Thursday, February 26, 2009

Dear Evan Davis - are journalists doing enough to warn people of impending problems?

Aeons ago, before HBOS, RBS, AIG, Citibank and the whole shebang came crashing down around our heads, you asked a very interesting and important question: "did we (journalists) do our best to warn people of impending problems during the upswing of the [economic] cycle?”

You asked the question during a session at the Radio Festival in Glasgow in July 2008, and the clear inference of your intervention was that the fourth estate had failed -- pretty conclusively -- to warn the general public about the risks in the financial markets and the economic consequences that these risks might hold.

I agreed with you at the time, and I don't think much has changed in the intervening months. I read any number of articles, and listen to many, many radio programmes on the subject of the financial crisis, but the messages remain confused, distracting, sometimes disingenuous to the point of mendacity (not you, of course, but the many bankers and regulators who pontificate about why it was other people's fault, rather than a systemic problem with colossal consequences). This probably reflects the complexity of the financial markets, but other factors are at play here, not least that there's a whole crowd of people out there - especially in London, Washington and New York - who want to point fingers at others.

The reason for writing to you now is that after I joined you on the Today programme last Friday, several colleagues have commented that you glossed over my suggestion that tax havens have played a significant, though hidden, role in fomenting the current crisis. Unfortunately lack of time prevented me from expanding on this point. Worse still, my interlocutor on the programme pooh-poohed the idea and pointed the finger of blame firmly at the US sub-prime mortgage market.

Wrong! The US sub-prime mortgage market might have been amongst the straws that broke the camel's back, but it was just one element in a much bigger picture: yes residential property markets have bubbled, but not just in the US. Commercial property markets also bubbled and have now tanked (take a look at what's happening in the Emirates now). Two big issues stand out here. One is why banks and regulators allowed the massive build up of debt (personal, commercial and public) and yet failed to properly assess the risks these posed to social and economic stability. Another, related issue, is the gigantic macroeconomic imbalances that have built up in the global economy as a result of huge flows of licit and illicit capital, generally from the South to financial markets in the North, or from FSU countries heading westwards. Tax havens were crucial in driving both of these processes.

One part of the failure to understand the nature of the risks lay with the sheer complexity of the instruments used to securitise debt. Another part lay with the opacity of the structures created by banks and other businesses to shift assets and liabilities off-balance sheet. Another part lay with the way in which these structures are located across a multiplicity of jurisdictions, leading to a fragmentation of regulatory effort and a lack of clarity over which regulatory authority has responsibility for particular transactions. Yet another problem lay with the fact that many of the structures were created to achieve some form of tax arbitrage in a low tax jurisdiction. Alongside the tax arbitrage, the same players were looking for ways of exploiting opportunities for regulatory arbitrage. And we're not just talking about securitised debt here. The leveraging of hedge funds reached such levels that they were no longer instruments for mitigating risks: they were able to shape market movements to create one way bets. Likewise the private equity funds, who were also able to profitably exploit opportunities for tax arbitrage.

This witches brew of complex instruments, leveraged finance, regulatory arbitrage, tax avoidance, fragmented regulation, opaque structures, and the rest, shares a common denominator. Much of this activity happens in lightly regulated offshore financial centres, located in tax havens like Cayman, the Channel Islands, Dublin and London. Why? Because of the culture of lax regulation. Because of the opportunities for tax avoidance. Because of the lack of operational transparency. Because the ability for capital to structure its operations across a wide number of OFCs creates a fragmented regulatory environment in which everyone assumes that transactions are taking place elsewhere.

These places have acted as crucibles for much of the financial innovation of the past few decades, but too many people still think of them as a marginal feature of the financial market topography, rather than a central feature of contemporary financial capitalism.

Now I can understand why this is difficult terrain for journalists. Facts are scarce and its often hard to join the dots without having considerable insider knowledge. And that knowledge is a valuable commodity, more likely than not busy making money rather than scrutinising the markets in a critical way. But surely there is sufficient circumstantial evidence now out there to start raising searching questions: which is exactly where your talent lies. Care to discuss this further with us?

best wishes



Blogger Henry said...

It is no wonder that nobody warned of the approaching tsunami because mainstream economics is working to defective theory and the experts could not see it coming. The theory ignores the role of land which is one of the two primary factors of production.

Underneath all the jiggery-pokery was a classic debt-fuelled land price bubble running to the standard 18 year cycle. Fred Harrison predicted this bust, give or take a couple of months, as far back as 2005, just as he predicted the crash of 1992 five years before it happened. But then Harrison is working to a different model which takes land into account.

The core problem is the practice of lending for land purchase, wrapped up inside house purchase, on the security of land whose value has been puffed up by all other lenders doing the same thing. The end product is toxic debt secured on bubble land values. Everything else - "securities", "investment vehicles" and all the other nonsense - is constructed on top of these unstable foundations. The government must have lost its marbles to be insuring such debt at the taxpayers expense.

A prerequisite for a repetition is to shift taxation very substantially onto the rental value of land, which will strongly discourage lending for land purchase.

3:44 pm  

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