Tuesday, April 23, 2013

How the legacy of Thatcher and Reagan made the 2008 financial crisis inevitable.

All sort of explanations have been put forward to try and explain the 2008 financial crisis. Some of them have been almost unbelievably simplistic (most bankers are crooks - closer to the truth than most people care to imagine), while some of them have been irredeemably complex and opaque (anything written by Adair Turner)!

What no-one can deny is that the impact of the 2008 financial disaster has left most of us very much worse off, with very little sign of being able to enjoy a more benign financial stability for many years to come.

Some men and women have made significant fortunes out of the demise of the financial sector, many of them through schemes and designs which were purely criminal and which were designed to benefit them individually, at the expense of their clients, and shareholders. Investigations continue into the activities of HBOS, RBS and others. If you doubt the truth of this statement, recall Balzac; "...Behind every great fortune, there is a great crime..."

I have identified the year 1986 as the moment which saw a series of important, indeed, some would say, seminal moments, in the history of the development of fantasy financing, and opened a number of doors to providing opportunities for financial change. What was not realised at the time, except by a very small few, was that these changes, would in time, bring about the very destruction of the markets on which they depended.

1986 became the tipping point for the way in which many people came to view the financial sector, and much of the impetus for potential change arose out of a series of important cases and phenomena which had marked out the previous years, both in the USA and in the UK. But the financial sector is nothing if it is not cunning, and any proposed changes soon became muzzled and doomed to failure.

The years before 1986 I have designated as 'the Decade of Greed' an era which became a leitmotif for the worst kind of financial scandals on both sides of the Atlantic. After 1979 and the election of Margaret Thatcher, London suffered from a plethora of scams and frauds perpetrated largely in the Futures and Commodities markets, in many cases, from criminal breaches of the extant and perfectly reasonable legislation designed to prevent ignorant investors being inveigled to part with their money in pooled investment schemes, with the aim of being invested in speculative Futures contracts. 

Following the election of Margaret Thatcher, the London Financial Market had experienced a revolution in the way investor's money was handled and permitted to be invested. Legislation which sought to protect the financially foolhardy from their ignorance was repealed. Committed to some heavily theoretical visions of 'free markets', none of which I believe she truly understood, except that she had been assured that such actions would lead to the ending of the pernicious influence of 'socialism', Thatcher had embarked on a wholesale change of the way in which the City of London was permitted to operate internationally, and centuries of old traditions which separated the functions of competing financial interests were swept away, and in so doing, she had opened the gates both to some extremely dubious financial investment capital, but also to some highly undesirable American and European investment advisors.

I simply do not believe that Thatcher and her advisers, caught up in a political re-structuring of society gave any thought to the implications of these changes, but by aligning the City with the way in which the rest of the world did business in banking, securities and derivatives, and spurred on by the glad-handling of the spivs and wideboys in the Square Mile, who understood a potential financial killing when they saw one; and encouraged by the common cause made by senior civil servants and apparatchiks who saw this as a way of setting the UK free from the yoke of Socialism, the Thatcher Governments turned the way the City was regulated on its head, and in so doing created a monster from which there is little chance of escape!

Thus, US Cosa Nostra Mafiosi who had become a major nuisance in New York in selling dubious third-market securities through unregulated bucket-shops, flooded into the London market to help all those first-time equity owners transfer their BT, British Gas and TSB shares for worthless, restricted stock in US companies which could not be traded on any exchange in the world. The US mafia and their fellow-travellers walked away with millions and millions of pounds worth of British tax-payer's value from wider share ownership, but no-one cared because the whole process was designed to get the shares into the hands of the City institutional slickers as quickly and as cheaply as possible, and if the US Mafia could lend a helping hand, then what the hell? Nothing was going to be allowed to stem the tide of deregulation!

Even when I visited the DTI from the Fraud Squad and showed them evidence acquired from the Manhattan District Attorney's office of the identity of some of the men running investment companies in London, and their criminal Cosa Nostra antecedents in New York, the aloof civil servants just laughed at me, and accused me of '...seeing the Mafia behind every bush..!'  

One junior staffer even went so far as to opine that if things were as bad as I said, "...perhaps we should invite the Mafia to come and regulate the City, as they would do the job so much more efficiently..." Her departmental principals all thought this was very witty and amusing. She later went on to become a senior regulator with one of the alphabet soup regulatory agencies, funny role for a woman who thought so little of the need for regulation.

The civil servants' message was very clear; "...The Government doesn't want anything getting in the way of wider share ownership, so get back to your office and stop meddling in issues of high policy, Mr Plod..!" 

They didn't give a flying fuck if London became, as it did, the fraud capital of Europe. They didn't want to put their possibilities of promotion and their putty medals at risk, and they were content to sit back and do nothing while all the time, the London market was sold to the lowest bidder.

In this era in the USA, a number of very clever men were making a vast fortune out of a practice known as 'arbitraging', which put at its simplest, was identifying shares of companies which were financially undervalued, and then making take-over bids for those companies, stripping out all the value, and then dumping the rest of the business and its staff to fend for themselves, leaving factory premises open to the skies and whole Mid-West towns full of unemployed workers.

Men like Carl Icahn, Dennis Levene, Ivan Boesky, and Michael Milken, complete with a whole list of hangers' on, including from the UK, Sir James Goldsmith. These men had driven a swathe right through US Corporate America, and had asset stripped all the residual value which was intended to support these companies through the hard times.

They had been able to succeed because of the favourable tax treatment of debt instruments that was introduced by Ronald Reagan when he became President in 1981. Among all the other de-regulatory changes he introduced into the management of financial markets, in his free-market rhetoric-driven, Chicago School of Business political theories, this did much to undermine the validity of the US market space.

Ronald Reagan rarely catches any blame these days for the present economic mess that has destabilized markets in the United States and around the world. In fact, ironically, some Americans still praise the former president for taking the country in bold new directions during his years in the White House, in much the same way that people in the UK still praise Margaret Thatcher.

These admirers rarely acknowledge how central Reagan’s ideas, championed by Thatcher in the UK, were to the market difficulties troubling us today. As the country’s greatest champion of deregulation, Ronald Reagan contributed more to today’s unstable business climate than any other American. His long-standing campaign to minimise the role of government in American life, produced the conditions that ultimately proved disastrous for international business. 

The main problem with both free-marketeer's outlook was a failure to recognize that much government regulation can serve business interests very effectively, particularly if you want to serve the interests of the majority, as opposed to the privileged few. Many of the regulatory programs started by Franklin D. Roosevelt’s New Deal in the 1930s aimed to promote fairness in economic competition. That legislation required greater transparency so that investors could more intelligently judge the value of securities in the stock market. The reforms mandated a separation of commercial and investment bank activities, since speculative investments by commercial banks had been one of the principal causes of the financial crash. Roosevelt’s New Deal also created a bank insurance program, the FDIC, which brought stability to a finance industry that had been on the verge of collapse. 

These and other improvements of the New Deal era worked well. For the next half century American markets operated with impressive stability, they spread the wealth of America among a vast new emergent middle class, they sponsored and delivered the 'American Dream', they enabled the USA to win the 2nd World War and help it to re-build a shattered Europe and Japan, and still the country’s financial system did not suffer from the kinds of shocks that have upset the American economy in recent years.

But Regan was fixated by Chicago School 'trickle-down' economic thinking which mandated removing as much regulation as possible because it was perceived as a brake on enterprise, and raising taxes on the low-paid while reducing taxation on the rich. The removal of rules that promoted fair business practices, that prevented conflicts of interest, that limited levels of speculative capital, and which taxed certain profits at premium rates, fostered dangerous risk-taking. When the requirements for managing Savings and Loan institutions (the US equivalent to our Building Societies) became lax in the 1980s, leaders of those organizations, now freed from rules which kept them on the straight and narrow, threw money around and invested money recklessly in ways that had hitherto been denied to them. Many institutions, unsurprisingly, failed or came close to failure, and the cleanup cost more than $150 billion. Yet strangely, no-one thought to blame the de-regulation mania for that crisis, and no blame would stick to the Teflon President. 

At the same time, the arbitrage mania for stripping companies of their assets meant that no Chief Executive could risk keeping any volume of cash or asset value on the books of his company for fear that the 'Arbs' would strip him of it, and his job would go as well. The end result was an orgy of speculative M&A activity which drove a hugely over-valued market in a seemingly endless money-go-round of pointless acquisitions which made money only for the bankers and the lawyers, but most of the newly merged companies, which were forced to pay the costs of the acquisition process made less revenue or profit as a result of the mergers than before.

The reality was that the  securities of these well-capitalised target companies had become the subject of an insane-level of insider-information broking, so that the information of which shares of which companies were about to become merger targets drove an industry of insider dealing. The end result after some serious investigation of the arb industry by the SEC and the US Justice Departments, was a series of major prosecutions for insider dealing and securities fraud. One of the leading promoters, Mr 'Greed is Good' Ivan Boesky, realising that his fraudulent rampage was over, and on learning that some of his co-criminals were facing criminal charges, walked into the offices of the SEC and offered a complete confession of his wrong-doing in return for a plea deal.

One of his scams had been to get involved with massive fraudulent share dealing in the shares of Guinness plc, when they were the subject of an attempt to take over the interests of Distillers plc in the UK. His confessions to the SEC were passed to the UK Department of Trade and Industry. 

The DTI opened an investigation of the Guinness/Distillers Group battle and in so doing they opened up a Pandora's box of criminal activity. They uncovered the very worst examples of criminal British Corporate take-over activities, including illegal share support operations, share price manipulation, market rigging, a complete refusal to acknowledge the rules of the Companies Acts dealing with take-over conduct, a flaccid and gutless Take-Over Panel, and a generation of stockbrokers, broker/dealers, lawyers and consultants dedicated to the wholesale commission of fraud in the pursuit of wealth beyond the dreams of avarice. The Guinness case laid bare the truth of the so-called 'gentleman's club' of the City and exposed it for being a swamp of criminality.

When confronted with the level of City fraud which was now being uncovered as more and more cases began to be investigated by the new Serious Fraud Office, even Margaret Thatcher was shocked sufficiently to instruct Cecil Parkinson that in order to look good about tackling benefit fraud, they would have to 'get the handcuffs on' the City players!

The chief prosecuting counsel at the first trial of Guinness defendants said of them; 

"...The defendants were so carried away by greed and ambition that they were prepared to be dishonest and commit criminal offences. They were so greedy for money and power that they were prepared to cross the line which defines what is legal and what is dishonest..."

This case in 1986 finally made politicians sit up and accept that the City of London was a hot-bed of fraud, financial wrong-doing and general criminality, and that something finally had to be done to deal with the awful recognition that the City was an organised criminal empire. The Blue Arrow trial which swiftly followed, cemented that realisation, particularly as the jury convicted the main protagonists, a series of blue-blooded merchant bankers, of offences of criminal dishonesty.

So shocked was the City Establishment and its friends in Government, the Judiciary and the upper reaches of the Great and Good, that the message quickly came down from up above. There would never again be another Blue Arrow-style prosecution, and that has been the same message ever since.

The introduction of the Financial Services Act 1986, ushered in what was supposed to be the answer to a new regime of financial regulation. This was the tipping moment, when the City was supposed to move from an effectively wholly unregulated entity, ruled over by a series of toothless and wholly captured institutions run by the Great and Good, to an effective mode of financial control.

Margaret Thatcher, never a politician at ease with detail, and still besotted by the de-regulatory theories of Reaganomics, permitted the City of London to organise its own financial regulatory structure, within the framework of the Financial Services Act. Like many of the politicians who followed her, Blair, and Brown in particular, she was completely bamboozled by the City's protestations of good intent. The Tower of Babel of regulatory institutions the City fathers created in the following years, was designed specifically not to work in any effective manner whatsoever. The City truly moved to an effectively wholly unregulated entity, ruled over by a series of toothless and wholly captured institutions run by the Great and Good.

The introduction of new agencies of control, including the Serious Fraud Office, the Securities and Investments Board and the plethora of other agencies created a massive impression of structure and control, but was effectively wholly useless at implementing any meaningful regulation, and was always intended to be useless. And so it has all proved to be. 

Certainly, by the end of the 1990's the message in the City of London was that the much discredited Securities and Investments Board, which was about to be superceded by the new Financial Services Authority, had no intention of prosecuting any banking wrong-doing. The coded messages were passed out by ministers that as long as the City continued to bring in the money, ministers and regulators would turn a blind eye to the shenanigans being carried on the chaps in the suits. 

The whole period since the emergence of the FSA has been one long era of regulatory retreat and incompetence, marked out by a whole generation of staffers who have produced little in the way of work product other than hot air! The list of Chairmen and Chief Executives, many coming directly from the discredited banking business itself has provided a self-fulfilling prophecy for an agency that was not capable of doing anything effectively and lacked the leadership or the moral compass to take the lead in regulatory control.

The banks instead became embroiled in an American-led orgy of dubious financial creation and uncontrolled gambling, untroubled by virtually any regulatory controls whatsoever. Recent troubles in the American economy can be attributed directly to a weakening of business regulation in the public interest, which is, in large part, a consequence of Reagan’s anti-government preaching. In the absence of oversight, lending became a wildcat enterprise.

Mortgage brokers easily deceived home buyers by promoting sub-prime loans, and then they passed on bundled securitised documents to unwary investors. Executives at Fannie Mae packaged both conventional and sub-prime loans, and they too, operated almost free of serious oversight. Fannie’s leaders spent lavishly to hire sixty Washington lobbyists who showered congressmen with campaign funds. Executives at Fannie were generous to the politicians because they wanted to ward off any attempts at regulation. 

British banks assisted in defrauding some of their high-net worth clients by encouraging them to invest in long-term investment strategies, with money leveraged on the asset value of their properties through asset-release schemes. The money released had to be placed in what were little more than Ponzi or roll programme schemes, some of them being promoted by crooks who were already under investigation the US. This scandal has been effectively covered up by the FSA and other agencies and many innocent people are still out of pocket, but there is no agency left to speak for their rights.

Meanwhile, on Wall Street, brokerage firms became deeply committed to risky mortgage investments and did not make their customers fully aware of the risks. The nation’s leading credit rating agencies, in turn, were not under much pressure to question claims about mortgage-based instruments that were marketed as Blue Chip quality. Government watchdogs were not active during those times to serve the interests of the public and the investors. 

From the moment in 1986 when Ivan Boesky grassed up his mates in the arbitrage scandals, and rolled over on the Guinness fraud, regulators on both sides of the Atlantic should have realised that the regime of soft-touch regulation was over. The Guinness case and the Blue Arrow sham proved that the Great and Good in the City took no notice of rules and laws designed to make the City a clean place in which to do business, but no-one wanted to have to seize the nettle of cleaning out the Auguean stable.

The policies of de-regulation imposed by Thatcher and Reagan led to an era of wrong-doing and institutional banking and financial institutional fraud from which it will take many years for us to recover. Yet even now, there is not a politician who has the gumption or will to face down the financial sector, and impose a regime of control which will work. No-one has gone to jail for any of these frauds or white-collar crimes, truly the fat cats my believe that they are a protected species.

I am grateful to Robert Brent Toplin, Mr. Toplin, Professor of History at the University of North Carolina, Wilmington,who is the author of a dozen books including Radical Conservatism: The Right’s Political Religion (2006). for his seminal article, "...Blame Ronald Reagan For Our Current Economic Crisis..."


simoncz said...

Ernest Saunders, the only man in history to make a full recovery from Alzheimers.
You really can't make this stuff up.


AC said...

Unfortunately history does not begin in 1979 or 1986 or even 1929 ! Maybe if you did a little bit more research and looked into 1920 and 1971 you might find some insights into what free markets really are ? Why not have a look at the Scottish free banking system - over a hundred years of anything goes banking ? You might even discover that friedmanite macro isn't free market in any way, shape or form.

AC said...

The real legacy of Thatcher and Reagan is to get people thinking that the total fiscal state is inevitable and will last a thousand years. Thus free market capitalism is destructive and must to opposed at all costs because all the things it needs (hard money, competition, savings, losses, small government) all are destructive to the total welfare-warfare bismarckian state.

AbogadoNZ said...

As ever Rowan's analysis and comment is right on message - you can't trust bankers, regulators or government (of any colour). The important issue now is to debate and decide what is to happen in the future. Sadly I think it has to start with politics as that is the where change will flow from. It is going to mean finding and then supporting an opposition party with an appetite for change and the backbone to face down the establishment. It can be done - the Atlee administration is the most recent British example just as the New Deal was for the USA. The hard part is going to be getting 'joe public' motivated to participate as faith in politics is at an all item low. When all said and done my glass is very much half full.

Demetrius said...

Good one, linked to it on Wednesday under "Flowers That Bllom In The Spring", essentially about how present policy cannot work, especially if you allow crooks to do the job.

Jason said...

What a great analysis! The UK needs to see more of these history lessons because no-one is getting it yet really.

My only points:

1. Let’s not stick with “Chicago School” only. Let’s name and shame Milton Friedman. His were the theories that deregulated the banks, and he didn’t live to see the mess.

2. Regulation is the preservation of a common pool resource -- market fairness. As Adam Smith already knew, someone who wins big on the market can skew the market. The market at that point is no longer “free”, thus the only question is who is going to regulate it, the people who make the money or someone impartial. Late in the game there is no-one impartial since the banks buy the politicos and turn the democracy into de facto oligarchy. It has happened repeatedly through history.

3. The one factor missing in the analysis altogether is the most important -- oil. Without the extra drawdown from the North Sea and Alaska resources, respectively, Thatcher and Reagan could never have engineered their booms. Since there are so few who understand the connection of economics to energy (here’s an exception), and since Osborne doesn’t listen to any of them, the failure rate of his policies will continue to be 100%. Only energy growth can produce economic growth -- and energy growth is gone for good.

Note what happened to Iceland after they dealt with their rotten banking sector. Allowing some banks to fail would have been far better than the bigger crash now on the horizon.

Unknown said...

Good posting.

Unknown said...

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