Bank of England to directly finance UK government’s extra spending

 Chris Giles and Philip Georgiadis in The FT

The UK has become the first country to embrace the monetary financing of government to fund the immediate cost of fighting coronavirus, with the Bank of England agreeing to a Treasury demand to directly finance the state’s spending needs on a temporary basis.  

The move allows the government to bypass the bond market until the Covid-19 pandemic subsides, financing unexpected costs such as the job retention scheme where bills will fall due at the end of April.  

Although BoE governor Andrew Bailey opposed monetary financing earlier this week, Treasury officials felt it was best to have the insurance of the central bank willing to finance its operations in the short term. 

It highlights the extraordinary demands on cash the government has experienced in recent weeks, which it feels it cannot finance immediately in the gilts market. 

In a statement to financial markets on Thursday, the government announced it would extend the size of the government’s bank account at the central bank, known historically as the “Ways and Means Facility”, which normally stands at just £370m. 

This will rise to an effectively unlimited amount, allowing ministers to spend more in the short term without having to tap the gilts market. In 2008, a similar move saw the facility rise briefly to £20bn. 

The scale is likely to be large. The government has already tripled the amount of debt it wanted to raise in financial markets in April from £15bn announced in the March 11 Budget to £45bn by the start of this month.  

Although the gilts market showed severe stress in the middle of March as the coronavirus crisis deepened, the government has so far had little difficulty raising finance, especially as the BoE had already committed to printing £200bn to pump into the government bond market to ensure there was sufficient demand for gilts and improve market functioning. 

This direct monetary financing of government would be “temporary and short-term”, the Treasury said in its statement. 

“As well as temporarily smoothing government cash flows, the W & M Facility supports market function by minimising the immediate impact of raising additional funding in gilt and sterling money markets,” it added. 

It said any drawings on this facility would be repaid as soon as possible before the end of the year. 

Market reaction was muted. Sterling was trading 0.1 per cent higher against the US dollar at just below $1.24 shortly after the announcement, while the yield on the benchmark 10-year UK gilt was flat at 0.37 per cent.  

But many economists saw the Treasury’s demand to be financed directly as a big step. 

Tony Yates, senior adviser at Fathom Consulting and a former BoE official, said the move was “an indication of the extraordinary pressures on government”. He added, however, that UK monetary financing of government deficits was unlikely to turn Britain into Zimbabwe because, once the crisis was over, the UK’s capacity to raise taxes again remained intact.  

But just as the quantitative easing the BoE has introduced since 2009 has never been repaid, Richard Barwell, head of macro research at BNP Asset Management and also a former BoE official, said temporary moves such as this often became more permanent as time passed. 

“Persistent monetary financing feels inevitable. Central banks just need to figure out a plan for how to best get into it and how they might eventually want to get out of it,” he said. 

The Ways and Means Facility had long been used as a financing means of government for day-to-day spending before the BoE would sell government bonds to the market, but by 2006 it had become an emergency fund with the financing of government undertaken by the Debt Management Office on a scheduled basis. 

Less than a month ago, the BoE said there was little chance there would be any need to use the facility, demonstrating just how much stress government finances have come under in the past few weeks. 

In a call with journalists on March 18, Mr Bailey said the facility was just a “historical feature”.  

“I don’t think at the moment we’re facing an inability of the government to fund itself, so, yes, it’s there, but it’s not a frontline tool,” Mr Bailey said at the time. 

In an opinion column in the Financial Times earlier this week, the BoE governor pledged not to slip into permanent monetary financing of the government. He said the central bank would not engage in permanent monetary financing, but did not rule out temporary operations that he said would not be inflationary. 

“Short-term operations play an important role in stabilising market conditions and counteracting any immediate tightening of monetary conditions,” Mr Bailey wrote.  

Fran Boait, executive director of Positive Money, an advocacy group, said: “This use of direct monetary financing demonstrates once and for all that the government does not depend on the market to finance its spending. Hopefully now we can have an honest debate about how our collective resources should be allocated.” 

Will the coronavirus crisis rehabilitate the banks?

Lenders who triggered financial crash are now being asked to funnel stimulus money to companies and individuals write David Crow, Stephen Morris and Laura Noonan in The FT

On the day that Lehman Brothers filed for bankruptcy in September 2008, the front page of the Financial Times carried a photograph of John Thain, the then chief executive of Merrill Lynch. He was getting into his car after hours of talks at the Federal Reserve Bank of New York, and looked like a man who had stared into the abyss. In the following days more pictures would emerge of bankers leaving crisis meetings with policymakers, their ashen faces a portent of the horror to come. 

As coronavirus rages and brings the global economy to a near standstill, bankers are once again roaming the corridors of power. In early March, Donald Trump summoned the chief executives of Bank of America, Citigroup and other large lenders to the White House, while Rishi Sunak, the UK chancellor, has held meetings and calls with their counterparts in Britain. 

But this time is different, bankers say. Rather than being admonished for their role in causing the 2008 crisis, they are being called on to help distribute unprecedented stimulus programmes worth trillions of dollars designed to save the global economy from collapse. Although governments and central banks are providing much of the cash, lenders are being asked to serve as the “transmission mechanism” to ensure support finds its way to the companies and consumers who need it most. 

Mike Corbat, chief executive of Citigroup, says the US lender is in “daily contact” with the White House and regulators, “relaying information . . . [on] what we’re seeing in the marketplace . . . what’s under stress”. In France, the finance minister and bank governor now speak daily to Frédéric Oudéa, chief executive of Société Générale, a bank that became a pariah in 2008 following a rogue trader scandal. 

“The difference with 2008 is that we were seen as the problem then, everybody today knows the problem is the virus,” Mr Oudéa says. “We are one of the activities that has to function . . . we are the doctors of the economy.” (A dangerous thought - Editor)

 While that description will jar with some, the difference in the tone of the discussions between governments, policymakers and banks has surprised some veterans of the financial crisis. “I don’t want to quote [former Goldman chief executive Lloyd] Blankfein and say we’re doing ‘God’s work’, but at least it feels like we’re on the side of the good this time round,” says one banker who advised the UK government in 2008. 

Whether banks can maintain this new-found trust depends in large part on their ability to withstand coronavirus and its aftershocks. That in turn rests on whether post-financial crisis reforms — some of which the banks are lobbying furiously to relax — have left the system strong enough to survive. Banks appear to have passed the first test: a short but pronounced period of market mayhem and a co-ordinated drawdown of hundreds of billions of dollars of credit by corporations feeling the strain. One policymaker says that, faced with the coronavirus fallout, the global banking system of 2007 would have already imploded by now. 

Jes Staley, chief executive of Barclays, says that “by any measure, the financial markets have traded and demonstrated volatility never seen before,” noting the “significant value destruction happening in pools of assets”. But, so far at least, the system is operating as it should. “It’s pretty extraordinary that with this amount of distress you haven’t seen more failures in asset management companies.” 

He adds that the potential harbingers of a full-blown financial meltdown have not yet happened, such as a mutual fund preventing investors from making withdrawals. “There are just a lot of things you’d expect to happen before you start to see a real crisis,” says Mr Staley. 

The real test of the resilience of banks and the wider financial system is yet to come. Huge swaths of the global economy, from airlines to retailers, have seen their revenues all but evaporate. Many companies and consumers will default on their loans, leading to a string of excruciating credit losses for banks that will hit profitability and blast a hole in their balance sheets. Meanwhile, ultra-low interest rates introduced by central banks to support the economy during the pandemic will put extra pressure on profits generated from lending. 

“Everything in the world is on hold, and this cannot not be reflected in the financial world,” says Romain Boscher, chief investment officer for equities at Fidelity International. “Banks are still too big to fail, but also too crucial to disappear.” 

Standard & Poor’s, the rating agency, last week warned that the US banking industry — which generated $195bn of profits last year — could swing to a $15bn loss in the next 12 months. Analysts at Berenberg say US and European lenders are facing an average 30 per cent plunge in profits this year and next. “Confronted with reduced activity, lower-for-longer interest rates, inflexible costs and higher loan losses, the outlook for bank earnings is one-way traffic,” they wrote in a recent note to clients. 

Despite these headwinds, some bank executives have projected confidence. Ana Botín, executive chairman of Santander, the eurozone’s largest lender, told a financial services conference in March that the bank was forecasting only a 5 per cent drop in earnings this year, and that it expected no impact on its capital levels or midterm financial targets. Appearing via video link from a locked down Madrid, Ms Botin said those estimates were based on a “V-shaped” recession — a sharp shock followed by a rapid recovery, but stressed this was only one possible scenario. 

However, some bankers say that such talk is premature, bordering on wishful thinking.

“If someone can tell me when they think [the virus] is going to be contained globally, and we will get back to a normalised global economy, then I can tell you what the credit cycle will look like,” says an executive at a rival global bank. “But given that no one can predict that, I find it hard to see people going out and being so confident.” 

The depth of credit losses hinges on the amount of risk that countries are willing to share with the banking sector. Governments and central banks have rolled out fiscal and monetary stimulus programmes on a scale not seen since the second world war, ranging from central bank-backed credit facilities to loan guarantees and bailouts for industries including the US aviation sector. One Swiss bank executive says that absent such extraordinary support, banks’ loss-absorbing capital buffers “would have been like a brolly in a hurricane”. 

One banker advising the UK government — which has earmarked £330bn for corporate loan guarantees and a commercial paper financing facility — says the schemes are untested. In particular, he warns that the guarantees will only apply to future lending. “It’s for new money, not for all the loans we’ve already made that are going to go bad.” 

Bank executives have also warned that new accounting rules in Europe — which force lenders to set aside provisions for bad loans at an earlier date — will aggravate the problem by quickly impairing capital buffers and crimping their ability to lend at the very moment companies and consumers need cash. Policymakers are sympathetic, and have taken steps to reduce the shock of the new regulations. On Friday, regulators agreed to soften the impact of similar rules in the US. 

But relaxing the rules will only buy time. “If the world blows up and all this government intervention doesn’t work, then this will eventually get to banks,” says the banker advising the UK government. “It will be an old-fashioned credit loss crisis, but on a scale not seen before.” 

Even if banks can absorb the losses, some of the actions taken by policymakers will hurt the sector in the long run. Although recent interest rate cuts by the US Federal Reserve and the Bank of England are intended as a temporary measure, the 2008 crisis showed that central banks can struggle to increase rates once an immediate economic shock has passed. Meanwhile, a boom in first-quarter trading revenues for investment banks will probably only provide a short-term fillip. 

Standard Chartered’s head of finance Andy Halford warns that “incredibly low interest rates” could cause corporate and retail depositors to move their cash out of accounts that have tended to pay a higher rate of interest in exchange for having the deposit locked up for a specific period of time. “Banks like to have deposit stickiness that can be used to underpin lending,” he says. “[If] there is less inclination to put money into sticky pots, there is less confidently there for circulation into the system.”6

The coronavirus crisis might have given banks an opportunity to repair their public image, but it also brings new reputational risks. As the transmission mechanism for doling out state aid, they will be required to perform a thorny task: deciding which companies should receive financial assistance and which would have struggled to survive regardless of the virus, and should therefore be cut loose. One policymaker says “picking winners and losers” could provoke a long-term public and political backlash against the banks. 

“We want to avoid any moral hazard . . . governments should not just shell out money,” says Lars Machenil, chief financial officer of BNP Paribas, the French bank. “If a company, an airline for example, was in good shape in February then the government guarantees are [there] just to get it through the Covid-19 period.” 

Mr Corbat says banks must walk a “fine line” between “being as supportive as we can be” without “in any way calling into question the soundness” of the bank or the financial system. “The last thing that we all want to see is . . . our consumers, our small businesses and our big businesses coming out of this . . . [with a] precariously bigger or larger position of indebtedness.” 

Although many retail and consumer borrowers have been given payment holidays, some will never be able to repay their loans, which could lead to a wave of bankruptcies and repossessions that will test the public’s patience. 

“This crisis did not originate in banking, but they can be part of the solution, and it might engulf them if, instead, they turn away,” says Paul Tucker, chair of the Systemic Risk Council, a group of former regulators, and previously deputy governor of the Bank of England. “They must not gouge customers, and need to suspend dividends and high-end bonuses. It is not a moment to put themselves first.” 

Peter Orszag, an executive at Lazard who was White House budget director in 2009-10 in the first Obama administration, warns that the new-found trust between banks and policymakers could come under strain. 

“I don’t want to call this the honeymoon period, because what’s going on is so awful, but there is a bit of coming together and recognising goodwill,” he says. However as banks are forced to decide which consumers and companies receive support, political and public opinion could change. “What happens is that six months in the dynamic can start to shift — the backlash doesn’t start immediately.”6

Like other businesses, banks are also facing huge logistical obstacles, with their scattered staff either working from home or off sick. A lockdown in India, where many lenders have chosen to locate call centres, is making it harder to deal with a deluge of incoming customer inquiries. Some banks have had to put restructuring efforts on hold, like HSBC, which last week said it would pause the vast majority of redundancies barely two months after it announced plans to slash 35,000 jobs. The cost of running a bank, already stubbornly high, is only going to rise. 

Above all else, the survival of banks and the global financial system depends on whether governments can contain the public health crisis. 

Brian Moynihan, chief executive of Bank of America, says the $2tn stimulus agreed last week by US lawmakers was of “a substantial size and dimension that most of us think is big enough to help do the trick”. 

But he acknowledges the wider challenge: “What they’re doing on fiscal and monetary [policy] . . . is terrific, but the real thing that they have got to solve is the healthcare crisis.”

Now the world faces two pandemics – one medical, one financial

Coronavirus fears are feeding financial and economic anxiety and vice versa. Breaking the cycle will not be easy, but it is possible writes Robert Shiller in The Guardian  

 

The normally busy Schiphol airport in the Netherlands. Photograph: Patrick van Katwijk/Getty Images


We are feeling the anxiety effects of not one pandemic but two. First, there is the Covid-19 pandemic, which makes us anxious because we, or people we love, anywhere in the world, could soon become gravely ill and even die. And, second, there is a pandemic of anxiety about the economic consequences of the first.

These two pandemics are interrelated but are not the same phenomenon. In the second pandemic, stories of fear have gone viral and we often think of them constantly. The stock market has been dropping like a rock, apparently in response to stories of Covid-19 depleting our lifetime savings unless we take some action. But, unlike Covid-19, the source of our anxiety is that we are unsure what action to take.

It is not good news when two pandemics are at work simultaneously. One can feed the other. Business closures, soaring unemployment, and loss of income fuel financial anxiety, which may, in turn, deter people, desperate for work, from taking adequate precautions against the spread of the disease.

Moreover, it is not good news when two contagions are, indeed, global pandemics. When a drop in demand is confined to one country, the loss is partially spread abroad, while demand for the country’s exports is not diminished much. But this time, that natural safety valve will not work, because the recession threatens nearly all countries.

Many people seem to assume that the financial anxiety is nothing more than a direct byproduct of the Covid-19 crisis – a perfectly logical reaction to the disease pandemic. But anxiety is not perfectly logical. The pandemic of financial anxiety, spreading through panicked reaction to price drops and changing narratives, has a life of its own.

The effects financial anxiety has on the stock market may be mediated by a phenomenon that the psychologist Paul Slovic of the University of Oregon and his colleagues call the “affect heuristic.” When people are emotionally upset because of a tragic event, they react with fear even in circumstances where there is no reason to fear.

In a joint paper with William Goetzmann and Dasol Kim, we found that nearby earthquakes affect people’s judgment of the probability of a 1929- or 1987-size stock market crash. If there was a substantial quake within 30 miles (48km) during the previous 30 days, respondents’ assessment of the probability of a crash was significantly higher. That is the affect heuristic at work.

It might make more sense to expect a stock market drop from a disease pandemic than from a recent earthquake, but maybe not a crash of the magnitude seen recently. If it were widely believed that a treatment could limit the intensity of the Covid-19 pandemic to a matter of months, or even that it would last a year or two, that would suggest the stock market risk is not so great for a long-term investor. One could buy, hold, and wait it out.

But a contagion of financial anxiety works differently than a contagion of disease. It is fuelled in part by people noticing others’ lack of confidence, reflected in price declines, and others’ emotional reaction to the declines. A negative bubble in the stock market occurs when people see prices falling, and, trying to discover why, start amplifying stories that explain the decline. Then, prices fall on subsequent days, and again and again.

Observing successive decreases in stock prices creates a powerful feeling of regret for those who have not sold, together with a fear that one might sell at the bottom. This regret and fear prime people’s interest in both pandemic narratives. Where the market goes from there depends on their nature and evolution.

To see this, consider that the stock market in the US did not crater when, in September-October 1918, the news media first started covering the Spanish flu pandemic that eventually claimed 675,000 US lives (and over 50 million worldwide). Instead, monthly prices in the US market were on an uptrend from September 1918 to July 1919.

Why didn’t the market crash? One likely explanation is that world war one, which was approaching its end after the last major battle, the second battle of the Marne, in July-August 1918, crowded out the influenza story, especially after the armistice in November of that year. The war story was likely more contagious than the flu story.

Another reason is that epidemiology was only in its infancy then. Outbreaks were not as forecastable, and the public did not fully believe experts’ advice, with people’s adherence to social-distancing measures “sloppy”. Moreover, it was generally believed that economic crises were banking crises, and there was no banking crisis in the US, where the Federal Reserve System, established just a few years earlier, in 1913, was widely heralded as eliminating that risk.

But perhaps the most important reason the financial narrative was muted during the 1918 influenza epidemic is that far fewer people owned stocks a century ago, and saving for retirement was not the concern it is today, in part because people didn’t live as long and more routinely depended on family if they did.

This time, of course, is different. We see buyers’ panics at local grocery stores, in contrast to 1918, when wartime shortages were regular occurrences. With the Great Recession just behind us, we certainly are well aware of the possibility of major drops in asset prices. Instead of a tragic world war, this time the US is preoccupied with its own political polarisation, and there are many angry narratives about the federal government’s mishandling of the crisis.

Predicting the stock market at a time like this is hard. To do so well, we would have to predict the direct effects on the economy of the Covid-19 pandemic, as well as all the real and psychological effects of the pandemic of financial anxiety. The two are different but inseparable.

Wartime finance fit for wartime economic conditions. Sunak as British Prime Minister?

Rishi Sunak’s coronavirus rescue package is crucial for a collapsing economy. Social partnership is back writes Will Hutton in The Guardian  

 

Food queues at Covent Garden market in London during the Second World War. Photograph: Trinity Mirror/Mirrorpix/Alamy Stock Photo


Last week, the British economic and financial system came very close to breakdown. An extraordinary number of companies were, and are, in acute financial distress, threatening mass lay-offs and the cessation of swathes of economic activity. There was an almost complete collapse in investor confidence, with attempts to sell every financial asset – even high-quality government bonds – in a desperate quest to hold cash. Such was the loss of generalised faith in the integrity of the system that the governor of the Bank of England, Andrew Bailey, came close to shutting the financial markets.

The scale of the incredible drama – much more acute than the financial crisis of September 2008 and still unfolding – only commanded half our attention. Most eyes understandably were focused on the march of the coronavirus and the missteps and miscommunications of a prime minister unsuited for the leadership demands of high office.

The confusion and growing public panic at the uncertain response was amplified manyfold in the financial markets, matched by fear and uncertainty in the real economy that produces the goods and services we want and need. The Treasury and the Bank of England stared into an abyss. Thankfully their officials, derided by the cabal of second-rate ideologue advisers at Number 10, were up to the task.

Here Boris Johnson – and the country – got lucky. The Conservative party, broken by the triumph of anti-EU ideology and the wilful disregard for fact that is the hallmark of the Brexiter mindset, now offers the weakest talent pool in its long history. But the chancellor, Rishi Sunak, is an unexpected outlier. Officials report that he is proving highly intelligent, economically literate, agile and with acutely sensitive political antennae. Thus the unprecedented interventions last week – with much more to come in the weeks ahead.  

Even as I write, the Treasury and the Bank are in urgent talks to organise bailout packages for a number of top companies (including, but not only, airlines), sometimes taking government share stakes along the lines of the bailout of RBS in 2008.

But it was only last Monday that the government genuinely thought that if it stood behind business with a massive programme of soft loans, with grants for hard-hit sectors, it might escape without having to go much further. It did not need to sully its hands with un-Tory propositions – underwriting worker incomes together with improved benefits for those thrown out of work.

However, the crisis of confidence in the financial markets and intense lobbying by the CBI and the TUC soon changed minds, none faster than the initially sceptical Sunak. After all, business cannot prosper without buyers for its products: the good health and predictable incomes of the working population are vital. The last vestiges of Thatcherite individualism are being torched. Social partnership is back with a vengeance

Meanwhile, the top echelons of the Bank of England witnessed the consequences of the outbreak as mounting panic in global trading hit British markets badly, all magnified by Johnson’s bumbles. The sterling crisis expected with a no-deal Brexit was brought forward: a currency dependent on the “kindness of strangers”, given the scale of Britain’s monumental international balance of payments deficit, was in near freefall. There had to be a twin response: a fiscal one that “would blow the bloody wall down” and a shock-and-awe monetary intervention to try to steady shattered bond markets.

The Bank moved first, committing to a £200bn programme of printing money to buy bonds (quantitative easing) and cutting interest rates to a symbolic 0.1%. For the moment, the markets have steadied. Then came Sunak’s measures, the centrepiece of which was the commitment to pay 80% of the wages (up to £2,500 a month) of workers threatened by lay-off. He also ratcheted up support for renters and those on universal credit.

Two million people working in the now shut hospitality sector will be immediately eligible, along with up to five million more as the economy contracts by at least one fifth in the months ahead, with the expected package for the self-employed adding yet more. At its peak, the cost per month will exceed £25bn and the scheme will plainly need extending. The budget deficit in 2020-21 will comfortably exceed £200bn, to be financed, if necessary, by the Bank of England printing money. There are no other options. One privy to the policy told me that even at the last they were unsure whether Sunak “had the balls”. He did. It is what had to be done – and is being reproduced across Europe and North America. 

It is wartime finance for wartime economic conditions. Over and above the multiple bailout packages currently being negotiated will come state direction and manufacture of vaccines, key medical products, respirators, and the takeover of private hospitals. Key workers – in the NHS, police, transport and food supply chain – will have to be marshalled in their millions and their wellbeing and health protected. Rationing of key foodstuffs will need to be imposed. The only way to head off a full-scale collapse of sterling and protracted economic depression will be to defer Brexit for at least a year or, as one source told me, five years. Government communications will have to be infinitely more sure-footed. The government itself has to be 100% trusted.

The open question is whether Johnson’s government, with its “frighteningly weak” core at Number 10, as one insider reported to me, can do what is necessary. If not there will, as in wartime, have to be a national government (headed by Sunak with Keir Starmer as his deputy). Johnson is too divisive a figure, too thin-skinned, too unserious in his messaging and with too divisive a history, to lead.

Sunak and Starmer offer competence and humanity above ideology. Whether through the deferral of Brexit or smart and well-thought-through state direction of the economy, they will do what is needed to get us through. In the meantime, take social distancing seriously. Be one of those who put society and social obligations first. And stay safe.

Ha Joon Chang speaks: Economics for the people

Lecture 1.1 - The Nature of Economics

Lecture 2 - What is wrong with Globalisation?

Lecture 1.2 - Why all economics is political

Lecture 7 - Inequality - What is it and why does it matter

Lecture 9 - The role of the state

Lecture 5 - Why are some countries rich and others poor?

Lecture 8 - Understanding Production

Lecture 10 - Finance and financial crises

Lecture 3 - Conceptualising the individual

Lecture 12 - Industrial policy

Lecture 4 - Can economics save the planet?

Lecture 6 - Will robots take your job?

Lecture 11 - Can economics save the planet?

Economic development

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.

Boeing's travails show what's wrong with modern capitalism

Matt Stoller in The Guardian

The plight of Boeing shows the perils of modern capitalism. The corporation is a wounded giant. Much of its productive capacity has been mothballed following two crashes in six months of the 737 Max, the firm’s flagship product: the result of safety problems Boeing hid from regulators.

Just a year ago Boeing appeared unstoppable. In 2018, the company delivered more aircraft than its rival Airbus, with revenue hitting $100bn. It was also a cash machine, shedding 20% of its workforce since 2012 while funneling $43bn into stock buybacks in roughly the same period. Boeing’s board rewarded its CEO, Dennis Muilenburg, lavishly, paying him $23m in 2018, up 27% from the year before.

There was only one problem. The company was losing its ability to make safe airplanes. As Scott Hamilton, an aerospace analyst and editor of Leeham News and Analysis, puts it: “Boeing Commercial Airplanes clearly has a systemic problem in designing, producing and delivering airplanes.”

Something is wrong with today’s version of capitalism. It’s not just that it’s unfair. It’s that it’s no longer capable of delivering products that work. The root cause is the generation of high and persistent profits, to the exclusion of production. We have let financiers take over our corporations. They monopolize industries and then loot the corporations they run.

The executive team at Boeing is quite skilled – just at generating cash, rather than as engineers. Boeing’s competitive advantage centered on politics, not planes. The corporation is now a political machine with a side business making aerospace and defense products. Boeing’s general counsel, former judge Michael Luttig, is the former boss of the FBI director, Christopher Wray, whose agents are investigating potential criminal activity at the company. Luttig is so well connected in high-level legal circles he served as a groomsman for the supreme court chief justice, John Roberts.

The company’s board members also include Nikki Haley, until recently the United Nations ambassador, former Nato supreme allied commander Edmund PGiambastiani Jr, former AIG CEO Edward M Liddy, and a host of former political officials and private equity icons.

Boeing used its political connections to monopolize the American aerospace industry and corrupt its regulators. In the 1990s, Boeing and McDonnell Douglas merged, leaving America with just one major producer of civilian aircraft. Before this merger, when there was a competitive market, Boeing was a wonderful company. As journalist Jerry Useem put it just 20 years ago, “Boeing has always been less a business than an association of engineers devoted to building amazing flying machines.”


High profits masked the collapse in productive skill until the crashes of the 737 Max

But after the merger, the engineers lost power to the financiers. Boeing could increase prices, lay off workers, reduce quality and spend its cash buying back stock.

And no one could do anything about it. Customers and suppliers no longer had any alternative to Boeing, and Boeing corrupted officials in both parties who were supposed to regulate it. High profits masked the collapse in productive skill until the crashes of the 737 Max.

Boeing’s inability to make good safe airplanes is a clear weakness. It is, after all, an airplane aerospace company. But because Boeing is America’s only commercial airplane company, the crisis is rippling across the economy. Michael O’Leary, CEO of Ryanair, which ordered 58 737 Max planes, says his company cannot grow as planned until Boeing, “gets its shit together”. Contractors and subcontractors slowed production of parts for the airplane, and airline customers scrambled to address shortages of airplanes.

Far from being an anomaly, Boeing is the norm in the corporate world across the west. In 2016, the Economist noted that profits across the corporate sector were high and persistent, a function of a lack of competition across swaths of the economy. If corporations don’t have to compete, they can raise prices to buyers, lower what they pay to suppliers and workers, and reduce quality.

High profits result in sloth and corruption. Many of our industrial goliaths are now run in ways that are fundamentally destructive. General Electric, for instance, was once a jewel of American productive capacity, a corporation created out of George Westinghouse and Thomas Edison’s patents for electric systems. Edison helped invent the lightbulb itself, brightening the world. Today, as a result of decisions made by Jack Welch in the 1990s to juice profit returns, GE slaps its label on lightbulbs made in China. Even worse, if investigator Harry Markopoulos is right, General Electric may in fact be riddled with accounting fraud, a once great productive institution strip-mined by financiers.

These are not the natural, inevitable results of capitalism. Boeing and GE were once great companies, working in capitalist open markets.

So what went wrong? In short, the law. In the 1970s, a host of thinkers on the right and left – from Milton Friedman to George Stigler to Alfred Kahn to the current liberal supreme court justice Stephen Breyer – argued that policymakers should take restraints off capital and get rid of anti-monopoly rules. They used many terms to make this case, including deregulation, cost/benefit analysis, and the consumer welfare standard in antitrust law. They embraced the shareholder theory of capitalism, which emphasizes short-term profits. What followed was a radical consolidation of market power, and then systemic looting. 

Today, high profit margins are a pervasive and corrupting influence across the government and corporate sectors. Private equity firms moved capital from corporations and workers to themselves, destroying once healthy retailers like RadioShack, Toys R Us, Payless and K-Mart.

The disease of inefficiency and graft has spread to the government. In 1992, Harvard Professor Ash Carter, who later become the secretary of defense under Obama, wrote that the Pentagon was too difficult to do business with. “The most straightforward step” to address this, he wrote, “would be to raise the profit margins allowed on defense contracts.” The following year Prof Carter was appointed assistant secretary of defense for international security policy in the first Clinton administration, which followed his advice.

Earlier this year, the defense department found that one defense contractor run by private equity executives had profit margins of up to 4,451% on spare parts it sold to the military. Consulting giant McKinsey was recently caught trying to charge the government $3m a year for the services of a recent college graduate.

The ultimate result of concentrating wealth and corrupting government is to concentrate power in the hands of a few. We’ve been here before. In the 1930s, fascists in Italy and Germany were gaining strength, as were communists in the Russia. Meanwhile, leaders in liberal democracies were confronted by a frightened populace losing faith in democracy. American political leaders were able to take on domestic money lords with a radical antitrust campaign to break the power of the plutocrats. Today we are in a similar situation, with autocrats making an increasingly persuasive case that liberal democracy is weak.

The solution to this political crisis is fairly simple, and it involves two basic principles. One, policymakers have to increase competition for large powerful companies, to bring profits down. Executives should spend their time competing with each other to build quality products, not finding ways of attracting former generals, or administration officials to their board of directors. Two, policymakers should raise taxes on wealth and high incomes to radically reduce the concentration of wealth, which will make looting irrational.

Our system is no longer aligning rewards with productive skill. Despite the 737 Max crisis, Boeing’s stock price is still twice as high as in July 2015, when Muilenburg took over as CEO. That right there is what is broken about modern capitalism. We had better fix it fast.

How Britain can help you get away with stealing millions: a five-step guide

Dirty money needs laundering if it’s to be of any use – and the UK is the best place in the world to do it writes Oliver Bullough in The Guardian 


Kleptocrats, fraudsters and crooks steal hundreds of billions of pounds, dollars and euros from the rest of us every year, but that gives them a problem: how can they stop the rest of us knowing what they’ve done with the proceeds? They have to stop their haul looking suspicious, to cleanse it of any criminal taint, or face losing their hard-stolen cash.

Money laundering, as this process is known, is notoriously difficult to uncover, investigate and prosecute. Occasionally, however, an insider breaks cover – someone such as Howard Wilkinson, who blew the whistle on perhaps the largest money-laundering scheme in history, the movement of €200bn of suspect funds through the Estonian branch of Denmark’s biggest bank between 2007 and 2015, most of it earned in the dodgier corners of the former Soviet Union, some perhaps belonging to Vladimir Putin himself. 

“No one really knows where this money went,” Wilkinson, a former Danske Bank employee, told Denmark’s parliament last year. Once the money had got into the global financial system, “it was clean, it was free.”
Britain’s most famous money launderer is HSBC, thanks to its systematic cleansing of the earnings of the Latin American drug cartels over the second half of the last decade, for which it was fined $1.9bn by the US government in 2012. But that was a tiny operation compared to the Danske Bank scandal. If gathered together, the suspect funds moved through the bank’s Estonian outpost could buy HSBC, with more than enough left over to buy Danske Bank too.

The scandal has been big news in Denmark and Estonia, but barely grazed public consciousness in the UK. This is strange, because Britain played a key role. All of the owners of the bank accounts that first aroused Wilkinson’s suspicions had their identity hidden behind corporate structures registered in the UK – including Lantana Trade LLP, the one that may have been connected to Putin. That means this is not just a Russian, Estonian or Danish scandal, but something far closer to home. In November, Wilkinson told a European parliament committee that the countries hosting these companies are just as culpable. “Worst of all is the United Kingdom,” he said. “The United Kingdom is an absolute disgrace.”

The British government is supposedly committed to tackling grand corruption and financial crime, yet Britain’s involvement in this mega-scandal has never been mentioned in parliament, or been addressed by ministers. It is far from the first time that British companies have been involved in high-profile money-laundering. Among the characters who have used British shell companies to hide their money are Paul Manafort, disgraced former chairman of Donald Trump’s election campaign, and Viktor Yanukovich, overthrown president of Ukraine, among thousands of lower-profile opportunists.

It is increasingly hard to avoid the conclusion that Britain tolerates this kind of behaviour deliberately, because of the money it brings into to our economy.
That being so, why should hardened criminals be the only ones getting rich off Britain’s lax enforcement? Here’s how you too can use British shell companies to cleanse your dirty money – in five easy steps.

 

Step 1: Forget what you think you know

If you have ambitions to steal a lot of money, forget about using cash. Cash is cumbersome, risky and highly limiting. Even if Danske Bank had used the highest denomination banknotes available to it, that €200bn would have weighed 400 tonnes, an amount four times heavier than a blue whale. Just moving it would have been a serious logistical challenge, let alone hiding it. It would have been a magnet for thieves, and would have attracted some unwelcome questions at customs.

If you want to commit significant financial crime, therefore, you need a bank account, because electronic cash weighs nothing, no matter how much of it there is. But that causes a new problem: the bank account will have your name on it, which will alert the authorities to your identity if they come looking.

This is where shell companies come in. Without a company, you have to act in person, which means your involvement is obvious and overt: the bank account is in your name. But using a company to own that bank account is like robbing a house with gloves on – it leaves no fingerprints, as long as the company’s ownership information is hidden from the authorities. This is why all sensible crooks do it.

The next question is what jurisdiction you will choose to register your shell company in. If you Google “offshore finance”, you’ll see photos of tropical islands with palm trees, white sands and turquoise waters. These represent the kind of jurisdictions – “sunny places for shady people” – where we expect to find shell companies. For decades, places such as Anguilla, the British Virgin Islands, Gibraltar and others sold the companies that people hide behind when committing their crimes. But in recent years, the world has changed – those jurisdictions have been cajoled, bullied and persuaded to keep good records of company ownership, and to reveal those records when police officers come looking. They are no longer as useful as they used to be.

So where is? This is where the UK comes in. When it comes to financial crime, Britain is your best friend.

Here is the secret you need to know to get started in the shell company game: the British company registration system contains a giant loophole – the kind of loophole you can drive a billion euros through without touching the sides. That is why UK shell companies have enabled financial crime all over the world, from giant acts of kleptocratic plunder to sad and squalid frauds that rob pensioners of their retirement savings.

So, step one: forget what you think you know about offshore finance. The true image associated with “shell companies” these days should not be an exotic island redolent of the sound of the sea and the smell of rum cocktails, but a damp-stained office block in an unfashionable London suburb, or a nondescript street in a northern city. If you want to set up in the money-laundering business, you don’t need to move to the Caribbean: you’d be far better off doing it from the comfort of your own home.

Step 2: Set up a company

The second step is easy, and involves creating a company on the Companies House website. Companies House maintains the UK’s registry of corporate structures and publishes information on shareholders, directors, accounts, partners and so on, so anyone can check up on their bona fides.

Setting up a company costs £12 and takes less than 24 hours. According to the World Bank’s annual Doing Business report, the UK is one of the easiest places anywhere to create a company, so you’ll find the process pretty straightforward.

This is another reason not to bother with places like the British Virgin Islands: setting up a company there will cost you £1,000, and you’ll have to go through an agent who will insist on checking your identity before doing business with you. Global agreements now require agents to verify their clients’ identity, to conduct the same kind of “due diligence” process demanded when opening a bank account. Almost all the traditional tax havens have been forced to comply with the rules, or face being blacklisted by the world’s major economies.

This means there are now few jurisdictions left where you can create a genuinely anonymous shell company – and those that remain look so dodgy that your company will practically scream “Beware! Fraudster!” to anyone you try to do business with.

But Britain is an exception. While it has bullied the tax havens into checking up on their customers, Britain itself doesn’t bother with all those tiresome and expensive “due diligence” formalities. It is true that, while registering your company on the Companies House website, you will find that it asks for information such as your name and address. On the face of it, that might look worrying. If you have to declare your name and address, then how will your company successfully shield your identity when you engage in industrial-scale fraud?

Do not be concerned, just read on.

Step 3: Make stuff up

This third step may be the hardest to really take in, because it seems too simple. Since 2016, the UK government has made it compulsory for anyone setting up a company to name the individual who actually owns it: “the person with significant control”, or PSC. Before this reform it was possible to own a company with another company and, if that company was not British, the actual owner could hide their identity.

In theory, the introduction of the PSC rule should have prevented the use of a British shell company to anonymously commit financial crime. Don’t worry though, because it didn’t. Here is the secret: no one checks the accuracy of the information you provide when you register with Companies House. You can say pretty much anything and Companies House will accept it.
So this is step three: when you’re entering the information to create your company, make mistakes. Suspicious typos are everywhere once you start delving into the Companies House database. For instance, many money-laundering investigations involving the former USSR eventually bump against a Belgian-based dentist, whose signature adorns the accounts of hundreds, if not thousands, of different companies, including Lantana Trade LLP. When he was tracked down to his home address in Belgium last year, the dentist claimed that his signature had been forged and that he had no connection to the companies. Whoever was filing the documents was remarkably imaginative when it came to spelling his name. Every document filed with the UK registry has the same signature, but his name is spelt in at least eight different ways: Ali Moulaye, Alli Moulaye, Aly Moulaye, Ali Moyllae, Ali Moulae, Ali Moullaye, Aly Moullaye and, oddly, Ian Virel.

With such boundless opportunities for creativity, why not have fun? Recently, while messing about on the Companies House website, I came across a PSC named Mr Xxx Stalin, who is apparently a Frenchman resident in east London. It is perhaps technically possible that Xxx is a genuine name given to Mr Stalin by eccentric parents – but, if so, such eccentric parents are remarkably widespread.

Xxx Stalin led me to a PSC of a different company, who was named Mr Kwan Xxx, a Kazakh citizen, resident in Germany; then to Xxx Raven; to Miss Tracy Dean Xxx; to Jet Xxx; and finally to (their distant cousin?) Mr Xxxx Xxx. These rabbitholes are curiously engrossing, and before long I’d found Mr Mmmmmmm Yyyyyyyyyyyyyyyyyy, and Mr Mmmmmm Xxxxxxxxxxx (correspondence address: Mmmmmmm, Mmmmmm, Mmm, MMM), at which point I decided to stop.

As trolling goes, it is quite funny, but the implications are also very serious, if you think about what companies are supposed to be for. Limited companies and partnerships have their liability for debts limited, which means that if they go bust, their investors are not personally bankrupted. It’s a form of insurance – society as a whole is accepting responsibility for entrepreneurs’ debts, because we want to encourage entrepreneurial behaviour. In return, entrepreneurs agree to publish details about their companies so we can all check what they are up to, and to make sure they’re not abusing our trust.

The whole point of the PSC registry was to stop fraudsters obscuring their identities behind shell companies, and yet, thanks to Companies House’s failure to check the information provided to it and thus to enforce the rules, they are still doing so. How exactly could society find someone who gives their identity as Mr Xxxxxxxxxxx, and their address as the chorus of a Crash Test Dummies song?

Even when the company documents provide an actual name, rather than a random selection of letters, the information is often very hard to believe. For example, in September, Companies House registered Atlas Integrate Services LLP, which declared a PSC with a date of birth that showed her to be just two months old at the time. In her two months of life, she had not only found time to get started in business, but also apparently to get married, since she was listed as “Mrs”. The LLP’s incorporation document states: “This person holds the right, directly or indirectly, to appoint or remove a majority of the persons who are entitled to take part in the management of the LLP”. It does not explain how exactly a babe in arms would achieve this.

This is not a one-off. The anti-corruption campaign group Global Witness looked into PSCs last year, and found 4,000 of them were under the age of two. One hadn’t even been born yet. At the opposite end of the spectrum, its researchers found five individuals who each controlled more than 6,000 companies. There are more than 4m companies at Companies House, which is a very large haystack to hide needles in.

You don’t actually even need to list a person as your company’s PSC. It’s permissible to say that your company doesn’t know who owns it (no, you’re not misunderstanding; that just doesn’t make sense), or simply to tie the system up in knots by listing multiple companies in multiple jurisdictions that no investigator without the time and resources of the FBI could ever properly check.

This is why step three is such an important one in the five-step pathway to creating a British shell company. If you can invent enough information when filing company accounts, then the calculation that underpins the whole idea of a company goes out of the window: you gain the protection from legal action, without giving up anything in return. It’s brilliant.

But don’t dive in just yet; there are two more steps to follow before you can be confident of doing it properly.

Step 4: Lie – but do so cleverly

Most of the daft examples earlier (Mmmmmmm, Mmmmmm, Mmm, MMM) would not be useful for committing fraud, since anyone looking at them can tell they’re not serious. Cumberland Capital Ltd, however, was a different matter. It looked completely legitimate.

It controlled a company called Tropical Trade, which, in October 2016, cold-called a 63-year-old retired postal worker in Wisconsin identified in court filings as “MJ”. On the phone, a salesman offered her an investment product, which – he said – would make returns of 81%. He chatted about his wife and family and came across as “kind and trustworthy”, MJ later told police. “During two weeks in November of 2016, she allowed Tropical Trade to charge $34,500 on her Mastercard and Visa credit cards,” the filing states. When she tried to get her money back, her emails and calls were ignored, and she never saw it again.

She had fallen victim to the global epidemic of binary-options fraud. Binary options are a form of betting on the stock market that are now banned in many countries – including Israel, where much of the industry was based – since fraudsters used the idea to fix odds, keep winnings and target the vulnerable. According to the FBI, taken as a whole, these fraudsters may have been fleecing their marks of up to $10bn a year.

When US police came looking for the people behind Cumberland Capital Ltd, they searched the Companies House website and found that its director was an Australian citizen called Manford Martin Mponda. Anyone researching binary-options fraud might quickly conclude that Mponda was a kingpin. He was a serial company director, with some 80 directorships in UK-registered companies to his name, and features in dozens of complaints.

It already looked like a major scandal that British regulation was so lax that Mponda could have been allowed to conduct a global fraud epidemic behind the screen of UK-registered companies, but the reality was even more remarkable: Mponda had nothing to do with it. He was a victim, too.

Police officers suspect that, after Mponda submitted his details to join a binary-options website, his identity was stolen so it could be used to register him as a director of dozens of UK companies. The scheme was only exposed after complaints to consumer protection bodies were passed onto the City of London police, who then asked their Australian colleagues to investigate.

Companies House has since deleted Mponda’s name from documents related to dozens of other companies, but it was too late for “MJ” and thousands of other victims. A small number of the binary-options masterminds have been caught, but the money they stole has vanished into the labyrinth of interlocking shell companies, and the individuals behind Cumberland Capital have not been identified.

“Most of the binary-options firms claimed to be in the UK. People are more likely to deal with a UK company than a company in Israel, as it has a better reputation when it comes to finances,” said DS Alex Eristavi of the City of London Police’s investment fraud team. “Companies House records are provided in good faith. There’s not so much scrutiny as goes on in, say, Italy or Spain, where you have to go through the lawyers and do it properly. Here the information is submitted voluntarily. People don’t realise that, they take it as being carved in stone.”

So here is step four: don’t just lie, lie cleverly. British companies look legitimate, so look legitimate yourself. Steal a real person’s name, and put that on the company documents. Don’t put your own address on the documents, rent a serviced office to take your post: Paul Manafort used one in Finchley, the binary options fraudsters went to Liverpool, and Lantana Trade was based in the London suburb of Harrow.

The financial documents you file look better if they’ve been audited by an accountant, so file genuine-looking accounts, and claim they’ve been audited by a proper accountancy firm. That isn’t checked either, so just find an accountant online and claim you’ve employed them. Accountants quite regularly find themselves contacted about accounts they have never seen before, and make the unwelcome discovery they have been personally named as having approved them.

Steps 1-4: A brief recap

So, to summarise the tricks so far, if you want to create an impenetrable weapon for committing fraud: first, forget about the supposed offshore centres and come to the UK; then take advantage of the super-easy Companies House web portal; then enter false information; and finally make sure that information is plausible enough to deceive a casual observer.
We’re nearly there. It’s time for the final step. 

Step 5: Don’t worry about it

I know what you’re thinking: it cannot be this easy. Surely you’ll be arrested, tried and jailed if you try to follow this five-step process. But if you look at what British officials do, rather than at what they say, you’ll begin to feel a lot more secure. The Business Department has repeatedly been warned that the UK is facilitating this kind of financial crime for the best part of a decade, and is yet to take any substantive action to stop it. (Though, to be fair, it did recently launch a “consultation”.)

Before 2011, only registered company-formation businesses could access Companies House’s web portal, which meant there was a clear connection between an actual verified individual and companies being created, since you could see who had created them. There was still fraud, of course, but it was relatively easy to understand who was responsible.

In 2011, then-business secretary and Liberal Democrat MP Vince Cable decided to open up Companies House, and everything changed. After Cable’s reform, anyone with an internet connection, anywhere in the world, could create a UK company in about as much time as it takes to order a couple of pizzas, and for approximately the same amount of money. The checks were gone; there was no longer any connection to a verifiably existing person; it was as easy to create a UK company as it was to set up a Twitter account. The rationale was that this would unleash the latent entrepreneurship within the British nation by making it easy to turn business ideas into thriving concerns.

Instead of unchaining a new generation of British businesspeople, however, Cable let slip the dogs of fraud. At first, this rather technical modification to an obscure corner of the British machinery of state did not garner much attention, but for people who understood what it meant it was alarming. One such person was Kevin Brewer, a Warwickshire businessman who had been in the company forming business for decades, and who attempted to warn Cable of the potential risks inherent in the new policy.

The method Brewer chose to make his warning was perhaps slightly unwise. He registered a company – John Vincent Cable Services Ltd – with Vince Cable listed as the sole shareholder, then wrote to the business secretary to explain what he had done. It was intended as a demonstration of how easy it is to file unverified information with Companies House, but it failed to focus attention in the way he had hoped. Jo Swinson MP, who worked with Cable, wrote Brewer a stern letter, telling him he should not have done what he did, and assured him that the new system was very good. Brewer concluded that the coalition government was not going to take his concerns seriously.

In 2015, there was a general election, Cable lost his seat, the Conservatives formed a majority government, and Brewer decided to try again with the same stunt. He created Cleverly Clogs Ltd, a company apparently owned by three people: James Cleverly MP, Baroness Neville-Rolfe, who was a minister in the business department, and a fictional Israeli called Ibrahim Aman. Brewer was no more successful in persuading Tories than he had been at persuading Liberal Democrats, however. At that point, he gave up on his attempt to show the government it was enabling limitless opportunities for fraud.

There is, it turns out, a simple explanation for why successive governments have failed to do anything about it. Last year, when challenged in the House of Commons, Treasury minister John Glen stated that Companies House simply couldn’t afford to check the information filed with it, since that would cost the UK economy hundreds of millions of pounds a year. This is almost certainly an exaggeration. Anti-corruption activists who have looked at the data say the cost would in fact be far less than that, but the key point is that the reform would pay for itself. As Brewer has pointed out, “the burden of cost is one thing. But the cost of fraud is far greater.”

VAT fraud alone costs the UK more than £1bn a year, while the National Crime Agency estimates the cost of all fraud to the UK economy to be £190bn. The cost to the rest of the world of the money laundering enabled by UK corporate entities is almost certainly far higher. Spending hundreds of millions of pounds to prevent hundreds of billions’ worth of crime looks like a sensible investment, however you look at the data, particularly since the remedy – obliging Companies House to check the accuracy of the information filed on its registry – would be so simple. (When I put this to Companies House, they provided the following statement: “We do not have the statutory power or capability to verify the accuracy of the information that companies provide. However, tackling abuse of the register is a key priority and that’s why we work closely with law enforcement partners to assist their investigations into suspected cases of economic crime and other offences.”)

That is not to say that the government has taken no action. It is illegal to deliberately file false information in registering a company, and punishable by up to two years in prison. In late 2017, Companies House at last alerted prosecutors to the activities of one persistent offender. The target of the prosecution was Kevin Brewer, for the crime of trying to inform politicians about how easy it is to create fake companies.

He was summonsed to appear at Redditch magistrates’ court and, on legal advice, pleaded guilty in March 2018. After adding together his fine, and the government’s costs, he is £23,324 the poorer – quite a high price to pay for blowing the whistle. He is paying it off at £1,000 a month, and remains the only person ever convicted of spoofing the UK’s corporate registry, which is quite a remarkable demonstration of Companies House’s failure to do its job. 

Following his conviction, Brewer’s company National Business Register was removed from the list that Companies House publishes of company formation agents, which had been a key source of new business for him. “There are company formation agents on that list who have permitted huge amounts of fraud, and I’ve been excluded for trying to expose it. I find it incredible that they should turn a blind eye,” he told me. “Is it deliberate? Are they actually trying to get this money into the UK? I don’t want to believe it, but I can’t explain it any other way.”

We don’t know the answer to that, but it does give us lesson number five: don’t worry about it. Commit as much fraud as you like, fill your boots, the only reason anyone would care is if you kick up a fuss. And what sensible fraudster is going to do that?