Thursday, October 28, 2010

On foreclosuregate, efficiency and tax havens

We have been reading occasional stories about the foreclosure mess in the United States.

For those who don't know about it, here is a quick summary, to start with. In the run-up to the financial crisis that erupted in 2007, banks and other financial institutions packaged up bundles of mortgages into entities which were then themselves diced up and sold on, once or more than once, to other investors, in a process known as securitisation. The chain of ownership between houseowner and the ultimate holder of the mortgage risk often involved many links, with ownership passing from hand to hand many times over. But evidence has recently been emerging that mortgage servicers had been cutting corners and not doing the proper paperwork while ownership was being handed down these chains, and the result is an almighty legal mess throwing into question the whole basis for the securitisation deals and the chain of ownership. It is throwing a huge question mark over the banks. (Here is just one story giving some examples of what has been going wrong.)

One of the most important sites following the situation is the well-regarded Naked Capitalism, which notes something in one of its latest blogs that struck us as being particularly important.

"The media has finally woken up and is reporting on a wide range and variety of bogus foreclosure actions, vitiating the industry claims that all foreclosure actions are correct. And before some readers try the argument that a few errors here and there are no big deal, try telling that to someone threatened with the loss of their home. This sort of thing was impossible in the pre-securitization era, and for good reason: the process of dealing with real property was cumbersome by design. It was fault intolerant because the consequences of error can be catastrophic to the participants. Any process that has a lot of safety features and checks is going to be inefficient. It was inevitable that a drive for efficiency at all costs would compromise the integrity of the system."

Now this Naked Capitalism paragraph reminds us of our fairly recent blogging on the parallels between tax havenry and actions that people traditionally think of as corrupt.

Exhibit A in the tax havens' defence is that they make the flow of international finance more "efficient".

As we mentioned in that previous blog, some people argue that bribery is efficient because it allows, for instance, that business to get its container through the port, or to get its permissions to start trading, or whatever. The correct response to this "efficiency" argument for bribery is that what is efficient for a single individual or entity may well not be efficient for the system as a whole. And a system plagued by bribery, or other forms of corruption, is certainly less efficient than one that is relatively free of such evils. Corruption gives an advantage to insiders, at the expense of the majority. In the process it undermines the rules, systems and institutions that promote the public good, and undermines our faith in those rules. It rots the system, in other words.

What do tax havens do? They allow people or entities to get around various obstacles to doing the business they want: cutting that tax bill, providing "light-touch" financial regulation, or whatever, and getting the deal done faster and more, er, "efficiently." But what are the obstacles that tax havens help us get around? Why, tax, financial regulation, criminal laws, transparency requirements, and all kinds of other things that are put there for very good reason: to promote the public good, and prevent insiders from abusing the public good. Tax havens (or secrecy jurisdictions as we sometimes call them) are the ultimate insiders' tool, not least because of their fondness for secrecy. At heart, they promote escape: escape from all the constraints and responsibilities of living in society. In allowing a minority of insiders to escape these things, and to free-ride off the backs of others, they undermine the rules, systems and institutions that promote the public good, and undermine our faith in those rules. In other words, they rot the system. (And Richard Murphy's latest blog on why tax havens are the enemies of free markets just reinforces the point: read it, if you haven't yet.)

And this is why the Naked Capitalism article on foreclosuregate reminded us of this very argument: because we are seeing the same underlying process at work. As a reminder of what they said about the dodgy paperwork:

This sort of thing was impossible in the pre-securitization era, and for good reason: the process of dealing with real property was cumbersome by design. It was fault intolerant.

The securitisation game tried to make the whole process more "efficient" - and in the process, corrupted the system. Again, as they note:

It was inevitable that a drive for efficiency at all costs would compromise the integrity of the system.

And, we should add, it compromised our faith in the integrity of the system. Which means it has corrupted the system.

We can't help once again reminding our readers of the words of John Maynard Keynes in 1933.

"There may be some financial calculation which shows it to be advantageous that my savings should be invested in whatever quarter of the habitable globe shows the greatest marginal efficiency of capital or the highest rate of interest. But experience is accumulating that remoteness between ownership and operation is an evil in the relations between men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation."

He was quite right. And his words, of course, can be applied perfectly to the analysis of tax havens.

For much more in-depth analysis of our corruption from TJN's perspective, click here.

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