I admit, sound like a conspiracy theory. It involves powerful people meeting in private offices, hundreds of billions of euros, and clandestine deals determining the fates of entire countries. All that's missing is a grassy knoll or a wandering band of illuminati. There are, however, two crucial differences: these events are still unfolding – and they're more worrying than any who-killed-JFK fantasy I've ever heard.

Cast your mind back to the euro crisis talks last year, when the future of Greece was being decided. How much Athens should pay its bailiffs in the banks, on what terms, and the hardship that ordinary Greeks would have to endure as a result.

There were times when the whole of 2011 seemed to be one long European summit, when you heard more about Papandreou and Merkozy than was strictly necessary. Yet you probably didn't catch many references to Charles Dallara and Josef Ackermann.

They're two of the most senior bankers in the world – among the top 1% of the 1%. Dallara served in the Treasury under Ronald Reagan, before moving on to Wall Street, while Ackermann is chief executive of Deutsche Bank. But their role in the euro negotiations, and so in deciding Greece's future, was as representatives of the International Institute for Finance.

The IIF is a lobby group for 450 of the biggest banks in the world, with members including Barclays, RBS and Lloyds. Dallara and Ackermann and their colleagues were present throughout those euro summits, and enjoyed rare and astounding access to European heads of state and other policy-makers. EU and IMF officials consulted the bankers on how much Greece should pay, Europe's commissioner for economic affairs Olli Rehn shared conference calls with them.

You can piece all this together by poring over media reports of the euro summits, although be warned: you'll need a very high tolerance threshold for European TV, and financial newswires. But Dallara and co are also quite happy to toot their own trumpets. After a deal was struck last July, the IIF put out a note bragging about its "catalytic" role and claiming its offer "forms an integral part of a comprehensive package".

By now you'll have guessed the punchline: that July agreement was terrible for the Greeks, and brilliant for the bankers. It was widely panned at the time, for slicing only 21% off the value of Greece's loans, when Angela Merkel and many others agreed that financiers ought to be taking a much bigger hit. As the German government's economic adviser, Wolfgang Franz, later remarked in an interview: "If you look at the 21% and our demand for a 50% participation of private creditors, the financial sector has been very successful." Another way of putting it would be to say that the bankers overpowered even the strongest state in Europe.

None of this was inevitable. Iceland had made it clear that simply defaulting on one's loans didn't immediately lead to economic apocalypse. Across Greece, there were massive, repeated protests about the enormous spending cuts that citizens would suffer by paying off Goldman Sachs and the rest. And there was a growing movement in Greece and Portugal and France, among other countries, questioning the legitimacy of some of these loans.

None of these voters, none of these opinions got even a fraction of the consideration, let alone the face time, that was extended to Dallara and Ackermann. At Corporate Europe Observatory in Brussels, Yiorgos Vassalos has been tracking the negotiations over Greece: by his reckoning only the IIF got to have such personal, close-up access. These were summits settling how much misery would be imposed on the Greek people – and no trade unions or civil society groups got a say in them. "The only key players in those meetings were European governments and the bankers," says Vassalos.
Mindful of appearances, the EU has been less eager to admit to the influence of the bankers' lobby. When European officials were first asked by Corporate Europe Observatory about the extent of IIF access, they responded that it was limited to the Greek government. Only when it was pointed out that the Wall Street Journal and Bloomberg were reporting that Dallara met Merkel and Nicolas Sarkozy at midnight at an October summit to finalise a bigger reduction of the value of Greek debt did the officials back down: the IIF, they agreed, had been negotiating with a range of governments, on a whole host of issues to do with Greece's future.

So the bankers whose excesses helped land Europe in this mess then get to sit round the big EU table, like any other government, and decide who should pay for it. And the answer, unsurprisingly, is: not them. The bigger question is: why finance has been granted such power? In a forthcoming paper entitled Deep Stall, the Centre for Research on Socio-Cultural Change gives one compelling reason: because so many countries across Europe are, through both their public and private sectors, so dependent on financiers in other countries for credit. That includes Britain, which relies on 10 eurozone countries for loans worth over 70% of its annual national income – a higher proportion even than Italy. The tale of the IIF and how it got such a powerful say on the fate of ordinary Greeks is really a chapter in a much bigger story of how governments across the western world got swallowed up by their finance industries.

Immigration Song

Immigration Song

by Giffenman

Its immigration say the Tories
The cause of all our worries
So lets shut the door
Keep the peril from our shore
And the BNP can make our curries

The fault may lie with the bankers
Managers, footballers and rich wankers
Yet its the always the brownman
yellowman and other bogeyman
Who will be showered with hard conkers

So lets shut the door
Keep the peril from our shore
And the BNP can make our curries

Why does the UK government struggle to reach its net migration target?

Figures show net migration is at a record high. To understand why, we must break it down into its main components

• 
• • Matt Cavanagh
  • guardian.co.uk, Friday 24 February 2012 17.30 GMT
  • larger | smaller
  • Article history

Statistics out this week show that 250,000 more people came to the UK than left in the 12 months to June 2011. Photograph: Clara Molden/PA

"Net migration" – total immigration, including both foreign and returning British nationals, who are intending to come for a year or more, minus total emigration – is the metric which ministers have chosen for their overall target.
They have pledged to cut it "from hundreds of thousands to tens of thousands" by 2015. But the latest statistics out this week show net migration remaining at a record high: in the 12 months to last June, 250,000 more people came to the UK than left. In other words, in its first 15 months, the government made no progress towards its target.
Why is cutting net migration so difficult? To answer this question, we need to break it down into its main components.

Emigration

This may seem like a surprising place to start, but – contrary to the narrative of anti-immigration campaigners, and Conservative ministers – it is emigration not immigration that has driven recent changes in net migration, with immigration remaining stable since 2004. One of the government's problems is that emigration remains low by recent standards.
This week's figures show a small rise in emigration of UK nationals, up 12% to 143,000, but this is offset by a fall in emigration of foreign nationals. Fewer people seem to want to leave the UK for work-related reasons during a time of global economic downturn, and retirement and "lifestyle" emigration by British nationals – highly dependent on UK house prices and pensions – remains lower than before the financial crisis.
The government plans to make it harder for working migrants to stay longer than five years, and for overseas students to stay on and work after graduation: these changes should mean that in future years, more foreign nationals will start returning home, but are unlikely to make enough of a difference to help the government hit its target.

Work migration and the immigration 'cap'

Despite the rhetoric, the only kind of immigration which is actually "capped" is one sub-category of working migrants, those from outside the EU, and excluding those on "intra-company transfers", and certain other exceptions. This covers 20,000 out of total immigration of just under 600,000 – around 3%.

Students

Overseas students are the largest category of migrants coming for a year or more, around 240,000. The government intends to reduce this number, and believes its policies are already starting to have an effect: the number of student visas fell by 4% in 2011. But it will be challenging to reduce the numbers enough to help meet the overall target.
The Department for Business, Innovation and Skills has lobbied internally against more severe restrictions on student visas, concerned about the impact on higher education finances (given the cuts in central government funding) and about the UK's position in this lucrative global market, one of the few areas of potential growth and export revenue over the coming years.

Family

Immigration on the "family route" has been falling over recent years, but ministers need it to fall faster if they are to hit their target. They are planning to introduce a minimum income requirement, which could disqualify around half of the roughly 50,000 who currently come to the UK on this route. But if this goes ahead, it is highly likely that this policy will be challenged in the courts.

European Union migration

The slight fall in the number of work visas granted to foreign nationals from outside the EU (down 7%) appears to be more than offset by an increase in the number of eastern Europeans coming to the UK to work, with eastern Europe continuing to contribute around 50,000 to the overall net migration figure.
The government cannot control migration to and from the EU, and trends here are hard to predict, but if the performance and prospects of the UK economy decline relative to those EU countries which are crucial to migration, such as Poland, this could reduce net migration, as fewer Poles arrive and more return home; however, there could still be more immigration from other struggling economies like Greece.
Overall, the government finds itself in the perverse position that its best chance of hitting its net migration target is if the UK experiences a prolonged economic downturn. If instead, as we all hope, we start returning to growth late this year or early next, ministers will face a more difficult set of choices. The risk is that the net migration target will force them to attempt more drastic reductions in work and especially student migration, simply because those are the easiest categories to control, and despite the fact that they are also the most economically beneficial categories, and the kind of immigration which surveys suggest the public are least bothered about.

The mathematical equation that caused the banks to crash

 Ian Stewart in The Observer 21-02-12

It was the holy grail of investors. The Black-Scholes equation, brainchild of economists Fischer Black and Myron Scholes, provided a rational way to price a financial contract when it still had time to run. It was like buying or selling a bet on a horse, halfway through the race. It opened up a new world of ever more complex investments, blossoming into a gigantic global industry. But when the sub-prime mortgage market turned sour, the darling of the financial markets became the Black Hole equation, sucking money out of the universe in an unending stream.

Anyone who has followed the crisis will understand that the real economy of businesses and commodities is being upstaged by complicated financial instruments known as derivatives. These are not money or goods. They are investments in investments, bets about bets. Derivatives created a booming global economy, but they also led to turbulent markets, the credit crunch, the near collapse of the banking system and the economic slump. And it was the Black-Scholes equation that opened up the world of derivatives.

The equation itself wasn't the real problem. It was useful, it was precise, and its limitations were clearly stated. It provided an industry-standard method to assess the likely value of a financial derivative. So derivatives could be traded before they matured. The formula was fine if you used it sensibly and abandoned it when market conditions weren't appropriate. The trouble was its potential for abuse. It allowed derivatives to become commodities that could be traded in their own right. The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended.

Black-Scholes underpinned massive economic growth. By 2007, the international financial system was trading derivatives valued at one quadrillion dollars per year. This is 10 times the total worth, adjusted for inflation, of all products made by the world's manufacturing industries over the last century. The downside was the invention of ever-more complex financial instruments whose value and risk were increasingly opaque. So companies hired mathematically talented analysts to develop similar formulas, telling them how much those new instruments were worth and how risky they were. Then, disastrously, they forgot to ask how reliable the answers would be if market conditions changed.

Black and Scholes invented their equation in 1973; Robert Merton supplied extra justification soon after. It applies to the simplest and oldest derivatives: options. There are two main kinds. A put option gives its buyer the right to sell a commodity at a specified time for an agreed price. A call option is similar, but it confers the right to buy instead of sell. The equation provides a systematic way to calculate the value of an option before it matures. Then the option can be sold at any time. The equation was so effective that it won Merton and Scholes the 1997 Nobel prize in economics. (Black had died by then, so he was ineligible.)

If everyone knows the correct value of a derivative and they all agree, how can anyone make money? The formula requires the user to estimate several numerical quantities. But the main way to make money on derivatives is to win your bet – to buy a derivative that can later be sold at a higher price, or matures with a higher value than predicted. The winners get their profit from the losers. In any given year, between 75% and 90% of all options traders lose money. The world's banks lost hundreds of billions when the sub-prime mortgage bubble burst. In the ensuing panic, taxpayers were forced to pick up the bill, but that was politics, not mathematical economics.

The Black-Scholes equation relates the recommended price of the option to four other quantities. Three can be measured directly: time, the price of the asset upon which the option is secured and the risk-free interest rate. This is the theoretical interest that could be earned by an investment with zero risk, such as government bonds. The fourth quantity is the volatility of the asset. This is a measure of how erratically its market value changes. The equation assumes that the asset's volatility remains the same for the lifetime of the option, which need not be correct. Volatility can be estimated by statistical analysis of price movements but it can't be measured in a precise, foolproof way, and estimates may not match reality.

The idea behind many financial models goes back to Louis Bachelier in 1900, who suggested that fluctuations of the stock market can be modelled by a random process known as Brownian motion. At each instant, the price of a stock either increases or decreases, and the model assumes fixed probabilities for these events. They may be equally likely, or one may be more probable than the other. It's like someone standing on a street and repeatedly tossing a coin to decide whether to move a small step forwards or backwards, so they zigzag back and forth erratically. Their position corresponds to the price of the stock, moving up or down at random. The most important statistical features of Brownian motion are its mean and its standard deviation. The mean is the short-term average price, which typically drifts in a specific direction, up or down depending on where the market thinks the stock is going. The standard deviation can be thought of as the average amount by which the price differs from the mean, calculated using a standard statistical formula. For stock prices this is called volatility, and it measures how erratically the price fluctuates. On a graph of price against time, volatility corresponds to how jagged the zigzag movements look.

Black-Scholes implements Bachelier's vision. It does not give the value of the option (the price at which it should be sold or bought) directly. It is what mathematicians call a partial differential equation, expressing the rate of change of the price in terms of the rates at which various other quantities are changing. Fortunately, the equation can be solved to provide a specific formula for the value of a put option, with a similar formula for call options.

The early success of Black-Scholes encouraged the financial sector to develop a host of related equations aimed at different financial instruments. Conventional banks could use these equations to justify loans and trades and assess the likely profits, always keeping an eye open for potential trouble. But less conventional businesses weren't so cautious. Soon, the banks followed them into increasingly speculative ventures.

Any mathematical model of reality relies on simplifications and assumptions. The Black-Scholes equation was based on arbitrage pricing theory, in which both drift and volatility are constant. This assumption is common in financial theory, but it is often false for real markets. The equation also assumes that there are no transaction costs, no limits on short-selling and that money can always be lent and borrowed at a known, fixed, risk-free interest rate. Again, reality is often very different.
When these assumptions are valid, risk is usually low, because large stock market fluctuations should be extremely rare. But on 19 October 1987, Black Monday, the world's stock markets lost more than 20% of their value within a few hours. An event this extreme is virtually impossible under the model's assumptions. In his bestseller The Black Swan, Nassim Nicholas Taleb, an expert in mathematical finance, calls extreme events of this kind black swans. In ancient times, all known swans were white and "black swan" was widely used in the same way we now refer to a flying pig. But in 1697, the Dutch explorer Willem de Vlamingh found masses of black swans on what became known as the Swan River in Australia. So the phrase now refers to an assumption that appears to be grounded in fact, but might at any moment turn out to be wildly mistaken.

Large fluctuations in the stock market are far more common than Brownian motion predicts. The reason is unrealistic assumptions – ignoring potential black swans. But usually the model performed very well, so as time passed and confidence grew, many bankers and traders forgot the model had limitations. They used the equation as a kind of talisman, a bit of mathematical magic to protect them against criticism if anything went wrong.

Banks, hedge funds, and other speculators were soon trading complicated derivatives such as credit default swaps – likened to insuring your neighbour's house against fire – in eye-watering quantities. They were priced and considered to be assets in their own right. That meant they could be used as security for other purchases. As everything got more complicated, the models used to assess value and risk deviated ever further from reality. Somewhere underneath it all was real property, and the markets assumed that property values would keep rising for ever, making these investments risk-free.
The Black-Scholes equation has its roots in mathematical physics, where quantities are infinitely divisible, time flows continuously and variables change smoothly. Such models may not be appropriate to the world of finance. Traditional mathematical economics doesn't always match reality, either, and when it fails, it fails badly. Physicists, mathematicians and economists are therefore looking for better models.

At the forefront of these efforts is complexity science, a new branch of mathematics that models the market as a collection of individuals interacting according to specified rules. These models reveal the damaging effects of the herd instinct: market traders copy other market traders. Virtually every financial crisis in the last century has been pushed over the edge by the herd instinct. It makes everything go belly-up at the same time. If engineers took that attitude, and one bridge in the world fell down, so would all the others.

By studying ecological systems, it can be shown that instability is common in economic models, mainly because of the poor design of the financial system. The facility to transfer billions at the click of a mouse may allow ever-quicker profits, but it also makes shocks propagate faster.

Was an equation to blame for the financial crash, then? Yes and no. Black-Scholes may have contributed to the crash, but only because it was abused. In any case, the equation was just one ingredient in a rich stew of financial irresponsibility, political ineptitude, perverse incentives and lax regulation.

Despite its supposed expertise, the financial sector performs no better than random guesswork. The stock market has spent 20 years going nowhere. The system is too complex to be run on error-strewn hunches and gut feelings, but current mathematical models don't represent reality adequately. The entire system is poorly understood and dangerously unstable. The world economy desperately needs a radical overhaul and that requires more mathematics, not less. It may be rocket science, but magic it's not.
Ian Stewart is emeritus professor of mathematics at the University of Warwick.