Monocle Quarterly Journal

MONOCLE QUARTERLY JOURNAL

Banking. Economics. Politics.

3 5 4

6 12 CIRCUIT DISTANCE 2.892 MILES / 4.655 KM

VOLUME 2 ISSUE 1 QUARTER 1 2017 “I try to have a different relationship with the bike. I don’t give it a name, but I always speak with it. I don’t know if the other riders do the same. This is not only a piece of metal – there is a soul. The bike talks back too. But not with a voice, with the components.”

VALENTINO ROSSI

MONOCLE QUARTERLY JOURNAL

Banking. Economics. Politics.

VOLUME 2 ISSUE 1 QUARTER 1 2017 Published by Monocle Solutions (Pty) Ltd 13th Floor, Greenpark Corner, 3 Lower Road Morningside, Sandton South Africa [email protected] www.monocle.co.za

MONOCLE QUARTERLY JOURNAL ISSN 2519-0784

Volume 2 Issue 1 Quarter 1 2017

Editor-in-Chief: David Buckham Editor: Lynette Dicey Contributors: David Buckham, Michael Hunt, Natalie Clow-Wilson, Monocle Research Cover and book designer: Vanessa Wilson Typesetting and production: Quickfox Publishing Printing: Tandym Print, Cape Town

Where applicable, permissions to republish have been sought from the relevant copyright holders. ON THE MOVE

The blue jay scuffling in the bushes follows Some hidden purpose, and the gust of birds That spurts across the field, the wheeling swallows, Has nested in the trees and undergrowth. Seeking their instinct, or their poise, or both, One moves with an uncertain violence Under the dust thrown by a baffled sense Or the dull thunder of approximate words.

On motorcycles, up the road, they come: Small, black, as flies hanging in heat, the Boys, Until the distance throws them forth, their hum Bulges to thunder held by calf and thigh. In goggles, donned impersonality, In gleaming jackets trophied with the dust, They strap in doubt – by hiding it, robust – And almost hear a meaning in their noise.

Exact conclusion of their hardiness Has no shape yet, but from known whereabouts They ride, direction where the tyres press. They scare a flight of birds across the field: Much that is natural, to the will must yield. Men manufacture both machine and soul, And use what they imperfectly control To dare a future from the taken routes.

It is a part solution, after all. One is not necessarily discord On earth; or damned because, half animal, One lacks direct instinct, because one wakes Afloat on movement that divides and breaks. One joins the movement in a valueless world, Choosing it, till, both hurler and the hurled, One moves as well, always toward, toward.

A minute holds them, who have come to go: The self-defined, astride the created will They burst away; the towns they travel through Are home for neither bird nor holiness, For birds and saints complete their purposes. At worst, one is in motion; and at best, Reaching no absolute, in which to rest, One is always nearer by not keeping still.

Thom Gunn

Foreword

here is undeniably an existential question that plagues the financial markets, the banking system, and the western world in general. It goes like this: is capitalism, and its political enabler, Tliberal democracy, ultimately good? To be clear, by good I do not mean to invoke the idea of being fundamentally good in a moral sense. I mean is capitalism good at all, for anyone other than a very select few?

There is fair reason to ask this question. The world’s largest economy by far is now led by a man whose primary capability is to manipulate a television audience. The world’s second largest economy is not a democracy. There is a break-up taking place in Europe that threatens trade and enhances isolation. And there is a force of evil that feeds on terror, that now occupies large swathes of the Middle East and that only began its existence in the last decade.

The financial markets, their organs, and the intermediaries that are meant to drive the body economic – the banks – have been vilified to a point they last experienced in the lean years immediately following the Great Depression.

In fact, in many ways the situation is worse than in 1933 when the Glass- Steagall Act was first promulgated. At that time, there was at least clarity in thinking and the solution was relatively simple: split deposit-taking from investment banking. In today’s world, there is no clarity: there are a plethora of rules, there are extreme fines, there is political kow- towing and there continues to be manipulation of sectors of the market by institutional participants that amazes even the most battle-wearied of liberal democrats.

It has become increasingly difficult to continue to defend the notion of Adam Smith’s invisible hand when the system continues to employ and incentivise the most cunning and dishonest of traders. There are a few bad apples among many good that continue to destabilise the very fabric of liberal democracy.

9 As this issue of Monocle Quarterly Journal will cover, there has been continued erosion of general confidence and trust in the financial sector through manipulation of just about every aspect of the markets: from the LIBOR rate, to the price of aluminium, to the oil price, and even to the number of applicants for loans, as was witnessed last year in the Wells Fargo case. As articles in the Economics and Politics sections of this quarter’s issue elucidate, this erosion of any sense of a moral – or even fair – basis upon which capitalism can rest, is eroded also by industrial as well as new tech companies, from tax avoidance by Apple, to just plain nasty behaviour on the part of Uber’s CEO.

There is also compelling evidence that the gate-keepers of economic data and its dissemination are party to front-running in the markets, as is explored in an article on the UK’s inflation data. In the Politics section of this quarter’s issue, our contributor unearths the manipulation of the Financial Intelligence Centre Amendment Act in South Africa and the political motives behind it.

Despite enormous efforts being made by regulators, academics and bank executives to help defend the rights of firms to operate within the framework of a free market, these seemingly unending knocks to the confidence within the capitalist system have led to a right-wing political response that may gain permanent traction. As a review of polemical literature in this issue examines, even the liberal left has lost patience and is calling for an end to capitalism.

It is within the context of this battle – a battle to preserve the best ideas that have led undeniably to the substantial economic and social gains of the 20th century – that we have decided in this issue to reflect on something positive. We see the system that we call the international financial system to be a system of rules, whose players have certain freedoms within the boundaries of these rules, and who compete within the framework of a governed set of principles.

We liken this ‘governed freedom’ to the world of sport, particularly to MotoGP – the pinnacle of motorcycle racing. Like the markets, players take enormous risk to achieve success. They are flooded with information, with strategic decisions, and with many infinitely small tactical decisions. They participate within the boundaries of the rules of motor sport, both globally across many races throughout the year, as well as locally, within

10 Foreword particular races themselves. They face different climates, conditions, track temperatures, tyre choices, and they then need to execute to the best of their ability.

No-one questions their right to compete, nor their right to win, so long as they follow the rules. And it is a joy to watch. Their greatest protagonist is Valentino Rossi. We have an article on him in the Opinion section. He is meant to represent in this issue the very best of the free market – of racing to win – whilst respecting the rules of engagement. He does so with an attitude and aplomb that few possess and many envy.

This issue is therefore not only an examination of the state of the markets, but is also an ode to motorcycle racing, its history and its heroes. In the text, we attempt to remain squarely focused on the problems of continued market misconduct and market manipulation, whilst the photos and illustrations hopefully provide counterpoint, reminding us of the very essence of the ideas underlying capitalism: that competition is good and that it is fair, and that it brings out the very best in us.

David Buckham

Contents

BANKING

Bob Diamond and the Qataris: The Inevitable Truths of Behavioural Economics...... 17

How to Blind a Pilot: Aluminium Price Manipulation...... 21

Ghosts in the Machine: The Nemesis of Banking...... 29

ECONOMICS

Front-Running the UK Economy...... 55

Travis Kalanick and the Future of Leadership...... 59

Of Soothsayers and Evangelists...... 63

POLITICS

Apple and the Perverse Disincentives of the Tax Code...... 73

The FICA Bill: Emblematic of South Africa’s Current Political and Economic Issues?...... 79

OPINION

On the Infinite Beauty of Valentino Rossi...... 85

BANKING

Bob Diamond and the Qataris: The Inevitable Truths of Behavioural Economics

BY MONOCLE RESEARCH

ne of the more compelling and curious experiments that was “In short, the conducted by Kahneman and Tversky in the 1970s proved experiment that investors do not make rational decisions in taking risk. OThis experiment, conducted using a group of over one hundred college demonstrated that students to determine decision outcomes, was one of many experiments investors, when they conducted during their intense period of work during which they facing the chance effectively invented the science of behavioural economics. Specifically, in this experiment, they proved that investors tend to take more risk in the of losing, take more face of loss, than they would under the prospects of making a gain. The risk than when experiment is clearly laid out in several books, including Kahneman’s facing the chance of own as well as in the recently published Michael Lewis account of the winning ...” collaboration that led to a fundamental rethinking of the underlying assumptions of investment science.

In short, the experiment demonstrated that investors, when facing the chance of losing, take more risk than when facing the chance of winning, even when the outcomes are probabilistically equivalent. Kahneman and Tversky used university students as proxy for investors. Students were given a choice between a certain loss of USD 50, or a 50 percent chance of a zero loss and a 50 percent chance of a USD 100 loss. This was called Group B. A separate group of students was given the opposite choice: a certain gain of USD 50 or a 50 percent chance of a USD 100 gain and a 50 percent chance of a zero gain. This was called Group A.

Unexpectedly, the experiment found that when facing potential loss, investors take substantially more risk. To a large degree, this simple experi ment demonstrates the apparently illogical phenomenon of gambling as a human endeavour and the perennial success of Las Vegas and Macau. Loss, for reasons that cannot be explained by the Capital Asset Pricing Model, seems to engender a desire to take further and even greater risk. Basically, investors seem to repeatedly throw good money after bad.

17 BANKING

There is then to be found in behavioural economics some explanation for the otherwise inexplicable behaviour of the Qatari investment funds. Having made three rounds of heavy capital investment into the Deutsche Bank brand over the past six years – each round of which has led to substantial losses – they have in March of 2017 made a bid in partnership with Bob Diamond, previous CEO of Barclays, for the London loss- making broker Panmure Gordon at a substantial premium.

Qatar, along with other Arab-speaking states including Libya, had been sold post-crisis a story that went something along these lines: large diversified multinational banks had been oversold post-crisis, their price earnings ratios were substantially lower than diversified industrial firms, they would rebound and they would rebound strongly. It is somewhat ironic that it was investment banking salespeople from other large diversified banking groups that sold this story, including firms such as Goldman Sachs and Credit Suisse. Public investment funds from “Public investment primarily Arab states were encouraged to take substantial risk on specific funds from banks that were viewed as particularly under-priced.

primarily Arab In the cases of the state-run Libyan investment fund and the Qatari states were investment funds, these bets turned out to have no downside protection encouraged to take and experienced significant losses, in some cases of up to 80 percent of substantial risk book value. In the last round of capital raising that Deutsche Bank went through it was therefore surprising that the Qataris were tapped for cash on specific banks yet again. that were viewed as Bob Diamond too has had a tumultuous time of it of late. At one point, particularly under- post-crisis, he was regarded as being one of the most credible investment priced.” bankers of the modern era. He was handed the helm of Barclays at a time when Barclays was looking stronger than its peers on several fronts, but then in 2012 had to resign under the cloud of the LIBOR rigging scandal. Since then he has driven the creation of Atlas Mara, a unique offering from an investment perspective: an Africa-specific bank holdings company, which would take stakes in a wide range of African banks.

Atlas Mara, like the Deutsche Bank stakes that Qatar has held, has experienced value erosion of more than 80 percent since its listing in 2013. Whereas Deutsche Bank has been ravaged by continued problems with their capital adequacy levels, their inability to sell Deutsche Postbank, and the poor performance of their investment banking division, Atlas Mara has suffered from the macroeconomic reality that African growth was driven primarily by Chinese demand and a commodities price boom.

18 Bob Diamond and the Qataris: The Inevitable Truths of Behavioural Economics

The Chinese growth story is finally coming to a halt, even though it is “The Chinese growth being propped up to some extent by Chinese market intervention. And story is finally the commodities boom, for the foreseeable future, is over. Both parties then, the Qataris and Bob Diamond, are therefore part of Group B, the coming to a halt, loss-facing group, to use the language that Kahneman and Tversky used. even though it is

Their proposed investment in Panmure Gordon, a mid-cap stockbroker being propped up and investment bank of former glory based in London, does not seem to to some extent by be an investment that will necessarily alleviate the blood-letting that the Chinese market Qataris and Diamond have been suffering. intervention. And At best, it involves a leap of faith to accept that the firm can be turned the commodities around. There are no specific details as to how this would occur, especially boom, for the given the fact that Diamond has not clarified that he would be intimately foreseeable future, involved in the running of the firm. Like many other brokers, Panmure Gordon has come under increased pressure over the last several years in is over.” the face of increased regulations such as Mifid II, and extensive pressure on pricing. The firm, however, has suffered more than most, with several abrupt structural and management changes in only the past year.

At worst, this investment will yield the same outcomes that have plagued the Qataris and Diamond since 2013 – further brutal losses to investors. The Qataris as it happens have already experienced a loss on Panmure Gordon: their 23 million GBP stake in Panmure made in 2009 is now worth only 9 million GBP. Without access to the secret formula for success that Diamond and the Qataris must believe they possess, it is difficult to understand why they would wish to offer a premium to acquire the rest of Panmure Gordon.

Until such time as these investments pan out, it is perhaps easier to understand them in the context of Kahneman and Tversky’s experiment. These are investments that are being made not within the context of a rational investment universe, but rather by market participants whose idiosyncrasies are impinging on rationality. And those idiosyncrasies, at least for the time being, are that they are in significant loss positions at present. 

19 20 How to Blind a Pilot: Aluminium Price Manipulation

BY DAVID BUCKHAM

n 1994, airport officials in Rotterdam found it necessary to lodge a formal complaint against a company that they felt had begun to endanger the lives of their passengers and pilots. This company had Iamassed such a significant volume of aluminium in storage around the Rotterdam airport and sea port that the reflected light off the metal was blinding their pilots on take-off and landing. In investigations that followed, it was found that the actual owner of the aluminium, held through a series of offshore companies, was in fact a well-known, yet surprising entity: Goldman Sachs.

What – one may ask – would be the purpose of an investment bank, renowned for brokering corporate take-overs and mergers, and for underwriting equities and bonds, for owning such a tremendous volume of aluminium? The answer lay of course in the fact that Goldman Sachs had significantly ramped up their presence in the commodity trading markets.

Whereas within equity and debt trading operations – in which there is no actual physical delivery of the underlying asset – in the case of commodities, should the contract expire, the commodity itself needs “This company had to be physically delivered, to be stored at the very least, somewhere in amassed such a the world. In this case Rotterdam was the port which held the storage significant volume facilities that were required by Goldman. of aluminium in This kind of activity – that of taking large volumes of commodities onto storage around the their own balance sheets – already a stretch of the concept of banking, had Rotterdam airport been growing steadily since banks began offering commodity hedging as and sea port that the part of their raft of services to their corporate clients. reflected light off the Should Coca Cola, for example, wish to hedge the future cost of metal was blinding aluminium anticipating price volatility in the metal – a key component of their cost of production – they may wish to enter into a commodity their pilots on take- futures or forward contract with Goldman Sachs for a fee. There would off and landing.”

21 BANKING

“... by also seem nothing untoward about this – it being one of the core purposes dominating of financial services, at the service of industry and economic growth in general. In this regard, Goldman Sachs would be engaged simply in the the market for process for which banking is meant: that of financial intermediation. the storage and However, over time, the benefits to firms like Goldman Sachs and distribution of Morgan Stanley of trading commodities for their own balance sheets – aluminium to end- what is known as proprietary trading – far outweighed the margins they users, Goldman were making by providing commodity price hedging services to their clients. In fact, the business of proprietary trading commodities became Sachs was no longer so attractive to Goldman Sachs that they bought a firm called Metro acting as a financial International Trade Services in 2010, although they had made extensive intermediary.” use of this firm for some time prior.

The sole purpose of Metro, now a wholly owned subsidiary of Goldman Sachs, is to store and distribute aluminium. In taking control of Metro, Goldman was then able to slow down the delivery of aluminium from initial storage to delivery from an average of 40 days to more than triple that. In order to skirt around the rules that the London Metal Exchange (LME) had put into place to prevent precisely this nature of hoarding – which would have obvious price implications for the metal – Metro, instead of selling the aluminium to desperate end-users such as Coca Cola and Coors, would simply move the metal from one storage warehouse to another. They would do so on behalf of a trade that had been executed with a counterparty who did not wish to take delivery, and who may of course have been a trading counterparty of Goldman Sachs, if not Goldman Sachs themselves.

By dominating both the market for the spot and futures trading of aluminium, and by also dominating the market for the storage and distribution of aluminium to end-users, Goldman Sachs was no longer acting as a financial intermediary. In fact, they were acting as a competitor against their own clients, with the advantage of both having inside information in respect of the timing of demand as well as being the master of price determination. It should be noted that this nature of market manipulation, in which investment banks were able to inveigle themselves also into their clients’ businesses and from there to be allowed to radically manipulate prices, was only made possible through regulations that were introduced under the Clinton administration.

In 1999, several market observers and regulators had felt strongly enough that the OTC (over-the-counter) derivatives market was sufficiently opaque that they should lobby for increased regulation of all OTC trading.

22 How to Blind a Pilot: Aluminium Price Manipulation

Increased regulation would hopefully ensure that counterparties in trades would have to properly identify themselves, and that the purposes of the trades would have to be clearly understood. The derivatives market, after all, had already radically eclipsed the underlying market – betting on market prices had become a far larger business than the making of markets themselves.

The response from the Clinton administration to the lobbying for increased regulation was met with a fierce and somewhat malicious backlash. Larry Summers – one of Clinton’s key advisors at the time – led the charge to introduce a new act, called the Gramm-Leach-Bliley Act, which was quickly shepherded through Congress and ratified into law. Among other aspects of this Act, the law now insisted that there should not be more regulation of the OTC market, but less.

This Act also effectively repealed the 1933 Glass-Steagall Act, which “The derivatives had been written out of the ashes of the Great Depression, and which market, after had separated investment banking activities from commercial banking all, had already activities. It was precisely the cosy and unregulated relationship between radically eclipsed the the selling of equities, and the underwriting of equities that US regulators had clamped down on post-Depression – this conflict of interest being underlying market identified as one of the principal causes of the stock market crash of – betting on market 1929. In fact, it was the Glass-Steagall Act that forced JP Morgan to split prices had become a into JP Morgan Co. and Morgan Stanley the investment bank. far larger business In repealing Glass-Steagall, Clinton and Summers augured in the years than the making of of the banking hey-day, in which it was not uncommon for investment markets themselves.” banks to make returns on equity of over 30 percent using leverage of over 30 times equity. This was ultimately, in the final analysis, perhaps the key underlying cause of the 2008 financial crisis. Investment banks could now take on deposits, sell directly to retail end users, and most significantly in terms of the crisis, package mortgage-backed securities, as well as sell them to naïve buyers.

However, what is perhaps less well known is that the Gramm-Leach-Bliley Act also allowed in certain clauses that were lobbied by the investment banks in the hope of aiding their desire for even greater domination of the commodities trading business. After all, Goldman Sachs and Morgan Stanley were now facing increasing competition from non-banking entities that were on a huge growth spurt, such as Cargill and Glencore. An amendment to the 1956 Bank Holdings Act was easily passed in 1999 that in essence allowed Goldman to do openly what it had for some

23 BANKING

time wanted to do, and possibly had been doing through broken Chinese walls – to take delivery. Essentially, Goldman could now, through entities such as Metro, control not only the trading of aluminium, but also its storage and release.

A further piece of legislative engineering was required however, and this was the ratification of the Commodities Futures Modernization Act (CFMA) in 2000. It is particularly telling that at the dawn of the 21st century, a democratic US president – the leader of the western world, at the helm of a country that sells its brand of liberal capitalism as the only form of political governance worth fighting for – completely deregulated the OTC derivatives market whilst simultaneously legislating that, under the CFMA, the OTC contracts themselves were legally enforceable in a court of law. This is really a case of helping firms such as Goldman Sachs “Essentially, to have their cake and eat it. Goldman could now, To clearly explain: investment banking players in the commodities OTC through entities such market wished to ensure that they be allowed to make markets, price contracts for clients, delay delivery of the underlying, in a completely as Metro, control unregulated manner; but at the same time wanted the law of contract not only the trading on their side in collecting on debt. Recall, these investment banks had of aluminium, but already successfully argued – in lobbying the Gramm-Leach-Bliley Act – also its storage and that they should be allowed to do so on the basis that they were engaged in hedging activities on behalf of clients, and that market regulation of release.” complex derivatives would lead to an absence of liquidity and deleterious effects on price. Essentially, they had argued for the market in OTC derivatives to be entirely free of oversight, even SEC oversight.

Naturally, in a world without regulation, authorities would have no way to test whether trades in which investment banks or commodities houses were engaged in were of a ‘hedging’ nature or of a pure ‘trading’ nature. The problem, of course, with having enormous values of pure trading – or betting – on underlying prices in economically-critical commodities such as aluminium is that the price of the actual underlying commodity then becomes more driven by speculation – and specifically by highly leveraged speculation – than by supply and demand factors. By trusting that the free market would not overly speculate, the Clinton administration had not only augured in the financial crisis, but had also opened the door to the commodities price boom of the early 2000s.

Just as it is not the job of the police to enforce the payment of bets made at underground blackjack tables, the investment banks could hardly

24 How to Blind a Pilot: Aluminium Price Manipulation insist on having contracts enforced should they go bad – especially if “... the investment the purpose of the contracts was not to hedge, but rather to bet, just as banks achieved one might take a bet on the outcome of a turn of a card on a table in an illegal casino. precisely this: not only could they However, in lobbying for particular clauses to be scripted into the CFMA, the investment banks achieved precisely this: not only could bet to their hearts’ they bet to their hearts’ desire, they could also call on the authorities to desire, they could enforce the contracts should their counterparties balk at paying up. The also call on the investment banks wanted – despite wishing to conduct themselves free authorities to of any oversight or rules – to be able to go to court and make use of the institutions of law where it best suited them. One would have to search enforce the contracts hard for a more one-sided form of prudential oversight. should their

It is no coincidence that the price of food reached its highest level in counterparties balk 2008, since 1845 – that is, for over 150 years. For it was not only the at paying up.” price of aluminium that had been manipulated, or ‘financialised’ to use Rana Foroohar’s term in her remarkable book Makers and Takers, it was pretty much everything. The extent to which dominant market participants have entered into traditional businesses, obstructed them, and then altered them forever, beggars belief.

The sheer cynicism of the banking fraternity, when interrogated by Congress in respect of the specific amendments being made in 1999 and 2000 to the Bank Holdings Act of 1956 – which had been originally scripted to specifically prevent banks from competing against their own clients – was to cite the notion that financial firms engaging in ‘complementary’ businesses could benefit their clients. Credit card services, they argued, could be enhanced by offering travel advice, as an example.

To cite travel advice as a reasonable example of complementary business, and to use it as justification for being allowed to take delivery of underlying commodities such as aluminium, is to deliberately miss the wood for the trees. Remarkably, and inexplicably, the congressional subcommittees investigating at the time did not take umbrage at the banality of the argument. It really is – in retrospect – impossible to accept the naiveté of the lawmakers at the time. It is also impossible to accept the lack of accountability that has been taken by those same lawmakers and regulators to this present day.

More specifically, there has been virtually no accountability taken by western leaders or their advisors for helping usher in the dramatic run-up

25 BANKING

of events that led to the 2008 financial crisis. Alan Greenspan, in spite of the criticism that has been levelled against him, at least has the distinction of being perhaps the only economist in the history of western civilisation who admitted – albeit in the face of overwhelming evidence – that he might have been wrong. No such speech has yet been forthcoming from “There is no rational Larry Summers, who went on after his years as one of Bill Clinton’s most argument for trusted advisors, to become President of Harvard University.

not insisting on The aggression of firms such as Goldman Sachs is symptomatic of their regulating OTC nature, one could argue. They are what they are – highly competitive derivatives ...” players making use of each and every inch of advantage they can find on the field of play.

This is simply not an argument one can make in the case of Clinton and Summers. There is no rational argument for not insisting on regulating OTC derivatives, especially at a time when the face value of the derivatives market was doubling every three years.

To use a football metaphor: the fact that Maradona made use of the ‘Hand of God’ to help his country win the World Cup, or the fact that Luis Suarez savagely bit Giorgio Chiellini’s shoulder during Uruguay’s game against Italy in 2014, are insignificant infringements in comparison to those of Sepp Blatter.

If FIFA is to football what the US and Europe’s governments are to free market capitalism, then surely it is the leaders who should be hauled over the coals, not the delinquent players. Sadly, it took many years of intense pressure before FIFA was finally exposed. One suspects it will take even longer in the case of the financial markets. 

26 How to Blind a Pilot: Aluminium Price Manipulation

Ghosts in the Machine: The Nemesis of Banking

BY MONOCLE RESEARCH

What is the purpose of banking?

When one thinks of the impact of the 2008 financial crisis on banking “Since 2008, banks one thinks foremost of two things. First, of the enormous erosion in have lost their trust of the global financial institutions that once ruled the world. And shine, making second, of the plethora of new regulation that has been imposed on these same institutions as a result. poor investments for shareholders, These regulations, imposed both nationally and specifically within certain countries, and internationally – crossing trade and sovereign borders – frequently struck have been the by-product of a deep and convicted notion within a public down by rogue baying for blood that the greed exhibited by the banks leading up to the trading, ...” crisis is no longer tolerable, and needs to be reined in. The very idea of free-market capitalism – certainly in the guise that it took in the form of the 1990s style no-holds barred investment banking model – is no longer acceptable to western governments nor to its voters.

Since 2008, banks have lost their shine, making poor investments for shareholders, frequently struck down by rogue trading, by enormous fines and by internal misconduct that has led to congressional hearings and high- level resignations. At the same time, these institutions have been plagued by a mountain of paperwork and audit requirements that hang like an albatross around their necks, hindering their flight. They are the whipping boy of international commerce – and each time one of the key protagonists makes an effort to once again stand up from the floor to which they have been beaten, they seem to be hit by yet another unexpected blow.

In common parlance, names like Goldman Sachs, Morgan Stanley, and even the likes of Wells Fargo and Barclays, no longer evoke wonder and admiration, but rather engender derision.

The battle lines between the 1990s-banking model and the policing by the state of these institutions appear to have been drawn around the

29 BANKING

“In recent concept of the free market itself. The critical question being asked goes to literature, there is the integrity of these institutions, the question of who they serve. Is their purpose ultimately to return profits to shareholders, or are they rather an intellectual war custodians of something far broader and more meaningful? being waged on As listed entities that are privately owned, it seems logical that the banks this very question: should serve to maximise shareholder return. Yet, at the same time, can the general they serve a critical purpose within the broader economy, acting as good be served by a intermediaries in the supply chain of money, and as providers of credit to system that focuses private households and industrial companies across the world. In recent literature, there is an intellectual war being waged on this very question: almost entirely on can the general good be served by a system that focuses almost entirely shareholder return?” on shareholder return? Especially when the purpose of banking within broader society is to provide growth and equality through the provision of credit and financial intermediation.

The problem lies with efficiency not the free market

There is danger however in over-simplifying the problem of banking. The bind that the industry finds itself in today is not merely a stakeholder nor an agency problem. The issues plaguing the world’s largest banks will not be solved with a wave of a magic wand. Should the general public and western leaders suddenly and inexplicably return philosophically to the extreme version of the free market propagated by Milton Friedman, banks would not actually find themselves much better off. The framing of the problems within banking as simply an issue of solving the question of who they serve – whilst being compelling in its simplicity – is ultimately reductive.

This danger specifically lies in the assumption that banks were running efficiently in the first place, even prior to the 2008 financial crisis.

It is commonly understood that Lehman Brothers failed – as an example – because of a short-term liquidity squeeze owing to the toxic assets Lehman had accumulated. Its peer investment banks refused, at a critical moment, to roll over Lehman’s short-term borrowings, in what is known as the interbank market. These peer banks held back on providing Lehman liquidity because of their perception that Lehman held at that moment in time the most toxic of the Collateralised Debt Obligations (CDOs). These complex securities had been issued out of pass-through securities made up of cashflows emanating from the failing oversold US mortgage market. This, at least, is the most common perception of the cause of Lehman’s demise.

30 Ghosts in the Machine: The Nemesis of Banking

The problem of knowing aggregate exposure and risk

What is less well understood – and perhaps far more telling as a funda mental cause – is that Richard Fuld, the then-CEO of Lehman, did not have a proper handle on the aggregate risks faced by the bank as a whole. Specifically, he did not know – nor for that matter did anyone at Lehman know – the aggregate exposure or sensitivity of Lehman to a movement, for example, in the Mexican peso against the US dollar.

The executive management of Lehman did not even know – at an overall aggregated level – the sensitivity of the banks’ assets and liabilities to potential changes in the Fed funds rate. This may seem a profane remark, and untrue. But consider that the auditors who were called in to wind-up the balance sheet of Lehman post its failure, estimated that it would take up to a decade to unravel the trades that Lehman was counterparty to. “The executive These trades would have included not only the now infamous CDOs and management of their associated derivatives, the credit default swaps (CDSs) that were meant to protect the CDO-holder of counterparty risk, but also included Lehman did not such basic products as the Lehman mini-bond. The Lehman mini-bond even know – at an was a way for Lehman – prior to Bill Clinton in 1999 repealing the overall aggregated Glass-Steagall Act – to raise retail deposit funds for use in investment level – the sensitivity banking activities and trading, at that time against the law. of the banks’ assets By calling a deposit a bond, and by having smaller offshore banks on-sell and liabilities to these bonds in countries as far afield as China and Singapore, Lehman was able to raise significant funding, just as a retail bank would through potential changes in deposit creation. The difference was that the ultimate holders of the the Fed funds rate.” mini-bonds – pensioners in Hong Kong for example – did not realise the excessive risks that were being taken with their money. Lehman, after all, was a household brand, albeit a hallowed US brand, whose actual business activities were beyond the comprehension of even the financially literate.

On the asset side of its balance sheet Lehman held complex derivatives, bonds, and CDO securities. On the liability side of its balance sheet Lehman held substantial short-term money market funding from the interbank market, as well as rafts of cash raised through activities such as its mini-bond efforts from institutions around the world.

The actual counterparties to these mini-bonds was even a question of political debate in Hong Kong. Immediately following Lehman’s failure, the local Hong Kong banks eschewed any responsibility, calling themselves middlemen. Lehman was bankrupt and could not pay its

Ghosts in the Machine: The Nemesis of Banking bondholders, and the pensioners would therefore have to face the full brunt of their losses, irrespective of the fact that these bonds had been sold as safe investments. In the end, the Hong Kong Monetary Authority (HKMA) insisted that the local banks faced the full loss on the bonds, avoiding the significant social unrest that may have resulted.

The mini-bonds, however, put the problem of Lehman management knowing about their exposures, and the sensitivities of these exposures to “To be fair to changes in economic conditions, in context. If regulators, law-makers, Lehman, and to attorneys, civil rights activists and even auditors cannot easily and Richard Fuld, this accurately identify the market and credit risks of an asset or liability on Lehman’s balance sheet – even under the scrutiny of congressional sub- problem of not committees incensed by an enraged public post-crisis – then what chance knowing aggregate did Richard Fuld have? risk exposure or book sensitivity The ubiquity of the problem of smart managers was not and is not not knowing unique to Lehman.” This may seem a cynical question, for surely that is the purpose of having Harvard-educated top brass management – to have the right people in control of this complex world of banking, to steer the ship? But the Lehman story, in one form or another, has continued since 2008 to repeat itself, in one crisis after another in now almost all of the world’s largest banks.

To be fair to Lehman, and to Richard Fuld, this problem of not knowing aggregate risk exposure or book sensitivity was not and is not unique to Lehman. It is ubiquitous across the banking fraternity worldwide. And it is not a function of banks employing people who are not smart enough or enabled enough to calculate these risks and exposures. In fact, ironically, on occasion it can sometimes be as a result of having too many smart quantitative analysts, that the problems of calculating risk aggregation can be exacerbated. There have been several cases in recent years within banking of substantial discord between managers within specific institutions at odds with each other over the valuation of a particular trade or transaction. Often, there are simply too many quantitative analysts involved in the process of valuing or measuring the risk of a particular exposure.

The single most significant problem in banking is not in fact risk manage ment per se, it is actually a problem of information management. And

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“In the case of to put it more bluntly: it is an organisational design and management Richard Fuld, it problem that plagues the industry. Before embarking on a justification of this claim, it is worth touching on the more recent travails that Wells would seem unlikely Fargo and John Stumpf, its CEO, faced in 2016. that he deliberately wished to risk the The Wells Fargo fake account debacle existence of Lehman Wells Fargo – as has been widely reported – instituted, at senior levels Brothers ...” of management, a policy of compensating its retail banking sales staff specifically for raising accounts and loans, as opposed to compensating them against a more nuanced metric, such as risk-adjusted return on capital (RAROC).

Over several years, Wells Fargo’s blunt reward and compensation system led to extensive and broad sales abuse, the most severe of which included the creation by many sales staff of fake accounts that would result in them receiving inflated bonuses. The deleterious effects of this practice not only distorted US government statistics on money supply and consumer borrowings, but also, and most importantly, fraudulently distorted the profit, value and growth figures of the firm, published in its annual and semi-annual financial statements.

Not a single person has been successfully convicted of a crime for this practice, and no arrests were made, although many lost their jobs, John Stumpf’s included. He was also made to pay back over 75 million dollars in bonuses and salary to compensate shareholders. The question that naturally springs to mind is whether he knew of the practice, or worse, whether he sanctioned it. In the financial industry it would appear that this question is seldom successfully answered, nor even investigated, given the fact that very few individuals were ever held criminally liable for the practices that led up to the 2008 financial crisis.

In the case of Richard Fuld, it would seem unlikely that he deliberately wished to risk the existence of Lehman Brothers. On the contrary, he was extremely surprised by the call Hank Paulson made to him on the fateful day of the firm’s demise. One suspects that the same is true of John Stumpf. It seems more likely that he did not know of the practice, since it would not make sense to risk his entire career on what really amounted to a marginal distortion in sales across the entire portfolio of one of the world’s largest banking groups.

The reason, however, that he did not know, and the reason also that no-one in a regulatory oversight role would have known had a whistle-

34 Ghosts in the Machine: The Nemesis of Banking blower not led the Department of Justice to the details of the practice, is once again a function of organisational failure and specifically information management failure. Given the trillion-dollar balance sheet that Wells Fargo holds, and given its breadth and depth across geographical and divisional and product dimensions, it would be almost impossible for John Stumpf to have noticed a distortion at that level.

That is, unless he had inculcated the correct set of values and principles throughout his executive management. And hat is, of course, assuming he took sufficient care and attention to detail in the manner in which he consumed information.

Banks are not financial intermediaries, they are information processors “Rather than Rather than viewing banks as financial intermediaries, it is more useful in the context of this argument to view banks as information processing viewing banks machines. After all, banks do not actually make things. They do not have as financial storage facilities near airports or railways that hold stock. Their balance intermediaries, sheets are rich, but are made up most significantly of loans to individuals it is more useful and corporations, mere numbers in a system, rather than physical things. in the context of Their most significant costs are people costs and information technology this argument, costs. And their key assets – putting aside the obvious financial definition to view banks of loans as assets – is the data that represents those assets. as information Imagine if the representation of the assets held by a large diversified processing retailer such as Walmart were not properly managed. Imagine if the labels on products as different as ketchup to prams were incorrect, or machines.” misleading, or exaggerated. This would be the precise equivalent of getting the labelling of financial assets incorrect. But, precisely because financial assets are not bricks and mortar assets, they ironically receive less care than they should in their definition and processing.

The problem of labelling, however, is only the beginning of the overall challenge for banks. Banks tend to exist across multiple geographic locations, and they tend to sell products that are quite different from each other, with different risks associated, to very different types of customers. Once again, in a bricks and mortar context, it is quite simple to store children’s bicycles in a separate warehouse to perishable foods, for example. But in the case of financial assets, the difference between a leveraged-finance loan of several billion dollars to a public private

Ghosts in the Machine: The Nemesis of Banking partnership is not in fact particularly discernible from a regular mortgage loan to a single parent in Kentucky, other than in the numbers.

And to be even more precise, the distinction lies not in the numbers per se, but rather in the numbers about the numbers, in the codes. This is what is called metadata – it is the information about the numbers, and it is these codes that are interpreted by multiple systems across a bank “And to be even that actually help managers distinguish between their assets and their more precise, the liabilities. distinction lies not Once the ‘OK’ button on the appropriate screen has been pushed by in the numbers per the appropriate banker – the multitude of legal documentation notwith se, but rather in standing – the separation of the asset from its representation, in the case of banking, is immediate. The information about the asset is stored in the numbers about the machine, somewhere. The asset itself – being the expected future the numbers, in the cashflows emanating from the loan – is now actually a series of binary codes.” numbers held more than likely in what is known as the ‘cloud’. It is no wonder then – given the enormous complexity in properly representing information, storing it, and processing it – that there are not many more reported cases of severe information distortion in banking.

The first of five key challenges in banking today

There are five key challenges that banks face in transforming from sales organisations into efficient data processing organisations. The first is that they sell – both on the asset and liability sides of their balance sheet – a very broad range of products.

They sell retail deposits, as an example. But even this seemingly simple product has its own idiosyncratic complexities. These deposits can be of a fixed term or of a notice term nature. This term can range from one month to several years and can include all tenors in between. They can and do sell these products with complex characteristics of optionality and trigger penalties that kick in should the client wish to exercise early redemption. The risks embedded in this relatively simply product are complex: roll-over risk, early redemption risk, and these risks can differ by customer, as well as by the customer’s circumstances.

They also sell corporate loans, which are backed by physical or financial collateral – or that may not be collateralised at all, other than by the strength of a corporate customer’s balance sheet at a point in time. The collateral that banks hold against loans made to corporates, as well as loans made to individuals, may change in value not only on an annual

37 BANKING

“The problem is basis, but also on a daily basis, such as the value of an equity portfolio exacerbated by the over which the bank has taken cession. sheer volume of this In the market of loans called specialised lending, it is the future cashflows data – there may generated by the special purpose vehicle that ultimately borrows from the bank to build a school, or a road or a prison, that serve as collateral. be several hundred The value of this collateral in assessing the risks on this nature of loan million transactions depend on macro-economic forecasts and the impact of these predicted per day passing economic variables on the possibility and value of future free cashflow. through any of the The assets and liabilities of a bank are complex, not only because they larger multinational are so broadly different in the nature of their origination, but also banks.” because their resultant cashflows and the value of their collateral must also be predicted and recorded and constantly assessed. Whereas, in a large industrial firm, the asset values are often determined simply by market prices; in the case of banks, each and every individual loan and deposit needs to be individually valued both from a financial book value perspective, as well as from a risk perspective.

The complexity and breadth of the broad range of products that a bank markets and sells, and the difference in the data that represents these assets and liabilities, massively compounds the problem of information management. Data about transactions, each of which is in itself complex, and whose counterparties are unique and often related parties, is a complex problem to solve. The problem is exacerbated by the sheer volume of this data – there may be several hundred million transactions per day passing through any of the larger multinational banks. This is the first problem in banking: the issue of managing and interpreting the complexity of information generated out of product diversity and complexity.

The gap between accounting rules and risk rules

The second major challenge faced by banks is that the accounting rules and risk management rules governing the valuations and risk values of each and every asset and liability, differ substantially still today and have differed even more substantially in the past.

In the derivative trading market, for example, the value of a derivative – if it is a vanilla derivative product, such as a single stock equity option – is usually determined simply by calculating its market value using either reference values in the exchange traded market, or by using closed-form mathematical solutions such as the well-heeled Black-Scholes equation.

38 Ghosts in the Machine: The Nemesis of Banking

Recent accounting rules compel banks to treat the assets and liabilities made up of these derivative products as values that change daily, and whose profits and losses must pass through the income statement, and this treatment must be calculated to the day, using the most recent of market data.

In the case of a loan to a corporate, however, the accounting treatment will depend on the intentions of the bank in terms of why they are holding these positions in the first place. If the bank is simply holding a loan position for short-term purposes, expecting the position to change value in their favour, then these positions are deemed to be trading positions, and their accounting treatment should be the same as that for derivatives, i.e. accounted for as profits and losses through the income statement. Whereas, if the intentions of the bank are to hold these loans for the full period of their term, then these positions should be treated from an “These rules were accounting perspective as being held to maturity. implemented These rules were implemented to prevent the accounting arbitrage to prevent the that can exist for banks in treating balance sheet positions in ways that amount to distortive reflections to shareholders of their true exposures, accounting arbitrage and the risks inherent in these exposures – from a financial perspective, that can exist for as well as from a liquidity perspective. The bank, however, may not banks in treating always easily be able to distinguish between the two treatments in terms balance sheet of their intentions. They may not always know if they will hold a loan, or a portion of a syndicated loan, to maturity, since that may depend on positions in ways client behaviour or on changing market conditions, or even on changes that amount to in the bank’s own aggregate liquidity position. This treatment problem distortive reflections adds yet another dimension to the problem of accounting treatment. to shareholders ...” On the other hand, in terms of assessing and valuing the risks embedded in holding derivative positions, the rules pertaining to risk valuation are quite substantially different to those of accounting treatment. Under the 1996 amendment to the Basel rules for capital adequacy, the concept of Value-at-Risk (VaR) was introduced. This measurement effectively measures the probability of loss on a portfolio of all market-traded assets and liabilities, under a presumption of future economic conditions, and under the assumption that the values of these derivative positions are not perfectly correlated. Put simply, market risk measurement assumes that there exists a diversification effect in holding a broad range of derivative and underlying positions in a trading portfolio, and this introduces a significant non-linear aspect to the measurement of risk in the change of value in market-traded positions.

Ghosts in the Machine: The Nemesis of Banking

The VaR metric has been much maligned following its initial take-up, since it is complex and non-linear and is prone to significant model error. Yet it has been adopted throughout the world of banking in at least one of its three forms, the first being Historical Simulation, the second being Monte Carlo Simulation, and the third being what is called the Variance Co-Variance approach. Some banks and even regulators have moved away from VaR as a risk measure and have introduced what were meant to be more simplistic metrics, that have in actual fact their own idiosyncrasies and complexities. These are metrics that require, for example, the distinction between the portion of risk in a single derivative position that is deemed systemic risk, from the portion of risk held in that same derivative position that is deemed specific risk.

To make matters even more complex, post the 2008 financial crisis, there has been far greater focus on what is known as the Exposure-at-Default. In the case of an amortisation loan made to an individual or a corporation, the exposure at the expected time of default – should default occur – is relatively straightforward to calculate. One simply makes a guess at a default point in time and then projects the capital outstanding at the expected time of default.

In the case of facilities set up by the bank on behalf of corporate customers “Derivates are often which can then draw down funds from the bank as they require them – zero-sum games in obviously within certain boundaries called limits – the calculation of which the bank and Exposure-at-Default is far more complex. It would depend on a number of factors that include the customer’s historical draw-downs on facilities, its counterparty in a any changes that may have taken place to the customer’s balance sheet, trade are effectively as well as any delays or cost overruns that may have occurred to the taking a bet on the customer’s key capital expenditure projects. future value of a In the case of derivative exposures with corporate customers or banks, particular economic the situation is even more complex. The exposure that a bank faces on indicator ...” a derivative product needs to be assessed on an ongoing daily basis as opposed to on a monthly or annual basis, since the credit risk inherent in the possibility that the counterparty on a trade will not pay the bank back is only relevant if that trade is presently valued in the favour of the bank. Derivates are often zero-sum games in which the bank and its counterparty in a trade are effectively taking a bet on the future value of a particular economic indicator, or on the underlying value of a particular equity or debt index. On a daily basis, this means that on a particular derivative trade, the bank may actually owe money to its counterparty rather than be owed money.

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“For most front- The credit exposure risk embedded in a derivative or trading transaction is office banking therefore dependent on what is known as Potential Future Exposure (PFE), which itself depends on making assumptions about future underlying staff, these issues financial and economic indicators and feeding these assumptions into seem to them complex non-linear models. No wonder then that in the daily operations major hindrances of a bank, enormous effort and large numbers of highly sophisticated in performing the banking staff are required to simply reconcile between these two very different worlds – that is between the world of accounting valuations, sales and trading versus the world of risk valuations. functions they are This complexity in the accounting valuation as well as in the risk valua hired for.” tion of the products within a bank demonstrate the substantial difference between these types of financial assets and liabilities versus those non-financial assets that may be held by an industrial firm. From an information management perspective, the complex relationship between the accounting rules and the risk rules, governing value, require banks to constantly, frequently, and accurately manage market data, counterparty data, collateral data, and often cashflow data on behalf of a single trade. And they would need to be able to manage this data always in context to its associated fields – i.e. the correct and appropriate market data needs to be associated not with any trade, but specifically with those trades that require that market data.

In a diversified bank that operates across multiple jurisdictions, the challenge in accurately performing the information management processes required to reconcile between the world of accounting and the world of risk management, is one of the most significant cost areas within banking. Many banks have attempted to solve this problem through either simplifying their systems architecture, or through standardising their processes, but both approaches lead to enormous organisational challenges and both have significant disadvantages in terms of flexibility to respond to competition and rapidly changing market forces. For most front-office banking staff, these issues seem to them major hindrances in performing the sales and trading functions they are hired for. For regulators, auditors, but particularly for the finance and risk professionals who operate the systems and processes that manage the information generated by these trades, this is the heart and soul of the matter. Organisationally, a bank is far more likely to succeed if it performs these functions efficiently, than if it focuses primarily on sales incentives.

42 Ghosts in the Machine: The Nemesis of Banking

The absence of a single complete banking platform

This then leads to the third reason that banks are substantially encumbered in the efficiency of their operations. The challenge is that there exists no single standard or system or banking platform that can handle the operational aspects of providing banking products, accounting for these products using a standard accounting rules engine, and assessing the risks inherent in their products using a single risk measurement system.

In general, banks – especially the larger banks with well-diversified product ranges, as well as diversified across different countries and regions of the world – will possess literally hundreds of systems. These systems will have been implemented as long as forty years ago in some cases, such as the basic credit card system, which may have been written in Cobol code.

Often, banks will have different accounting rules engines for different “In general, banks – business divisions, as well as different sub-ledgers for each of those divisions. There will exist a raft of what is known as ETL (Extract, Transform, Load) especially the larger code that may be written in different programming languages – and there banks with well- are many – that act as translation layers between the different core banking diversified product systems (what is known as the product systems) and the accounting rules ranges, as well as engines. And then there will exist an even further and sometimes even more complex ETL layer between theses accounting rules engines and diversified across their respective sub-ledgers and their general ledgers. different countries

Naturally, the design of a sub-ledger and a general ledger will be based and regions of the on transforming the origination of loans and advances on the asset side world – will possess of the balance sheet, and deposits on the liability side of the balance literally hundreds of sheet, as well as all of the subsequent cashflows that result from these systems. originations, into debits and credits. These debits and credits will then be posted to the appropriate sub-ledger and ultimately to the general ledger to particular GL account codes, and this will allow the bank to possess a point-in-time view of its balance sheet.

These postings, however, will effectively aggregate values and data about banking transactions into a limited number of GL codes that will necessarily simplify the overall accounting view of the bank’s balance sheet into usually a few thousand rows of information. From an accounting perspective this will be acceptable, and this process can be audited both internally and externally fairly easily, owing to a long tradition of audit standards that exist throughout banking.

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The trouble is that the process of aggregation embedded into complex rules built into the accounting rules engines, into the sub-ledgers and general ledger, as well as into the ETL processes that prepare data for these accounting engines, loses critical customer-related and risk-related information and distinctions along the way.

If, for example, the general ledger does not have a particular categorical distinction between revocable and irrevocable facilities to retail customers, then this distinction will be lost in the accounting process “Either way, the as it is applied to the facility overdraft book of the bank on a monthly more diversified basis. This distinction, however, from a risk management and liquidity a bank, the more risk assessment point of view, is a critical one for regulatory purposes as acquisitive it has well as for the purpose of tactical and strategic management of the bank. been, and the longer Of course, one could simply implement a change to the general ledger its history, the so that it could absorb this distinction. However, upstream from the simplicity of adding a new GL code, there is an entire history of code that greater this challenge has been written by bank employees, contractors and consultants, over is in integrating the time frames often spanning more than a decade – often undocumented finance and risk – that will need to be rewritten and massaged to meet the new GL code requirement. And bear in mind that this is only one data distinction for views of the world.” only one type of asset in only one product system.

Often the facility overdraft book of a diversified banking group will be made up of several books that sit on different origination product systems in different countries. This could be the result of system decisions having been made under a ‘federal’ model – one in which the local managers are empowered to make their own operational decisions and whose success is measured on a local income statement level. Or it could be a result of the banking group acquiring local banks in new markets and thereby inheriting their legacy systems.

Either way, the more diversified a bank, the more acquisitive it has been, and the longer its history, the greater this challenge is in integrating the finance and risk views of the world.

It is not going too far in fact to say that this integration problem is the single greatest problem facing banks going forward, particularly in a world of ever greater complexity, frequency and detail in the demands of regulation.

Once again, the reason Richard Fuld and John Stumpf are deemed by the market to have failed in their duty of being effective custodians of their banks’ respective balance sheets, is not because they were inherently

BANKING

dishonest, or even derelict in their duties. It is perhaps because they failed to understand that their key role was to manage an information organisation, rather than a sales and marketing organisation.

This issue of senior management in banking emerging primarily from trading or transacting backgrounds is evidence – across many successful “Should banks banks worldwide – that in spite of the ongoing costs and frustrations of the complex problem of information management, the critical nature of be viewed first this problem is not yet fully understood. Should banks be viewed first as as information information processing organisations, and second as sales and marketing processing organisations, they would choose managers whose skills and purpose are organisations, and better aligned to the task. And, as elucidated, it is a complex and ever- changing task, fought on a highly competitive playing field. second as sales and marketing Banks have become an extension of state policy organisations, The fourth significant challenge that banks face today is the degree to they would choose which they have been coerced by government, and by the prevailing managers whose orthodoxy of the state, to act as policeman in a world increasingly driven skills and purpose by fear. are better aligned to There are many examples of this coercion and the manner in which the the task.” state is passing on responsibility and cost to banks throughout the world, but there are three areas of particular interest.

The first is tax. The imposition by the US tax authorities of FATCA (Foreign Account Tax Compliance Act) has led almost all banks world wide, irrespective of their own local laws, to implement complex FATCA indicia within their origination and client onboarding systems. Non-compliance, after all, can lead to an imposition on their clients of a significant withholding tax. This tax law has had an immediate and significant impact on so-called tax havens and the existence of secret bank accounts, and has led to significant political changes in countries such as Switzerland, whose economy has been historically propped up by the concept of non-disclosed bank accounts held in the names of offshore clients.

Of course, the net effect of reining in US tax dodgers is a positive one, and is an action that will be followed by most western nations in a process being implemented now called Automatic Exchange. These pieces of legislation should, over time, substantially reduce the degree and extent of tax avoidance that has led to such high and illogical tax rates in leading liberal democratic nations.

46 Ghosts in the Machine: The Nemesis of Banking

The question of course, for banks running as privately-owned institutions, is why the responsibility and cost for the hard labour required to identify US citizens and US-owned entities within offshore corresponding banks on a regular ongoing basis should be borne by them? Or, for that matter, why the corresponding bank – not even a US-based bank – should bear the cost on their side?

Irrespective, banks now face these costs, and any deviation – even to the slightest degree – in not meeting the US-written FATCA laws, can and will lead to souring relationships with US-based banks, as well as breaches of local laws in countries that have adopted the FATCA principles, sometimes under political pressure from their US ally. US tax laws have effectively – over a relatively short space of time – been written, codified, propagated, and implemented by banks worldwide. As Thomas Piketty – the renowned French economist – has pointed out on several occasions, FATCA and Automatic Exchange ended eight hundred years of Swiss bank account secrecy and client tax avoidance, in a matter of two years after FATCA was first conceived.

The coercion of banks into the fight against money- laundering and terror “ISIS, its cohorts, The second and third significant examples of just how deeply banks and all terrorist have been drawn into the world of cross-border politics, are the two organisations in requirements known as Anti-Money Laundering and Combating the general, would more Financing of Terrorism laws, commonly summarised as AML/CFT, and often combined into a single implementation within a bank. easily be beaten down by starving The idea is simple: ISIS, its cohorts, and all terrorist organisations in general, would more easily be beaten down by starving their supply their supply chain chain of funding rather than by fighting them in the streets at the cost of funding rather of soldiers’ lives. than by fighting Forcing banks to reveal the nature of their customers, their identities – them in the streets at and by exposing authorities to all suspicious transactions – will eventually the costs of soldiers’ lead to the noose being tightened around the necks of these terrorist lives.” organisations, and they will thus be starved of funding and of weapons – or so the theory goes. Whilst the CFT requirement is specifically targeted to fight terrorism, the AML rules are targeted to address other cross- border criminal activities, such as the laundering of money produced out of the international drug trade or trade in prostitution, or child- trafficking.

Ghosts in the Machine: The Nemesis of Banking

As with the tax example above, it is difficult to argue against this logic, and therefore it makes sense for governments working in tandem with each other against these terrorist organisations to force banks to bear the cost of implementing these systems. It is these systems that would possess the capability of constantly and diligently monitoring, observing and filtering through all transactions every day to sift out suspicious transactions.

The trouble is that this cost is not one that will assist banks in attracting equity investment and fresh capital. It is a cost whose outcome is asymmetric: no news is good news, whereas bad news could lead to extensive and painful fines or, worse, to sanctions. In all three of the cases cited above, the tax case, the terrorist financing case and the anti-money laundering case, it is sensible for banks to act as agents on behalf of the state, but the costs and complexity borne by these banks make them less attractive to investors, and more difficult to manage.

Once again, there is a significant risk in banking that does not exist in most industrial organisations, and that has to do with the fact that the business of money is at the heart of illegal and terrorist activity. As such, banks face a greater burden than industrial firms typically would, and this burden is one that has enormous downside risk if not properly addressed.

The ideal bank is one that is now extremely suspicious of its customers, “... there is a and is party to the notion of having to constantly know – irrespective of an individual’s rights of privacy – everything to do with its customers. significant risk This is not only a moral problem, it is an information management in banking that problem. As evidenced by the enormous fines levied against banks that does not exist in were caught trading with Syrian counterparties during the period of US most industrial sanctions on Syria, the financial risks are significant in not implementing world-class monitoring systems across all transactions emanating from organisations, and the bank. that has to do with the fact that the Increased capital and liquidity requirements on banks business of money Which brings the argument to the fifth major challenge facing banks is at the heart of today, and that is the increased capital and liquidity requirements that illegal and terrorist have been imposed on all international banks since the advent of Basel III activity.” and Dodd-Frank as a result of the anger generated out of the 2008 financial crisis.

These capital and liquidity requirements are complex but their net result is that the old-school banking model of the heyday of the 1990s has

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been broken. Banks used to borrow short and lend long and this is now heavily disincentivised through the imposition of a metric called the Net Stable Funding Ratio.

Tier 1 equity capital adequacy requirements have effectively doubled since the 2008 crisis. From a systemic point of view this makes sense, since banks on aggregate will now have far more loss-absorbing capability. But on an individual bank level, raising the capital adequacy ratio ironically makes each individual bank more likely to fail, and therefore far riskier, since although they hold more capital to absorb risk, they will fail at the very moment they need to employ this capital to actually absorb losses. If Lehman taught us anything it is that banks will not lend to their competitors in a challenging market.

Banks will, under increased capital adequacy rules, be able to absorb greater losses for longer, in theory. But they will never reach that point “... there has because they will see funding dry up in the interbank market far earlier, been a significant merely because they crossed the capital adequacy thresholds imposed explosion in the upon them. costs of managing In the context of a business environment in which there has been a and processing data, significant explosion in the costs of managing and processing data, and and in transforming in transforming banks from being sales organisations into information management organisations, the increased capital and liquidity require banks from being ments could not come at a worse time. sales organisations One can understand the necessity for regulators to buffer capital on into information aggregate, and to mitigate interbank liquidity dependency between management banks, but they impose these rules at a time that banks face innumerable organisations ...” challenges in simply managing the enormous complexity of information they already have at hand. Regulators also forget that banks need to operate as attractive investment prospects to outside investors, otherwise their equity funding will get cheaper, and will be even harder to come by.

In terms of liquidity risk, and the imposition of the Net Stable Funding Ratio, one should once again recall that Lehman had enormous exposure to the CDO market and this was the reason interbank funding dried up. It is true that their death-blow was exacted by their peer banks refusing to roll over short-term funding, but the underlying cause was a significant failure of judgement on the part of their management in building such a significantly dangerous exposure to a single asset class. And this is perhaps the main point – that the extent of this exposure was probably not known to them owing to a failure in information management.

50 Ghosts in the Machine: The Nemesis of Banking

Summary

In summary, banks are now riskier than ever before. They face enormous regulatory requirements, both from a financial and risk perspective. New regulations have reduced their ability to return value to shareholders, and has undermined the fundamental business model of banking in which they intermediate on the yield curve.

They also face enormously increased costs in implementing systems and processes that effectively make them an extension of government, but for which they are not compensated.

For older and larger and more diversified banks, the challenges inherent in legacy systems, and the challenges of conflicting local and international legislation, has massively increased their costs of integration and their ability to accurately and timeously provide critical information to their managers. “Banks are yet to Banks are yet to understand, in the main, that they are information understand, in the processing organisations, rather than brands and sophisticated sales main, that they people. The CEOs of internationally diversified banks have emerged out are information of a Harvard Business School inspired model, very much the Milton Friedman model – in which the focus is almost entirely based on processing shareholder return. organisations, rather

In a world in which banks have been forced to take responsibility for than brands imposing tax law, for fighting the war on terror, and to do so with and sophisticated increasing costs, increasing complexity and increasing capital require salespeople.” ments, shareholder returns are not likely to be that impressive for some time anyway.

Should bank executives take the long-term view, should they plan and execute information processing as their primary capability, and should they execute with the same kind of precision and care that one would expect in the aeronautical industry, for example, they will surely beyond any doubt be the executives who excel and leave a legacy of success.

This would require them of course to dodge some bullets, absorb Department of Justice fines, and have very thick skins. But, ultimately, the information executive, rather than the sales executive, will prevail. 

ECONOMICS

Front-Running the UK Economy

BY MONOCLE RESEARCH

n January 17th 2017, precisely 25 minutes prior to the “... in a hypothetical announcement of a crucial statistic relating to UK consumer world, had a price inflation, the traded value of the USD to GBP began a Osharp and steady rise from its level of USD 1.212 per GBP. The currency trader taken a had been trading in a range of USD 1.212 to USD 1.213 per GBP for USD 100 million some time. The announcement was imminent and would undoubtedly position, they have consequences on the exchange rate should the UK inflation figure would have made a diverge from analyst expectations of 1.4 percent. virtually Between 25 minutes prior to the announcement for the December risk-free profit of inflation figure and the actual announcement, the dollar began an inexorable rise to 1.218, the point at which it peaked, and the point at USD 500 000 in which the general population of traders, analysts, bankers and investors the space of half an learnt the truth: that, in fact, the UK inflation figure for the period hour.” ending December 2016 had eclipsed expectations and was reported at 1.6 percent.

Clearly, a selected number of individuals had had prior knowledge of the diversion of inflation data from expectations, and had then either traded the position themselves, or had leaked the information to others who had traded it on their own behalf. Whilst the actual trade would have at best only yielded a return of USD 0.006 per GBP, this amounts to a yield of 50 basis points – an enormously profitable trade, were one certain of the information about to be announced, and of its obvious implications to the value of GBP relative to the USD. It is also a trade that can be initiated, executed and shut down in the space of 30 minutes or less.

To stress the point: in a hypothetical world, had a trader taken a USD 100 million position, they would have made a virtually risk-free profit of USD 500 000 in the space of half an hour. Several recent studies have been conducted that have pointed out that in the UK in particular – where important statistical data are released to selected individuals, such as Prime Minister Theresa May, up to a day prior to the actual announcement – significant price diversion has been noticed in key financial indices and instruments.

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One recalls perhaps the most chilling example of this form of information arbitrage. In the week prior to the September 11th 2001 attacks on the World Trade Centre, the volume of put options acquired on US Airways was many multiples greater than normal trading volumes. In the case of the US Airways put trade, the effect was to strike – physically – at the economic epicentre of the western world whilst simultaneously substantially profiting from the attack itself.

In the case of early trading on the value of GBP versus USD – whilst being less dramatic and terrifying than the September 11th attacks – the persistent and fundamentally undermining nature of front-running the economic data releases, is ultimately undermining and deleterious to the broader economic and social conditions of the western world. It is this nature of insider trading – which continues to persist – that remains a “... the continued broadly destructive element to the financial markets in general. malpractice that These kinds of manipulations of the financial system have been revealed seems to go on to be ubiquitous across a range of markets – think of the broad extent of the LIBOR rigging scandal, all the way through to the manipulations unabated within the of the South African Rand. No analyst is yet able to successfully and financial markets cogently explain why, on Thursday the 16th of March 2017, at the very not only erodes moment that the US Fed increased the Fed funds rate, the value of the value for the average Rand counterintuitively strengthened against the USD. All logical theory would have it that were the spread between US rates and ZAR rates to investor, but also narrow, the carry trade on ZAR would be less attractive and the South erodes confidence in African Rand should weaken in response. the body economic Naturally, there is a persuasive argument that can be made that the rate itself.” increase, given the nature of the fiscal policies being adopted by the Trump administration, was virtually a given and had therefore been priced into the value of the Rand. What is not explainable is that the Rand, in the moments following the Fed announcement, immediately rallied. In the context of the current investigations into the manipulation of the Rand by currency traders in 17 banks worldwide, one is left with little solace in rational economic theory, since, in a world in which information is not shared equally, the reasons for currency moves could be subject to just about anything one could imagine.

This is in fact the real problem: the continued malpractice that seems to go on unabated within the financial markets not only erodes value for the average investor, but also erodes confidence in the body economic itself. This leads to the kind of primal response that one sees in the anti-Davos

56 Front-Running the UK Economy rallies, in the Occupy Wall Street movement, and in the general apathy “If there are fewer that pervades the western democratic system. good minds applied Unfortunately, the response from regulators and the response from to analysing the their masters, the politicians themselves, has been reactionary and idiosyncratic risk counterproductive in nature. Basel III, imposed upon banks post-crisis, has led to several extremely negative effects: increased capital adequacy within companies, demands have made banks far riskier, far more difficult to invest in, and there will naturally less efficient. be greater scope Within the world of investment management and sell-side investment for distortion and banking, the Mifid II directives, expected to be implemented by 2018 – even fraud within which demand that fees for research and fees for volume trading be clearly financial reporting, delineated – have already led to a substantial reduction in the number of rather than less.” research roles within the broker and investment banking industry, and to a blood-letting of jobs that are critical for the collective good. If there are fewer good minds applied to analysing the idiosyncratic risk within companies, there will naturally be greater scope for distortion and even fraud within financial reporting, rather than less.

Whilst these regulations appear to be necessary given the behaviour of financial institutions, their aggregate effect is negative. It reminds one of a teacher who, rather than isolating and disciplining a particular child, punishes the entire class and thereby erodes the process of learning.

It is remarkable how few individual criminal convictions have emerged out of the raft of market manipulations that have been uncovered over the past decade, and it is uncanny how executives have dodged the bullets. The only way those few who undermine the entire construct of western democracy and capitalism will stop is if one were to treat them as they should be treated, as criminals. 

Travis Kalanick and the Future of Leadership

BY MONOCLE RESEARCH

n the evening of February 5th 2017, the night of Super Bowl Sunday, Travis Kalanick, CEO and founder of Uber, the ride hailing app, took an Uber Black trip with two female friends, Oin a vehicle driven by a man by the name of Fawzi Kamel. Unbeknown to Kalanick, the conversation that then ensued in the vehicle was videocam recorded in full, and later posted on YouTube, much to the ire and embarrassment of Kalanick.

It displays – to the extent that a short piece of video footage can – the character of Kalanick: entering into an argument with the driver – prompted somewhat ironically by one of his female friends’ comment that Uber is currently having a hard time of it lately – over the steady reduction in fees that Uber Black drivers have been experiencing over the past several years. At its apex, the argument leads Kalanick to become dismissive, defensive and somewhat abusive when the driver claims he has, through his ‘employment’ with Uber, gone into bankruptcy and lost over USD 90 000, owing to Kalanick’s reduction of pricing per mile. “Undoubtedly, As recently as 2012, Uber Black car drivers charged USD 4.90 per mile, Kalanick had whereas they now charge USD 3.75 per mile. Kalanick at first denies this fact in the increasingly heated argument with Kamel, and loses patience received some and tells the driver, “Some people don’t like to take responsibility for cogent advice that their own shit.” the best response Days later, after the video goes viral, Kalanick takes on a meeker tone, to his belligerent writing in an email to corporate staff, “To say that I am ashamed is an outburst would be extreme understatement.” He goes on to write, “It’s clear this video is a an admission of his reflection of me – and the criticism we have received is a stark reminder that I must fundamentally change as a leader and grow up.” faults and a focus on his desire to alter the Undoubtedly, Kalanick had received some cogent advice that the best response to his belligerent outburst would be an admission of his faults manner in which he and a focus on his desire to alter the manner in which he leads – in leads ...”

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fact to address investors’ key concern as to whether he possesses the temperament to lead at all. Uber is now valued at USD 69 billion, and has been heavily funded by venture capitalists and institutional investors. The firm has been wracked by a rash of bad news of late – the source of “These troubles his friend’s original question, which led to the argument by the way – come on the heels of including sexual harassment suits, claims of a toxic corporate culture, other fundamental accusations of intellectual property theft, and the resignation of top business challenges design engineering personnel from the firm. that go to the heart These troubles come on the heels of other fundamental business of Uber’s business challenges that go to the heart of Uber’s business model: the status of drivers as one example, their lack of insurance cover, the reported rapes model ...” that have taken place in India, and their market share decline. As an example, Uber’s main rival in the US market, Lyft, has experienced a significant increase in market share since the anti-Uber social media campaign #deleteuber began on January 29th 2017.

According to TXN Solutions, a research company, Lyft’s market share of the US market went from 16.5 percent as at January 29th to 20.9 percent less than three weeks later. The friend’s question, whilst not being necessarily the kind of question Kalanick would have wished to face during the celebrations that mark that most endearing of American customs – Super Bowl Sunday – was nevertheless a fair one, and one that is being asked by investors and drivers not only in the US, but worldwide.

The Kalanick character analysis phase that began after the February 5th Super Bowl Uber Black ride debacle began in earnest with a Bloomberg Businessweek analysis piece that was published on February 28th and that was followed up in the Financial Times with a ‘Long Read’ piece published on March 9th 2017. Both articles detail the resignations within Uber management, and the risks to investors of having Kalanick at the helm of this behemoth of new age technology-driven commerce.

But neither ask what is the more compelling question. In no way wishing to diminish the severity of sexual harassment charges, nor the resignations of top officials, nor even the courtroom battles Uber is now ensconced in through its aggressive growth tactics, the real question goes back to Fawzi Kamel’s initial point to Kalanick. The prices per mile have steadily declined over the past four years, and surely this is unsustainable.

Between the moment when Kalanick goes postal on Kamel, and minutes before that in which Kalanick is still adopting the strategy of denial, Kalanick bleats, “No, no, no. You misunderstand me. We started high-

60 Travis Kalanick and the Future of Leadership end. We didn’t go low-end because we wanted to. We went low-end because we had to because we’d be out of business.”

Whilst one may be forgiven for thinking Kalanick is referring here to standards, he is not. He is in fact referring to prices when he uses the phrase “low-end”. This is the main point: Uber’s strategy, which Kalanick is executing and will continue to execute, is to use investor funding, aggressive lobbying tactics, and social media campaigns, to utterly elimi nate all competition. He is doing so not by offering a superior service, but by continuing to raise funding to subsidize rides, on a massive scale and worldwide, until the competition is starved of cash, and ultimately dies.

After this has been achieved he will then be able to raise prices to whatever level he wishes, earning his investors disproportionate profits – which is why they have been happy to invest in his loss-making business in the “Uber’s strategy, first place – and to do so in a monopolistic world. which Kalanick This is the main point he his making to Kamel: hang in there and all is executing and will be good, because then we can all share the spoils of total market will continue to domination. To blame him for this – in fact to expect him to apologise execute, is to use for this – is disingenuous. It is the investors we should question. They are knowingly investing in a firm that is still, to this day, generating negative investor funding, free cash flow. It is a firm that, despite negative free cash flow, is still aggressive lobbying dropping prices and margins. Uber is massively appealing primarily to tactics, and social investment for ride subsidization to an even greater extent than in 2012, media campaigns, to when Kamel started his venture as an Uber Black driver. utterly eliminate all The sole purpose of this investment strategy is to eliminate competition competition.” through pricing, the precise issue that the US government, antitrust lawyers, regulators, and the protectors of the freedoms of the capitalist markets have with China, and have had with Microsoft, as an example. Microsoft, after cynically embedding internet explorer search capabilities into their software bundle – which they insisted consumers needed to acquire as an embedded service – ultimately did lose a raft of antitrust cases. But by then it was too late. Their competition had been ravaged and left for dead.

If investors in Uber are happy to strangle competition in an industry as crucial as transport and logistics by knowingly supporting this business model, then they need to live with the consequences: and that is Travis Kalanick, whether he be of good moral stock or not. 

Of Soothsayers and Evangelists

BY DAVID BUCKHAM

here is a new and growing genre in bookshops that conceptually sits somewhere between Politics, History and Economics. It should properly be called Polemics, but the purveyors of the Twritten word will generally place this new material either on their History shelf or on their Economics shelf – possibly through a misunderstanding of the purpose of the books, or simply because they do not have Polemics as a dedicated section.

More likely, however, it is because polemical writing is usually about something, or more specifically about undermining something – such as politics – rather than being something in and of itself. Its underlying topic – if all polemics were to be grouped in their own section of a bookshop – would be a smorgasbord of confusing subjects. You would have Nassim Taleb’s Fooled by Randomness sitting alongside the holocaust denialist David Irving, rather than finding their books in the Economics and History sections respectively.

As it stands, Nassim Taleb is generally to be found beside luminaries such as Joseph Stiglitz, truly a case of putting the cat among the pigeons; and Irving’s Hitler’s War, insultingly, will be found sandwiched between David Stevenson’s The History of the First World War and Philip Short’s Pol Pot. Or worse, even in a respectable bookshop, it is not an impossibility to find Irving’s Goebbels: Mastermind of the Third Reich – a study in historical revisionism and a sycophantic nod to one of history’s worst psychopaths – hugging the jacket of William L. Shirer’s The Rise and Fall of the Third Reich, the definitive tome on how it was possible for Germany to allow the dominance and banal evil of Nazism to overcome them.

In the case of Nassim Taleb, whilst his books on the surface would appear to be about the financial markets and risk prediction, they are really and truly purely polemical pieces of invective against all – really all – economic modelling, infused with a sociopathic dislike of most economic thinking. They are frustratingly inconclusive and unhelpful in their results,

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appealing to a mysticism of perspective, and at best invoking little more than fear. In Irving’s case, despite the distasteful position he adopts, there is at least some academic basis, but his work quickly falls prey, both in its arguments, and in its facts, to his undeniable anti-Semitism. His purpose is no different to that of Trump’s advisor Steve Bannon, previously the chairman of Breitbart News, and about as right-wing a commentator as one could find in a liberal democracy at present. His purpose, clothed as academic history, is really a political purpose, a manifesto.

It is therefore one of the ironies of bookshop browsing as a casual activity that the observant browser will, on occasion, be able to identify the polemics amongst the historians, the economists, and the politicians. The ‘art’ of vociferous argument, infused with sarcasm, fraught with diabolical assumptions, aggressive in tone, and dismissive of scientific balance as a “The worst forms of genre of writing, is often scattered, unbeknown to most, throughout the polemical writing bookshop, like the spies who were embedded in European cities such as Berlin and Brussels, posing as artists and journalists, and clerks, during are no different the height of the Cold War. to the pamphlets To further confuse matters, one needs to stress that there is a distinction distributed at right- to be made within the genre of polemical writing itself. A lot of it is bad, wing rallies, preying and some of it is good. There is nothing wrong per se, in taking on, right on fear, urging from the start, a strong position in one’s argument, and pursuing that immediate and argument with vigour, whilst also acknowledging the existence and roots thoughtless action.” of the thinking and philosophies one is attempting to undermine. That is a very different matter, however, to writing a pure manifesto, picking one’s ‘truths’ out of context, perhaps even taking things further and engaging in the new and oddly accepted art of ‘post-truth’, exemplified by the phenomenon of President Trump’s tweets.

When an esteemed long-in-the-tooth publication such as Time magazine finds it necessary as recently as April 2017 to publish an issue on a solid black background cover, with the words only ‘Is Truth Dead?’ in the colour red, then it is apparent that there is value in making the distinction between good polemics and bad polemics. Good polemics inherit their value from the art of polemical writing, a genre and form of entertainment, and an essential part of the history of academic debate going all the way back to the Forum in Greece three thousand years ago, from bad polemical writing – the writing of unadulterated lies in an effort to justify, and to recruit, and to cloud better judgement. The worst forms of polemical writing are no different to the pamphlets distributed

64 Of Soothsayers and Evangelists at right-wing rallies, preying on fear, urging immediate and thoughtless action. To a large extent, the trouble lies in the value of truth one ascribes to the published word, irrespective of its true agenda.

Good polemical writing has a long history, stretching back to Greek and Roman literature, but in its modern form – post World War II – it finds its most strident voice in writers like Christopher Hitchens. In the passage of his oeuvre one can trace his transformation from war reporter, to essayist, to activist, and polemicist and finally, in his dying days, to biographer. If one is looking for something written by him, one is going to have to look in several sections within the bookstore: to find Hitch-22, his confessional autobiography which eclipses in excellence all his previous work, is easy – just go to Biography. Whereas to find his vitriolic attack on Mother Theresa – titled The Missionary Position just to give an idea of its tone – is far harder. It could be anywhere – in History, “To a large extent, in Politics, in Religion, or even in Economics. the trouble lies in

This is the trouble with the new genre within a genre of left-leaning the value of truth political writing that has emerged out of the ashes of the liberal agenda one ascribes to the – in the wake of the political sharp right turn that has overtaken western published word, democracy in the past eighteen months. It is writing that is infused with irrespective of its the anger that is felt by the democratic middle-class and whose mantle is carried by the left-wing, primarily US-based, academic. One thinks here true agenda.” of Edward Said, whose career has been spent deconstructing the Western notion of the Middle East. It is intelligent, insightful, factually accurate writing – but it is also angry.

Another US-based author, whose intelligence and academic credentials allow her to adopt a vitriolic style without descending entirely into the realms of political manifesto is Naomi Klein. Her two most significant contributions have been The Shock Doctrine – The Rise of Disaster Capitalism and This Changes Everything, her diatribe on climate change. In both cases an academic style, rooted in fact and analysis, is not intrinsically directed to add to a growing body of analysis and argument in a traditional scientific sense, but is rather a full-blast attack on our sensibilities, aiming, as per her title, to shock us towards change.

The entire purpose of her work is to achieve social and political change through her word, rather than to be canonised in a literary sense. She is capable of the latter, but her purpose is the former. This is a genre that includes at its roots Karl Marx’s Capital: A Critique of Political Economy.

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“One comes away To give an idea of the extent to which polemical writing has become feeling that one mainstream, one only needs to look at the praise The Shock Doctrine received. Tim Robbins as an example said of the book, “It could very well is given no time prove a catalyst, a watershed, a tipping point.” to consider one’s When picking up a book like Jane Mayer’s Dark Money: How a Secretive options – agree now Group of Billionaires is Trying to Buy Political Control in the US, one should immediately and ready oneself for a political speech rather than an enjoyable historical adopt the mantle, discourse or a reasoned argument. Naomi Klein called Mayer’s book or you will be cast “utterly brilliant and chilling”, and that is precisely how we are meant to feel: terrified. The generic argument goes something like this: since away as a victim World War II and the Bretton Woods Agreement, since the establishment of mainstream of NATO, since the imposition of the World Bank and the International oppression.” Monetary Fund and other untold evils imposed upon the world, the rich have got richer and the poor have got poorer.

What is worse, Mayer argues, is that we have been duped – we have bought into the notion of capitalism and we have forgotten that it is not necessarily married to democracy, that the two can be separated. And meanwhile – other than impoverishing the Third World, and replacing jobs with robots – we are also destroying the planet. If we don’t stop now, it will all end in Armageddon. Mayer’s take on the topic is to veer towards conspiracy theory and conjecture, digging deep into specific organisations and shaming the individuals who have profited from the political control they wield through economic domination.

Reading this type of book can sometimes feel like that conversation you find yourself in with an old friend from university you haven’t seen for a while. They used to be a little intense, but you had no idea that over the ten years since you’d last seen them they had become evangelical – either towards Fundamental Christianity or towards climate change.

Climate change evangelists are no less vigorous in their proselytising than Fundamentalist Christians, or Tea Party right-wingers for that matter. You come away feeling that you are given no time to consider your options – agree now immediately and adopt the mantle, or you will be cast away as a victim of mainstream oppression. And there is no shortage of such evangelical and angry writing in the new literature of economics: there is Wolfgang Streeck’s How Will Capitalism End? and there is also Yanis Varoufakis’ And the Weak Suffer What They Must? In Varoufakis’ case, to be fair, his brief stint as Minister of Finance during Greece’s battle with the IMF over the question of austerity is enough reason to give his

66 Of Soothsayers and Evangelists book more than a cursory glance. Streeck’s book, despite its academic prowess, and its innumerable facts and figures, never actually answers its eponymous question.

In this vein of academically-based work, angry and immediate in tone, and on the topic of the apparent failure of capitalism, Paul Mason’s book Postcapitalism: A Guide to Our Future, makes for interesting reading. Rather than focusing on the notion that through exposing the ills and evils of the modern capitalist framework readers will be more informed – and therefore more active in their resistance to capitalist oppression – Mason takes on a far more ambitious task. His book truly is a manifesto: it argues essentially that the battle between socialism and capitalism is already over – that socialism is not the only alternative to capitalism, that capitalism is already failing and is being replaced with what he terms ‘postcapitalism’. He argues that the ideals of postcapitalism can achieve a more equal world only if his specific steps and milestones are followed. “Rather than focusing on the The skeleton of his manifesto is clearly laid out in the preface to the book. He writes, “So, I want to propose an alternative: first, we save notion that through globalisation by ditching neoliberalism; then we save the planet – and exposing the ills and rescue ourselves from turmoil and inequality – by moving beyond evils of the modern capitalism itself.” Whilst it is not entirely clear what this would mean capitalist framework – insofar as moving beyond capitalism is concerned, even in the later chapters – he is at his clearest when describing the forces that will drive readers will be more this change. The kernel of his idea is that a ‘networked economy’, informed – and exemplified in his idea of ‘networked individualism’ rather than in the old therefore more active notion of the ‘community-based’ worker – and driven by new technology- in their resistance to enabled capabilities – will achieve the benefits of postcapitalism. capitalist oppression Once again, these benefits are, at best, opaque – even after a thorough – Mason takes on a reading. Of course, there are throughout the book the use of broad-stroke statements in respect of reduced inequality, and enhanced individual far more ambitious efficiency and a new kind of government. But there is little that one can task.” really call a defined outcome. Where he is most insightful, however, is in his analysis of the processes he claims as the key driving forces behind postcapitalism. Specifically, in describing the three impacts of the ‘new technology’ on the old notion of the market-driven neoliberal economy, he is fascinatingly original.

“First,” he argues, “Information technology has reduced the need for work, blurred the edges between work and free time and loosened the relationship between work and wages. Second, information goods are corroding the market’s ability to form prices correctly. Third, we are

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seeing the spontaneous rise of collaborative production: goods, services and organisations are appearing that no longer respond to the dictates of the market and the managerial hierarchy.”

His third point is palpable already in every aspect of our lives, from the way the consumer purchases goods online, to the rise of peer-to-peer lending, to the use of cryptocurrencies as viable exchange alternatives. Probably the best example of ‘collaborative production’ is Airbnb, which breaks and transcends international boundaries, personal space boundaries, and has significantly upended not only the hotel industry, but also the entire tourism and travel industry. In respect of his second point, it is easy to think of examples in which market prices are no longer correct – at least for periods of time. There are, after all, well-documented cases in which market prices have been significantly manipulated by individuals and “... new technology firms that have cynically corroded the market system – the prices of oil and the phenomenon or aluminium as examples, or LIBOR for that matter. of social media, in Mason, however, is at his best when dealing with his first point – that tandem with the technology has radically and permanently altered the nature of work itself. In describing the opacity of distinction between working within erosion of a stable a community, and living and existing for oneself, couched in the term work environment, ‘networked individualism’, Mason cites the work of London School of has created an Economics professor Richard Sennett. Sennett specifically studies the individual who impact of greater job flexibility within the new highly-mobile hi-tech workforce. lacks character, who is fragmented.” Mason, paraphrasing Sennett, writes compellingly: “If work rewards detachment and superficial compliance, values adaptability over skill and networking over loyalty… this creates a new kind of worker: s/he is focused on the short term, in life as in work, and lacks commitment to hierarchies and structures, both at work and in activism.”

It is worth going further and quoting Sennett directly. He writes: “The conditions of time in the new capitalism have created a conflict between character and experience, the experience of disjointed time threatening the ability of people to form their characters into sustained narratives.”

And this really is the trouble with the new polemicists, and with economic and political writing in general – that one has to sift and wade through mountains of words, most of it banal or arrogant or reductive, to come across this nugget of pure gold. What an especially compelling and insightful observation to bring to the lay reader’s attention: that new

68 Of Soothsayers and Evangelists technology and the phenomenon of social media, in tandem with the “And it is a pity erosion of a stable work environment, has created an individual who too that there is lacks character, who is fragmented. such a dearth of And this is why we find ourselves in the midst of an all-out battle to save reasoned analysis the ideas at the heart of liberal democracy – choice, freedom, courage, community, empathy, truth – in a world of Donald Trump and Marine Le that would provide Pen and Nigel Farage. We are not overcome by political forces that peddle cogent proposals for fear, who shut borders, who threaten violence, who feed on distrust – change – proposals because they have good ideas. We are overcome by them because we have that would not become fragmented by the very technologies and changes that we long ago accepted and embraced. necessarily require the adoption of an We are an Instagram, selfie generation. We post ourselves and our lives evangelical stance.” on Facebook, but mainly we post ourselves. If there is any doubt in anyone’s mind of the extent to which this is true, simply observe the following: as of writing the value of Facebook is USD 420 billion, whilst the value of General Electric, which differs in that it is a company that makes many useful things from refrigerators to jet engines, is valued at USD 250 billion.

Of course, it would be tremendously naïve to nostalgically wallow in dreams of a previous time. That would be to forget that those same times had their own post-truths – the imminent Russian invasion, the space race, the segregated US South, and of course apartheid – but Mason’s hidden nugget of truth is a blow to the gut. Of course we lack conviction in community, and of course we lack empathy. There really is no space in our lives for activism when we are so enamoured with ourselves in such a fragmented reality. There are various versions of ourselves: the one who goes to work, the several on social media, and the one in which we are part of a community. And in blending them, we have become less significant to others, and more significant only to ourselves.

It is a pity really that there is such a plethora of impassioned – yet unbalanced – writing on a topic as important as our political and economic future. And it is a pity too that there is such a dearth of reasoned analysis that would provide cogent proposals for change – proposals that would not necessarily require the adoption of an evangelical stance. There is danger in crowd psychology, and the adoption en masse of simplistic ideologies. 

POLITICS

Apple and the Perverse Disincentives of the Tax Code

BY DAVID BUCKHAM

he fact that Apple – the most valuable company on the planet “The fact that with a market capitalisation of USD 740 billion at the time Apple – the most of writing, and a gross profit margin of 40 percent for the last valuable company Tthree years – pays one of the lowest effective tax rates of any Fortune 500 company, is surely abhorrent. on the planet ... pays one of the lowest It is further perplexing, even to tax experts in the US and Europe, that the actual tax rate that Apple pays is a question of great complexity. One effective tax rates European regulator, at least, pins it as low as 0.005 percent, a number that of any Fortune 500 has been derided by Tim Cook, Apple’s CEO, as “total political crap”. He company, is surely is right about this: Apple does pay more tax than this microscopic rate abhorrent.” would suggest, but there is no doubt that Apple has significantly avoided paying the tax it should pay by offshoring its intellectual property, by headquartering in Ireland – whose corporate tax rate is 12.5 percent for trading income – and by engaging in the process of what is known as inversion.

The downside of inversion, from Tim Cook’s perspective, is that should the profits made offshore by Apple ever be repatriated to the US, the US corporate tax rate of 39 percent will apply. No problem: simply never repatriate the cash, and issue debt instruments in the US to pay shareholder dividends. This way Apple can maintain its argument that it is operating within the boundaries of international tax law whilst maximising shareholder return.

What Tim Cook is forgetting is that the underlying technologies that make his company so powerful – the internet, the microprocessor, the LED screen, basically the very idea of the computer itself – were invented and largely funded by US government grants and research, either directly, or indirectly through the provision of world-class education and research facilities. He is also forgetting that the environment in which Apple was founded is one that is unique in the world: a country in which

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“If Tim Cook is to entrepreneurship and risk-taking and innovation is encouraged more be believed, after so than anywhere else. To a significant extent, the current battle that is underway between European authorities and Ireland – in which Ireland, all, Apple never under a recent ruling, is forced to charge Apple USD 14.5 billion in back engaged in any taxes – perhaps misses the main point. illegal activity or If Tim Cook is to be believed, Apple never engaged in any illegal activity set up any illegal or set up any illegal structure to avoid paying taxes. They merely optimised structure to avoid the existing legislation. Tim Cook is also correct in calling the problem paying taxes. They a political one, rather than a legal one. He is of course referring to the merely optimised the apparent coincidence between the European Parliament’s tax claim on Apple and the US Department of Justice decision to fine Deutsche Bank existing legislation.” – in both cases for an amount that is approximately USD 14 billion.

What is telling, however, is that despite the furore over Apple back taxes, the debt that Apple issued in the US to pay shareholders a dividend – since they did not have cash to pay the dividend as it was trapped offshore – was a tax-deductible expense.

Think about it: interest payments on debt are treated by accounting standards worldwide as above-the-line expenses, and are therefore tax deductible. The more debt therefore that a corporate entity holds on its balance sheet, the greater its tax shield, and the lower its aggregate tax rate. On the other hand, if a company in the US has no debt, it will pay a tax rate of 39 percent on its profits before tax. The tax incentives then appear to be strongly weighted against profits, and thereby against equity holders, and appear conversely to be strongly weighted in favour of debt issuance and debt issuers, i.e. the banks.

Thinking in terms of a risk and return framework, in which one would like to see risk-taking rewarded with higher returns, it would seem that the manner in which the world calculates tax in general is perversely anti-capitalist.

Recall that it is the equity holders who are taking all the risk here – they face complete loss should an Enron or WorldCom-like event occur. Whereas the debt holders are protected not only under bankruptcy laws – they are armed also with the power to seize collateral and physical assets and even intellectual property. In extreme cases, they are able to sequestrate individuals. And, to be perfectly clear, should things really get rough, as they did in 2008, the debt holders may also be protected

74 Apple and the Perverse Disincentives of the Tax Code by the government, which will bail them out, as governments around the world bailed out their global and systemically important banks in the blink of an eye.

From a tax perspective, the incentives then – within a capitalist framework – seem perverse. The greater the debt, the lower the tax – the greater the profits, the higher the tax. The more innovative a firm is, and the less dependent they are on debt, the higher their tax rate will be, and the lower the return to shareholders will be. No wonder then that there was an enormous growth in US corporate leverage, as well as in household leverage, in the run-up to the 2008 financial crisis.

Increasing capital adequacy requirements on bank balance sheets is small shrift compared to the effect that a radical change to the US tax code would have on the problem of leverage and its deleterious effects on the world economy. It has been undeniably demonstrated by a raft of “The more economists that there is a direct correlation between aggregate debt levels innovative a firm and the advent of economic crises. is, and the less So then, imagine a different world in which one could alter the tax dependent they are code. And to be clear: this really would be a thought experiment, since on debt, the higher the unravelling of over 75 000 pages of US tax code would be more challenging to pass through Congress than any radical Trump idea that their tax rate has thus far been floated. will be, and the lower the return In this radical change to the US tax regime – hopefully leading to a knock-on effect worldwide as other countries adopt similar policies to shareholders to remain competitive – one invokes the following. Firstly, interest will be.” payments by corporations would only be tax deductible up to a certain ideal leverage level. Any interest expenses above this ideal leverage level would no longer provide a tax shield. Further, one could imagine in fact a tax liability being raised against excessive leverage – and excessive interest expense – in order to promote counter cyclical corporate behaviour

Secondly, all research work, all work related to patent submissions, and all work related to the creation of intellectual property, would be tax deductible. The shortfall in tax receipts from this second directive would be amply funded by tax receipts from the first.

Thirdly, the US would invoke a see-through principle, such that a single US corporate tax rate is applied to profits, irrespective of where in the world they are earned, and irrespective of corporate structure

75 BANKING

and financial engineering. Of course, this is already the case barring the continued manipulation of differences in international tax codes that are employed in sophisticated ways by Fortune 500 firms. Basically, an end to the process of inversion.

Fourth, the US corporate tax rate would be pulled back from its current eye-watering level of 39 percent to a far more reasonable rate, again amply funded by putting an end to inversion and the advantages of the Irish corporate tax rate, as an example.

Fifth, all tax havens would be shut down finally and thoroughly. The notion that thousands of companies can be domiciled in the Cayman Islands and that that is where the intellectual property and goodwill sits that generates billions of dollars in profit is simply absurd and a scourge upon the notion that we behave as civilised people. In fact, it is these tax “... it is these tax havens, frequently employed by both large corporate entities and wealthy havens, frequently individuals, that necessitate such high corporate tax rates in the first employed by both place, since the sheer value of what these islands rob from the mainland is staggering. large corporate entities and wealthy Finally, US tax authorities would do away with all dividend withholding tax and all capital gains tax. It is counterintuitive that an investor who individuals, that has taken the risk of total loss is taxed on profit; then – after retaining necessitate such earnings for the sake of sustainability – is taxed on dividends. And finally, high corporate tax after having taken all these risks and now wishing to exit the position, rates in the first is then taxed on capital gains. Whilst Apple’s global corporate structure would appear to be cynical and designed entirely around US tax code, place, ...” one is compelled to agree with Tim Cook were he ever to make the real point: that the tax code disincentivises investment. Of course, he can never make this point because it would jar with his position – that Apple is simply maximising returns under current conditions.

There is a wonderful Raymond Carver story called What We Talk About When We Talk About Love. For any student of American literature, it is a seminal piece. The story somehow gets to the very heart of relationships and how they are damaged and how people arrange their lives to manage their relationships without ever really speaking to each other, not properly.

When one follows the European case against Ireland and makes witness to the legal mud-slinging and technical complexity of calculating effective tax rates on firms like Apple and Pfizer, I sometimes think that what is

76 Apple and the Perverse Disincentives of the Tax Code needed is a complete reboot: something along the lines of What We Talk About When We Talk About Capitalism. Because what we are talking about right now are fines, wrist-slapping, loopholes and legal fees.

If there is any desire that remains for leaders to preserve the principal edict of capitalism: to reward innovation and to drag the middle and bottom of the bell curve of earners to better lives through broad-based economic growth, then we would have to address the main issue: tax. 

The FICA Bill: Emblematic of South Africa’s Current Political and Economic Issues?

BY NATALIE CLOW-WILSON

Why Drug Dealers Live With Their Mothers” was one of the essays that appeared in the popular book Freakonomics. In short, the study revealed that most drug dealers never leave home because of a simple “economic reality: they can’t afford to. Equally, when the Mafia infiltrator, ‘Donnie Brasco’, wrote of his years undercover, he described the life of his fellow ‘wise guys’ as financially insecure – albeit with brief spikes in income. It seems that it is really only the kingpins of the underworld who accumulate a stock of wealth too great for the base of a mattress. The banking system is thus not so easily avoided if you’ve managed to amass some wealth – by means foul or fair.

As far back as 1989, this became apparent to members of the G7 group of countries who initiated the formation of the Financial Action Task Force (FATF) – an inter-governmental organisation headquartered in Paris. The organisation’s core mandate is to set international standards for legislating, regulating and fighting against money laundering and the financing of terrorist activities. South Africa became a member of this body in 2003, but in 2001, we had already taken steps to introduce anti-money laundering legislation, with the promulgation of the Financial Intelligence Centre Act. This Act provided for the establishment of a supervisory body, “... the study namely the Financial Intelligence Centre (FIC), which requires financial revealed that most institutions to report on ‘suspicious or unusual transactions’ (amongst drug dealers never other things), with a view to detecting financial crimes that threaten the integrity and security of the financial system. This is also one of the over- leave home because arching objectives of the Financial Action Task Force. of a simple economic

The FATF monitors compliance levels of its members by means of peer reality: they can’t reviews, known as ‘mutual evaluations’. However, as far back as 2009, afford to.” South Africa’s Mutual Evaluation revealed a number of areas of non- compliance, including: customer due diligence and record-keeping, beneficial ownership and politically exposed persons (‘PEPs’). These issues

79 BANKING

were duly addressed by the FIC Amendment Bill, tabled by Treasury in Parliament in April 2015. The Bill went through the National Assembly in October 2015, following which, the normal parliamentary process began, reaching completion in May 2016. It was then presented to President Zuma on 13 June 2016 – either to sign or to refer back to the National Assembly, in terms of his constitutional duties. The President, however, took no action, later revealing that he had been petitioned not to sign, by Mzwanele Manyi of the The Progressive Professionals Forum and Danisa Baloyi of The Black Business Council. The official reasons behind their objections to the Bill were based on the claim that it was ‘unconstitutional’ because it allowed for warrantless searches. However, other objections relating to the Bill’s handling of politically exposed persons began to come to the fore, suggesting that opposition to the Bill lies at the heart of South Africa’s present political and economic reality.

President Zuma failed to take action by September 2016, thus prompt ing the Council for the Advancement of the South African Constitution (CASAC) to do so. They issued a letter urging him to comply with his duties, failing which, they would ask the courts to intervene. Once again, he did not act and CASAC approached the Constitutional Court on the matter in November 2016. CASAC’s court action was successful in that it forced the President to refer the Bill back to Parliament for debate, in January 2017. It was at these Parliamentary Standing Committee meetings on finance that the reality of the issue of politically exposed persons came to light. This became evident despite the fact that the debate was supposed to be confined to the issue of ‘warrantless searches’ – the “Failure to get the official reason for it being opposed in the first place. amendments passed Despite this opposition, a sufficient number of MPs were convinced by legal opinions that the Bill was indeed sound, and, in late February 2017, into law may not it was adopted by Parliament. Presidential sign-off, however, has yet to only result in South take place.

Africa being placed At the same time, South Africa received a ‘stay of execution’, so to speak, on a global blacklist, at the FATF’s plenary session in Paris from 20 to 24 February 2017, with but will have far- an extension being granted until June 2017 for the country to correct what the organisation terms ‘serious deficiencies’ (as documented in reaching economic the FATF’s “Outcomes of the February 2017 Meeting of the Financial consequences.” Action Task Force”). Failure to get the amendments passed into law may not only result in South Africa being placed on a global blacklist, but will have far-reaching economic consequences. These include making it more difficult (and hence more expensive) for South African banks to do business with international banks. Not to mention the implications for foreign direct investment in an emerging market seen to be very reluctant

80 The FICA Bill: Emblematic of South Africa’s Current Political and Economic Issues? to conform to international money-laundering best practice, as well as a freshly-awarded junk status rating.

Despite South Africa’s outdated laws, financial institutions are still obliged to comply with an FIC Act, last amended in 2008. More than a year after the dust had settled on the Gupta family’s landing at the Waterkloof airforce base in 2013, South Africa’s banks were quietly flagging transactions and re-considering their business dealings with the Gupta’s firm, Oakbay Investments. By mid-2016, the Financial Intelligence Centre had received a total of 72 ‘suspicious’ or ‘unusual’ transactions connected to the Gupta family, dating from 2012 to 2016, when the Big Four banks eventually closed all Gupta-related accounts.

The banks cited compliance with international banking rules as the reason they made the decision to close the accounts. They were followed by the South African branch of Bank of China in September 2016, and, “Uncannily, the most recently, Mumbai-based banking institution, Bank of Baroda (with branches in Sandton and Durban) has also shut down their accounts. expiration date Simultaneously, the Guptas began pursuing other avenues in order to be of the Vardospan able to transact financially. In November 2016, their business associates, deal was 31 March Salim Aziz Essa and Hamza Farooqui made a bid for the South African division of Habib Overseas Bank, through a company named Vardospan. 2017 – the day The Luxembourg-based parent company of Habib Overseas Bank, that the news of the however, attached a condition of sale: Vardospan needed to obtain a Finance Minister’s banking license in South Africa. Such a license is granted by the Registrar unceremonious of Banks, with the approval of the Minister of Finance. Uncannily, the expiration date of the Vardospan deal was 31 March 2017 – the day that midnight firing, the news of the Finance Minister’s unceremonious midnight firing, broke. broke.” At the time of writing, Pravin Gordhan’s successor, the newly appointed Minister of Finance, Malusi Gigaba, had not yet managed to approve Vardospan’s banking license. He may have been pre-occupied with the knowledge that S&P would downgrade South Africa to sub-investment status, one working day after his appointment. 31 March 2017 was also approximately one month after Parliament adopted the FIC Amendment Bill – and by when President Zuma should have signed it. If he does not sign the Bill, we will have to wait until June this year to see whether National Treasury’s newly-led delegation to Paris will be looked upon as kindly as our February representatives.

But, as recent history has shown, the FATF’s recommendations wield substantial de facto influence over financial institutions wanting to transact on a global stage – whether their home countries adopt the recommendations as law, or not. 

OPINION

On the Infinite Beauty of Valentino Rossi

BY DAVID BUCKHAM

e arrived by taxi at the track for the Saturday qualifying session and we were late. We had been held up by some poor planning, by breakfast at the hotel, and by the line of trafficW that had begun at least three kilometres from the main entrance to the Circuit de Catalunya. Breakfast had been wolfed down at the hotel on the beachfront of Barcelona. In retrospect, we should have just grabbed some croissants and headed out earlier.

The Circuit de Catalunya is forty-five kilometres out of Barcelona proper, and sits in the foothills between the Catalan capital and Girona, and it seemed to us that the entirety of Spain had decided on the same itinerary as us – qualifying on Saturday, a tour of the paddocks, and the main races on Sunday. We got out of the luxury sedan provided by the hotel and walked the freeway to the main gate and found ourselves run-walking in childish excitement to just get into the stands.

Security queues held us up, but it was no matter. The sheer number of fans for the 2016 MotoGP weekend in Catalunya, and the obsession that the Spanish have for the sport, had us in awe. There were thousands and thousands of people who had arrived on bikes. The sound of the machines ran like a base undertone throughout the Circuit complex, every now and then punctuated with the scream of an unencumbered monster GP “Luis Salom, we bike hitting 320 kilometres per hour down the main straight. Even in the learnt, a Moto 2 parking lot, it was heaven. rider, had perished When we finally got through security and found our seats, we began in the Friday to sense an undertone of strange stillness, of sadness. Luis Salom, we afternoon practice learnt, a Moto 2 rider, had perished in the Friday afternoon practice session, inexplicably session, inexplicably failing to make one of the last turns of the Circuit, failing to make one and sliding at high speed into a barrier wall, his heartbeat ceasing on the helicopter flight before even reaching the hospital. He was twenty-four of the last turns of years old. the Circuit ...”

85 BANKING

We could feel the sadness of his death hanging over the Circuit – there was something awkward about being there, about celebrating this arena of racing at the very limit of human endeavour, when that limit had already been crossed. I made a comment then to my friend who had joined me in Spain to see the main race and to see Rossi, our hero, that in our world – today’s world – the gladiators are not meant to die.

That discomfort had to pass however. We had to see qualifying, as did the crowds around us, and we shuffled along through the retail stands – Valentino Rossi caps, Marc Marquez caps, Lorenzo shirts and caps, Honda Repsol colours, Yamaha colours, Ducati colours and the paddock girls, geared up in heels and make-up and the gaudy unashamed in-your- face marketing that somehow makes the whole image even more alluring, not less. In some ways, I told my friend, it is like walking through a market in Jerusalem – so many conflicting ideas and views of the world vying for our attention. One must just pick one’s hero.

Of heroes, for us – as for most – there was and remains only the one. Rossi. His very name evokes meaning – meaning that is decoupled from the naming of the man himself. He is a brand, yes, but he has now transcended even that status. He is now an idea. Of the man Valentino Rossi, we can say this: he is a phenomenon, he has changed the way racing is executed at the highest level of the sport, he is a joker, he is a clown, he is a businessman, he is a beautiful man, and he is nine-times “He is a brand, world champion. Of the idea – of the idea we call Valentino Rossi – we can say far more. But to do so would first require that I explain why I love yes, but he has now the motorcycle racer called Rossi. transcended even There are two things I particularly love about Valentino Rossi. The first is that status. He is the way he races against his rivals, usually Marquez or Lorenzo through now an idea.” the 2015 and 2016 seasons. He races from behind to beat them through wiliness and through courage and by hook or by crook. He is unrelenting – and for this many despise him. He races to win and he does so without a doubt in his head that he deserves to win, not because he is better than them – because truth be told he is not – but because he is more realised than they are, as a man and as a human being.

You can see this in the way he rides: I challenge anyone to deny this. He is racing in a higher state of self-realisation than any of his competitors. He does not arrive at this arena of human courage with the youth and fearlessness of Marquez, nor with the precision and coldness of Lorenzo, nor with the flourish and gusto of Dovizioso – he arrives not for his

86 On the Infinite Beauty of Valentino Rossi career, nor even his fans, nor even for himself. This is not what he does, this is who he is. And this is truer in his case, than in any other, regardless of the sport.

The second thing I love about Rossi are his brief interviews post-race, and there have been many. In these brief flourishes with journalists waiting by the pits, he embodies the very essence of the Italian man: he gesticulates, he pontificates, he shrugs, he smiles. But behind his eyes is a childish spirit, a primordial joy, a lack of adulthood really, in which one can see – only just see that is – that for him, this whole thing, this whole journey, all his wins and his entire career, and the crowds and the fans, are to him surprising and to some extent – well – funny. He is amazed, to this very day that he gets to do this: to race motorcycles and to be adored for it. His joy is palpable and it is innocent and it is that of a child. And in this he is unique. “He is amazed, to this very day that he So those are my two reasons for loving Valentino Rossi. But, like most heroes – like Achilles, like Spiderman, like John F. Kennedy – there are gets to do this: faults, there are on occasion moments of hubris; and in Rossi’s case, there to race motorcycles is the problem for my friend and I on that particular weekend at the and to be adored Circuit de Catalunya that Rossi had not won a race for some time. for it.” We watch qualifying from an air-conditioned lunch spot that sits three or four stories up across the racetrack from the main stand on the main straight. The riders are breaking 320 kilometres per hour as they pass us, so most of the qualifying is watched on a TV set-up as the bikes blast by behind us like rockets. Intermittently, we go onto the balcony above the track and watch the speed of the machines and the men on the machines as they pass. Just to see the sheer speed of it. It is horrifying and beautiful to see, a flash of colour, and the sound – the sound is awesome.

One sees the bike and the man on the bike in that moment as one thing, for if one didn’t – if one separated the two in one’s mind – the danger of it, the proximity to death, would be too much to bear. I want to tell my friend this thought, I want to convey to him this idea, but I balk at the moment I am about to utter it. Because it cannot be said. Not then, not while the spectacle of this all is actually taking place. Perhaps later.

Rossi, as it happens, qualifies poorly. At least not too badly, but by no means is he in pole position. Marquez is phenomenal. Marquez may be taking risks, but they are not risks that are visible to us, even in the TV slow motion shots. He appears to be impenetrable. And then there

87 BANKING

“Why, I wonder, is Lorenzo. Our fear is that if Lorenzo gets out in front on the main would I expect Rossi straight and is the last to break on the right-hand corner at the end of the straight and he takes the lead, the other riders will never see the front of to win in Catalunya him again. It would be awful, I comment to my friend, to travel all the just because we have way to Catalunya to see such a thing. He nods his agreement. It would travelled to see him. be awful, he says. Or for that matter, if Marquez gets out in front, I say. It is illogical.” Yes, he says, but it would take a miracle for Rossi to win. He is tempering my expectations. Managing them to the extent he can. Why, I wonder, would I expect Rossi to win in Catalunya just because we have travelled to see him. It is illogical. We are not regular fans. We are connoisseurs of the sport. But still, if only Rossi would just win – why not on this one day, for us?

That night we go out and we imbibe in the spirit of Barcelona and we take responsibility for ourselves and for the moment and for the occasion. We do not over-indulge because we wish to reach the Circuit the next day fresh and in full essence and in connection to the track and to the possibility of a Valentino Rossi win. We watch Moto 3 from the stands at the last corner before the main straight – the battle between the fledgling racers whose careers in this division will either end after a few seasons, or will lead them to Moto 2, and then possibly on to the pinnacle of the sport, the sharp end. Where Rossi lives and battles.

There are crashes, as there always are in Moto 3, and as we walk along the track to the main stands to our luncheon we hear the voice of Brad Binder and his complaint at the riding style of his competitors and of the disappointment in his loss. We miss most of Moto 2, although we catch the start – the revving of the machines as the riders wait for the red lights to count down, and we see that very moment of clarity that exists at the interstice between stillness and movement, before these monsters of noise leap into action. It is surreal.

The balcony from which we watch the start of the main race is too packed to really make out the riders. I find myself jostling for position and I give up and go inside and join my friend in front of the TV. Rossi at turn one is down to fifth or sixth, I cannot recall exactly, but he is at least still in the mix. I am between two worlds: on the one hand, there is the comfort of the Dorna executive lounge, the canapes and the detail one can see of the race on the TV screen; and on the other there is the immediacy and reality of what is taking place just metres away on the balcony.

88 On the Infinite Beauty of Valentino Rossi

I flurry between both, in a schizophrenic daze, anxious as time is moving forward, the laps and the experience tumbling away, too fast. The crowd roars, I rush outside, there is a sea of green vr46 flags – Rossi’s race number for the past decade – waving wildly on the main grandstand opposite. Rossi has made it past two riders into third place. I am now pumping my fists into the air, screaming Rossi’s name with the rest of the balcony. He takes second position breaking late and dangerously and finally passes Marquez in a gladiatorial battle that goes on for several laps. He takes first position and is able to hold it.

I am standing now at the edge of the door to the balcony, on my toes, peering over the sea of spectators to catch a glimpse of Rossi’s blue Yamaha take the final right-hander into the main straight to take victory. The commentators on the TV are going wild and the crowd outside is going wild and it is beautiful. We are jumping up and down like children, even “Rossi has made it the German man travelling on his own whose conversation over lunch past two riders into has been dry. For some reason I hug him.  third place. I am now pumping my fists into the air, screaming Rossi’s name with the rest of the balcony.”

Index

A Cargill, 23 Dodd-Frank, 49 aluminium, 21, 22, 25 Carver, Raymond, 76 Donnie Brasco, 79 And the Weak Suffer What They Catalunya, 85 Dovizioso, Andrea, 86 Must?, 66 Cayman Islands, 76 Anti-Money Laundering Chiellini, Giorgio, 26 E (AML), 47 Circuit de Catalunya, 85–88 Essa, Salim Aziz, 81 Apple, 10, 73, 74, 76 Clinton, Bill, 22–24, 26, 31 Enron, 74 Atlas Mara, 18 Coca Cola, 21, 22 Europe, 26, 73 Automatic Exchange, 46, 47 Collateralised Debt Obligations European authorities, 74 (CDOs), 30, 31, 50 European Parliament, 74 B Combating Financing of European regulator, 73 Baloyi, Danisa, 80 Terrorism laws (CFT), 47 Exposure-at-Default, 41 Bank Holdings Act of 1956, Commodities Futures Extract, Transform, Load 23, 25 Modernization Act (ETL), 43, 44 Bank of Baroda, 81 (CFMA), 24, 25 Bank of China, 81 Congress, 23, 25, 75 F Bannon, Steve, 64 Cook, Tim, 73, 74, 76 Farage, Nigel, 69 Barcelona, 85, 88 Coors, 22 Farooqui, Hamza, 81 Barclays, 18, 29 Council for the Advancement FATCA (Foreign Account Tax Basel, 39 of the South African Compliance Act), 46, 47 Basel III, 49, 57 Constitution (CASAC), 80 Fed funds rate, 31, 56 Behavioural economics, 17 Credit Suisse, 18 FIC Amendment Bill, 80, 81 Big Four, 81 Finance Minister, 81 Binder, Brad, 88 D Financial Action Task Force Black-Scholes, 38 Dark Money: How a Secretive (FATF), 79, 80, 81 Blatter, Sepp, 26 Group of Billionaires is Financial Intelligence Bloomberg Businessweek, 60 Trying to Buy Political Centre (FIC), 79, 81 Breitbart News, 64 Control in the US, 66 Financial Intelligence Bretton Woods Agreement, 66 Davos, 56 Centre Act, 10, 79, 81 Department of Justice (US), Financial Intelligence C 35, 51, 74 Centre Amendment Bill, Capital Asset Pricing Model, 17 Deutsche Bank, 81, 74 80, 81 Capital: A Critique of Political Deutsche Postbank, 18 Financial Times, 60 Economy, 65 Diamond, Bob, 18, 19 Fooled by Randomness, 63

93 INDEX

Foroohar, Rana, 25 I Metro International Trade Fortune 500, 73, 76 International Money Fund Services, 22, 24 Freakonomics, 79 (IMF), 66 Microsoft, 61 French economist, 47 Ireland, 73, 74, 76 Middle East, 9, 65 Fuld, Richard, 31, 34, 44 Irving, David, 63, 64 Mifid II, 19, 57 Milton Friedman, 30, 51 G J Minister of Finance General Electric, 69 JP Morgan, 23 Greece, 66 Gigaba, Malusi, 81 South Africa, 81 Girona, 85 K Monte Carlo Simulation, 41 Glass-Steagall Act, 9, 23, 31 Kahneman and Tversky, 17, 19 Morgan Stanley, 22, 23, 29 Glencore, 23 Kalanick, Travis, 59, 60, 61 Mother Theresa, 65 Goebbels: Masterminds of the Kamel, Fawzi, 59–61 MotoGP, 10, 85, 88 Third Reich, 63 Klein, Naomi, 65, 66 Manyi, Mzwanele, 80 Goldman Sachs, 18, 21–24, 26, 29 N L Gordhan, Pravin, 81 National Assembly, 80 Lehman Brothers, 30, 31, 33, Gramm-Leach-Bliley Act, 23, National Treasury (South 34, 50 24 Africa), 80, 81 Le Pen, Marine, 69 Great Depression, 9, 23 NATO, 66 Lewis, Michael, 17 Greece, 64–66 Nazism, 63 LIBOR, 18, 56, 68 Greek Minister of Finance, 66 Net Stable Funding Ratio London, 18, 19, 68 Greenspan, Alan, 26 (NSFR), 50 London Metal Exchange, 22 Gunn, Thom, 7 London School of Economics, Gupta family, 81 O 68 Oakbay Investments, 81 H Lorenzo, Jorge, 86, 88 Occupy Wall Street, 57 Habib Overseas Bank, 81 Lyft, 60 over-the-counter (OTC), 22, Harvard University, 26, 33 23, 24, 26 Harvard Business School, 51 M Historical Simulation, 41 Mafia, 79 P Hitch-22, 65 Makers and Takers, 25 Panmure Gordon, 18, 19 Hitchens, Christopher, 65 Maradona, Diego, 26 Paris, 79, 80, 81 Hitler’s War, 63 Marquez, Marc, 86, 87, 89 Parliament, 80, 81 Hong Kong, 31 Marx, Karl, 65 Parliamentary Standing Hong Kong Monetary Mason, Paul, 67, 68, 69 Committee, 80 Authority (HKMA), 33 Mayer, Jane, 66 Paulson, Hank, 34 How Will Capitalism End?, 66 May, Theresa, 55 Pfizer, 76

94 Index

Piketty, Thomas, 47 South African Minister of US Airways, 56 Pol Pot, 63 Finance, 81 US Department of Justice, 74 Polemics, 63–66, 68 Spain, 85, 86 US Fed, 56 Postcapitalism: A Guide to Our Stevenson, David, 63 US president, 24 Future, 67 Stiglitz, Joseph, 63 US regulators, 23 post-Depression, 23 Streeck, Wolfgang, 66, 67 Potential Future Exposure Stumpf, John, 34, 44 V (PFE), 42 Suarez, Luis, 26 Value-at-Risk (VaR), 39, 41 President of Harvard Summers, Larry, 23, 26 Vardospan, 81 University, 26 Super Bowl, 59, 60 Variance Co-Variance, 41 Switzerland, 46 Varoufakis, Yanis, 66 Q Syrian, 49 Qatari investment funds, 18, W 19 T Walmart, 35 Taleb, Nassim, 63 Wells Fargo, 10, 29, 34, 35 R The Black Business Council, 80 What We Talk About When We Registrar of Banks, 81 The History of the First World Talk About Capitalism, 76 risk-adjusted return on capital War, 63 What We Talk About When We (RAROC), 34 The Missionary Position, 65 Talk About Love, 76 Robbins, Tim, 66 The Progressive Professionals “Why Drug Dealers Live With Rossi, Valentino, 1, 11, 86–89 Forum, 80 Their Mothers”, 79 Rotterdam, 21 The Rise and Fall of the Third World Bank, 66 Reich, 63 World Trade Centre, 56 S The Shock Doctrine – The Rise of WorldCom, 4 Said, Edward, 65 Disaster Capitalism, 65, 66 Salom, Luis, 85 This Changes Everything, 65 Y Semitism, 64 Time, 64 Varoufakis, Yanis, 66 Sennett, Richard, 68 Trump, Donald, 56, 64, 69, 75 YouTube, 59 Shirer, William L., 63 TXN Solutions, 60 Short, Philip, 63 Z Smith, Adam, 9 U Zuma, Jacob, 80, 81 South Africa, 10, 56, 79, Uber, 10, 59, 60, 61 80, 81 US, 26, 30, 31, 34, 46, 47, 49

“There is an existential question at present that plagues the financial markets, the banking system, and the western world in general. It goes like this: is capitalism, and its political enabler, liberal democracy, ultimately good? By good, we do not mean fundamentally good in a moral sense, but is it good at all for anyone other than a select few?

“Despite enormous efforts being made by regulators, academics and bank executives to help defend the rights of firms to operate within the framework of a free market, these seemingly unending knocks to the confidence within the capitalist system have led to a right-wing political response that may gain permanent traction. As a review of polemical literature in this issue examines, even the liberal left has lost patience and is calling for an end to capitalism.”

* * *

The Monocle Quarterly Journal is a business journal dedicated to continuously investigating and questioning the prevailing orthodoxy that is driving the governance of the banking and finance industries. This Journal chooses to overturn inherited notions that defy economic logic by bearing witness to, and commentating polemically upon, the regulatory, macro-prudential, and government intervention into private enterprise. This series is based both on formal in-house research as well as extensive external sources, coagulated into strongly argued positions on topics ranging from banking ROEs, to current political trends.

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