Equitable, Inequality and Iniquity

News here in the UK yesterday was dominated by the Parliamentary Ombudsman’s investigation of the role of regulators in the near failure of Equitable Life. The ombudsman’s report concludes that the regulators had failed to properly or effectively supervise the mutual insurance company over many years. Instead they were “passive, reactive, and complacent”.

In essence, the scandal of Equitable Life is that the regulators continued to permit Equitable Life to sell investors “guaranteed” investment products which it could not possibly have fulfilled under more realistic projected investment returns long after Equitable Life started to run into trouble. The company was finally forced to stop taking on new clients in 2001, with existing clients realising large portfolio losses.

The report suggests that regulators should have known better and acted sooner. Of course, Equitable Life’s executives, actuaries and salesmen should have known better and acted sooner too, but no one seems interested in holding them to account, forcing them to disgorge the years of high salaries, bonuses and City lunches. The ombudsman recommends instead government compensation for regulatory failings on the order of billions of pounds to investors who lost much of their life savings in the fiasco.

The report and its recommendations raise several interesting problems for which there are no good or easy answers.

First, of course, is that if Equitable Life investors are eligible for compensation for the serial failures of supine and co-opted regulators, then just about everyone else in the retail investment universe will be eligible for compensation soon too. If we agree that many of the existing banks, broker-dealers, investment funds, pension funds and insurance companies have exaggerated their performance and will face profitability/solvency issues – as seems quite likely – and that regulatory passivity, reactivity and complaisance over the past two decades is a contributory factor, then hundreds of billions in compensation may be claimed by investors when the systemic crisis now emerging intensifies. If we go further and suggest that many of the securities and investment products originated, packaged, underwritten, and sold by banks and investment banks during the past two decades made exaggerated claims as to likely performance, and that regulators collaborated in this process by relaxing accounting, disclosure, underwriting and capital adequacy standards, then the case for compensating the entire world of retail investors is close at hand.

Expect the Chancellor of the Exchequer (British for treasury secretary) to resist the ombudsman’s recommendations. Expect delay and obfuscation.

Second, market regulation and prudential supervision are a public policy means of building confidence in the integrity of financial markets which are a modern and systemic reflection of the old confidence scam of “The Pigeon Drop”.

Without the intervention of the “shill” who recommends safekeeping of the money, the scam wouldn’t work. The scam requires someone to reinforce the dupe’s perception of the con man as an honest actor trying to do the right thing while he is struggling with the impulse to make a quick gain in a doubtful enterprise.

For the past two decades the regulators of the world may have thought they were contributing to the integrity and efficiency of financial markets by acceding to every request from the banks and investment banks for relaxation of former strict standards of market regulation, accounting, underwriting, disclosure, and capital adequacy. In reality, they were just aiding and abetting the Big Con. That con game that got three generations of investors to trust their life savings to high living con artists. It wouldn’t have worked without the regulators and governments assuring us that the con artists were straight shooters respecting our best interests.

Investors relying on the professionals and the regulators to look out for the little guy were duped. They are going to lose much of their life savings. Some will be lost to fraud, some to insolvency, some to illiquidity, some to credit reassessment, and some to asset deflation. The rest will be lost to inflation and taxes as the rescue socialises trillions in liabilities to the public purse.

The serial mega bubbles in real estate, securities, derivatives and other asset classes were all a big con, convincing us to part with our cash on the premise that it would be returned to us with high yield returns. The central banks and regulators played the part of the shill to convince us that we stood to gain from handing our cash to the con artists.

David Maurer, in his book The Big Con puts it like this: “Con games never remain stationary. The principle may be old, but the external forms are always changing, for con men know they must adapt their schemes to the times. This is especially true of the big con. A good grafter is never satisfied with the form his swindle takes; he studies it constantly to improve it; as he learns more about people, he finds a way to use what he has learned.”

Third, I’m not sure that human nature doesn’t dictate the complaisance of regulators. People become regulators early in their careers, as a rule, and often lack the understanding or credibility to challenge rich and successful bankers. Also, both sides are keen to be seen to be reasonable, plausible and likeable – leading the bankers to be just as convincing with the regulators as with the dupes, and leading the regulators to be accommodating and credulous.

Rising income inequality since the 1970s exacerbated this natural human impulse. It is the nature of everyone, even regulators, to want to be liked and respected by the rich and influential. It is no accident that income inequality and political corruption are very highly correlated. When the bank CEO made 30 times the floor worker’s wage, he had much less influence relative to his regulators than when he made 3,000 times, or on occasion 30,000 times, the floor worker’s wage.

Regulators might be strict with a banker earning not much more than they are. They are lax and conciliatory when that same banker earns a huge multiple of their salary – especially if they have an eye on promotion or a later lateral shift to the private sector to top up their income and pension before they retire.

Perhaps this erosion of public values and civil service career commitment is the true evil of income inequality. It becomes impossible for the government to constrain greed, abuse and excess in the private sector when the executives have disproportionate wealth. Instead, everyone from the top down in the public sector curries favour with the super rich in the private sector. And the little guy who trusted the regulators when he handed his hard earned savings to the bankers, brokers, pension fund managers and investment fund managers loses job security, economic stability and a comfortable retirement.

If you wouldn’t trust your brother-in-law with $250,000, why would you trust a complete stranger? Because the government told you it was okay. They assured you it was the right and responsible thing to do and would help you make even more money. The regulators were there to ensure your interests were respected. Only they weren’t.

We didn’t know that the regulator and the complete stranger were in on the big con together. Maybe they didn’t know it either.

What we’ll all soon realise is that we’ve been duped.

14 Responses to "Equitable, Inequality and Iniquity"

  1. Juvenal   July 18, 2008 at 6:50 am

    In the realm of conspiracy theories, how’s this? Knowing full well of an impending global collapse in 2000, 2001 and with TPTB being caught off guard–a series of events were put into place to forestall the inevitable. Purposefully a blow was struck at world trade which enabled public mandate in unpopular foreign policy, allowed a CB to drop interest rates below wholesale inflation, and directed large players to desperately funnel money via creative instruments into the largest speculative play possible for all the population. Largest purchase for most American families…homes. Securities hid the reality that their investment value is dubious at best. Homes massively appreciated by manipulation of supply/demand curve. Easy lending allowed so much building activity to occur, layered loans collateralized by a falsely valued asset enabled further speculative purchases. And vehicles, furniture, travel, meals, frivolity. During which time TPTB positioned themselves by allowing dollar’s daily miniscule erosion but now apparent plunge. Those in the know reduced exposure to RE, equities, currencies. And when enough hapless Ponzi players were in good and deep in the debt trap and false illusion, PULL THE PLUG.Architecture to plunder the masses as the well-connected, politically savvy, and smart money make well timed exits. Complex design to buy time to offload liability in a sham economic setting that ensnared all but the most cunning and wise of money stewards.9-11, middle east policy, global warming, energy manipulation, stock market crash, commodity boom, hollowing of banking and industries, surprise ambush by derivative and securitization market. Surely no coincidence.Always we will be pressing noses to the plate glass windows looking in on the well-heeled crowds who now gain position by terrible but effective manipulations. Corruption, collusion, collapse in a caper that staggers belief. But as always follow the money, follow the political gain.

  2. London Banker   July 18, 2008 at 7:07 am

    @ JuvenalI’m shocked! Shocked I tell you! Just because the Bin Laden family financed George W Bush’s first business, and Prince Bandar is dearer to GHW Bush and Barbara than their own sons (he’s allowed to smoke in the house) is no reason to suggest that they might collude to rig global economics and politics to their advantage. Sure GHWB and Bandar have been financing terrorism and violence for 25 years since they launched the Safari Club. The payments through Riggs Bank from Prince Bandar’s BAE-funded account to the two 9/11 hijackers in California, however, were completely innocent charitable donations. Please don’t taint my diaries with your conspiracy theories! ;-)

  3. lenny   July 18, 2008 at 7:08 am

    Great post, as usual…the Pequot scandal in the US shows what can happen when a regulator…Gary Aguirre of the SEC…goes up against a powerful banker…John Mack…Mack successfully refused to testify for quite a while and Aguirre was fired.From NYT on Senate report: “The investigation of Pequot Capital Management could have been an ideal opportunity for the S.E.C. to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement,” the report said. Instead, the S.E.C.’s inquiry was undermined by a series of missteps, according to Senate staff workers who took the testimony of 30 people and reviewed 10,000 pages of documents.Mr. Aguirre responded to the report yesterday, saying that Christopher Cox, the S.E.C. chairman, “can bless” the conduct of those senior S.E.C. officials criticized in the report “or he can protect the capital markets by cleaning house.”

  4. Juvenal   July 18, 2008 at 8:03 am

    And to think that I believed I was on to a novel idea. Always late to the game and last picked. Yours is a banker’s mind, vast and vaultlike with labyrinthine ideas…and a little miserly in disclosing the whole picture. Too bad one must tote water for the wizard…and five time removed at that. How many more valuables (inner working working papers) have you in store for us? I’ll sweep the stairs while waiting.

  5. London Banker   July 18, 2008 at 8:34 am

    @ LennyExcellent example of the co-opting/discouraging dynamic in practice in the Mack/Aguirre standoff. I’ve seen it up close, affecting my own career and those of many colleagues I respected. When good people can’t stay in government (because your only option is to comply or resign), then government can’t be good. When government ceases to be good, it becomes dangerous.@ JuvenalSometimes I add 1 and 1 and get 5. That doesn’t make me right, but does make me wonder about the value 3 of dark matter influencing the outcome. When you start measuring and quantifying the dark matter, it gains substance until the answer 5 doesn’t seem so far fetched.

  6. Miss America   July 18, 2008 at 9:12 am

    Hey LB,Nice job as always. The failures of the UK regulators then are no different then the current failures of our market regulators not getting the Hedge Fund / Private Equity groups in order. Just how big and controlling do these entities have to grow, before someone finally puts their foot down and says ENOUGH! You have to be a moron to not realize how much they can shape and twist the market. I believe in free trade… but when you become big enough to shape and shift a market… you can no longer “free trade”. Things like “Holdings restrictions” which mutual & pension funds are bound by would help curb some of their influence… There are other regulations that need to be placed on them… but that is for a less busy day.More important then what I’d like to see done, is analyzing what has been recently done.My big question for you???? (actually, this is for anyone)With the recent wave of restrictions/controls (i.e. restricting short sells, extending credit facilities, etc) being made, I have come to the cross road of an important question that needs to be asked…Are they putting these controls in place because:A. What has happened?B. What is currently happening?…or…C. What IS GOING TO happen?That’s all I got today. I’m going to be busy. (On NR’s site, SBB and JLC are pretty much in the ballpark. Sorry, but there’s no blueprint or details for this crap… Just trends Sorta like the “banklord” prediction I made a few months back… I nailed that!!! …cause guess what the new hot trend I’ve seen is?!?!?!)Miss America

  7. r0tiNeK   July 18, 2008 at 11:26 am

    Yes, it sure is a right old mess that is unfolding. Luckily for me, I have been reading RGEMonitor since mid 2005 (as well as many other intellectuals). My passion for macroeconomics & yearning to understand "The Bigger Picture" has led me on an enlightening path and thanks to intellectuals like Nouriel Roubini, Brad Setser, London Banker, Karl Denninger, Mish Shedlock, Greg Peel (among many others) my understanding of the world is so much deeper & broader.Reality is the constant. It is reality. It doesn’t change. If you’re in touch with reality… you can be ahead of the game.Reality is that credit markets will go into convulsions as Fannie Mae/Freddie Mac and numerous other "Northern Rocks" which are too big to bail become insolvent. The cost of debt is about to soar, regardless of any Central Bank actions and nothing will be textbook normal as it should be. Everything will be upside down. We are at the end of the expansionary phase of a very long credit cycle which involved the inflation of ever bigger "bubbles". Now the Big Bertha has popped and there’s no more bubbles to inflate… only credit collapse

  8. r0tiNeK   July 18, 2008 at 11:34 am

    Karl Denninger’s very enlightening take on the unfolding events in America (Fannie Mae/Freddie Mac coming insolvency). He explains the distortions which will occur in the credit markets when Fannie/Freddie finally collapse:http://youtube.com/watch?v=TKa5vgZxVWU

  9. r0tiNeK   July 18, 2008 at 11:42 am

    Helicopter Ben explains that the reason The Fed ILLEGALLY bailed out (financed JP Morgan) Bear Stearns was because of risk of systemic credit crisis:http://youtube.com/watch?v=gRb1uOmDqwYFannie Mae/Freddie Mac are TOO BIG TO BAIL (despite the reassurances from Paulson and Bernanke). Once this institution becomes insolvent, it’s all over…

  10. TA   July 18, 2008 at 2:24 pm

    LB,Well done. You’ve managed to make Friday even more enjoyable. However, it’s time to connect the dots. Not cryptically or creatively – but actually putting names to events.MA,IMO, the flurry of new rules, regulations, and consolidations/eliminations are motivated by two related events.First, in less than six months a new administration will assume control and there are too many wild cards associated with regime change to risk leaving the heavy lifting (and its many loose ends) to a new administration.Second, what’s important isn’t what’s happened, what’s currently happening or even what’s GOING to happen, its how the landscape will look after the dust settles, and that the end result will be achieved by purposeful design, not merely chance events and responses.As you’ve pointed out previously, events are used to move chess pieces – some win, some lose and many get crushed in the process. Events are also used to create anxiety, fear and hopelessness as well as intended responses such as pacification and mobilization.The end game isn’t the events themselves or even the responses to them; its how the landscape will look after the dust settles, specifically, the concentration of national political and economic capital.If the crisis discussed herein is as deep and as broad as some maintain, is it possible that not just neighborhoods, but entire nations (i.e. government/ideology) will disappear?Perhaps I’m jaded by this past year’s events, but it seems that more than just higher down payments and an end to short sales is in the offing, its feels more like the shifting of tectonic plates.TA

  11. t   July 20, 2008 at 3:29 pm

    "Helicopter Ben explains that the reason The Fed ILLEGALLY bailed out (financed JP Morgan) Bear Stearns was because of risk of systemic credit crisis"The Fed; a good private institution, looking after the interests of its shareholders…

  12. Miss America   July 21, 2008 at 11:13 pm

    @ Pete CAWhat do you need to know about DTCC? (LB may be able to drum up some info for you??? I learned a lot from an article by James Wallin that LB provided for me some time ago)As you may know… the site is: http://www.dtcc.com/There’s plenty of good info within.@ AFA, Ponder, and Guests that say I need to “chill out”… By no means do I support the war in Iraq. Nor do I support “slaughtering innocent people”. I don’t believe in “Slaughtering” anyone! The fact that the motivation for going into Iraq was based on lies is extremely upsetting to most Americans that I have spoken to. I feel that the trust we give to our politicians should come with a certain degree of trust in return. …along with a high level of accountability. For the lies alone, I feel so betrayed, that I can’t help but think that something close to “treason” has been committed.…but beyond the lies, lays the foundation I believe to be most important in life: Human rights. …and crazy as it seems… Human rights have rarely been acquired without bloodshed, suffering, and many years of painful transition. If there is a better means of attaining human rights for individuals that live in an oppressive dictatorship… please write them down and submit them to every publication and politician you can. (I’d love to see the rough draft) It’s too easy to jump on the bandwagon of America Bashing, when things aren’t going well. Unpopular war… Bash American Warmongering. Unpopular economy… bash American greed. Let’s instead consider the women of Iraq? How about the average citizen in Afghanistan? (yes, I’m sure they loved the genocide that Russia was performing, or even worse was the oppression of the Taliban sect) Let’s hear about how great genocide is… I waiting??? …oh, and what did you and your country do about it… I’m waiting??? Tell ya what… there’s a little situation right now in Darfur. Let’s see someone else REALLY step up to the plate. (sure, there has been plenty of “support”… but what has been done outside of the USA?) What accomplishments have been achieved there?I agree that we should not put people into boxes. (as you said…) …but that’s just what LB does at times. The comment: “Americans are only 230 million of the 6.2 billion people on the planet. They are no more or less important than any other humans. They need to behave with more consideration of the planet and other humans sharing it.” Was in my opinion an EXTRDINARILY UNBALANCED STATEMENT! It was a perfect example of “PROPOGANDA”. If you can get behind that statement, and then further cheer it on, then I am sorry for you. …because it IN NO WAY REPRESENTS MYSELF, or the many other Americans who have nothing but “consideration” for the other people that share the earth with us. …and where the rubber hits the road, we donate more time & money for others, and shed more OF OUR OWN BLOOD for others then anyone!!! If you, or anyone else here believes in human rights, and can come up with the perfect non-violent/financial solution then lets here it. …but more importantly, let’s see some other countries “DO”.To quote one of my all time favorite movies, A Few Good Men:“Son, we live in a world that has walls and those walls need to be guarded by men with guns. Who’s gonna do it? You? You, Lieutenant Weinberg? I have a far greater responsibility than you can possibly fathom. You weep for Santiago and curse the Marines; you have that luxury. You have the luxury of not knowing what I know: that Santiago’s death, while tragic, probably saved lives and that my existence, while grotesque and incomprehensible to you, saves lives. You don’t want the truth because deep down in places you don’t talk about at parties you want me on that wall, you need me on that wall. We use words like honor, code, loyalty. We use them as the backbone of a life spent trying to defend something. You use them as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom I provide and then questions the manner in which I provide it. I would rather you just said "thank you," and went on your way. Otherwise, I suggest that you pick up a weapon and stand a post. Either way, I don’t give a damn what you think you are entitled to”AfA, Ponder, …You have every right to disagree with me, or what I say. Hopefully we can open each others eyes up to things. (these are my opinions which I feel are correct… but what’s right for me, might not be right for another. …so if you disagree, I’m open to hearing why.) Even though I choose to bang heads with LB on quite a few matters, there is no other opinion I value on the site more. Arguments can be healthy. I believe there aren’t enough people out there like London Banker. LB is active at trying to make the Earth a better place for its 6.2 billion passengers. …but when LB makes those general accusations about “Americans” I believe a slap on the hand is necessary. Consider my rant, a speeding ticket on our ride through this galaxy.AfA, I hope this didn’t read too harsh, as I was not trying to be aggressive. I was instead, trying to be “persuasive” …but I am not the best writer in the free speaking world.Miss America (the most chilled out person around)p.s. @ Guest on 2008-07-21 22:31:31 Really? It was about oil? I had no idea? …but then again, maybe it was about oil …and something else? Seriously! If it was only about oil, don’t you think we would’ve chosen an easier target? Venezuela? Cuba? Canada? Mexico?

  13. London Banker   July 22, 2008 at 3:18 am

    @ Miss AmericaI’ll reply by e-mail. Needless to say, the facts are on my side, but you’re excused from knowing them as they don’t seem to penetrate the US media fact-free firewall. Facts have a well known liberal bias. ;-)What we do agree on is the need for universal principles of human rights. Enforcement is where the problem always arises, as powerful men put themselves above the law and above principles. Today the war criminal Radovan Karadzic was arrested in Serbia. He was only arrested because Serbia wants to prove it belongs in the EU and can abide by EU standards on human rights. That is progress I can believe in, and perhaps a model for a future human rights strategy that curbs excesses elsewhere.

  14. AfA   July 22, 2008 at 11:40 pm

    Dear Miss America,First sorry for the late response, I had some interviews today. Second, you are welcome to dissect and criticize any of my ideas or opinions; I post them for that specific purpose. Third, I will abide by Professor’s request, so I keep it short and light.Montesquieu, in his epistolary novel Lettres Persanes (Persian Letters) which he didn’t originally signed when they were first published (that even when he was already famous), used two foreign fictive personas, in visit to Paris during early 1700’s, as an alibi for a critique of the French society and culture under the reign of Louis XIV. The anonymity and the use of a foreign perspective allowed him to demonstrate the good and bad in the Parisian life. Putting an outside eye, I believe, is a healthy exercise to self-improvement.As you said human rights are and should be acquired then sustained by each people, they cannot be served as a gift nor outsourced. Most people who fought for mine are in their graves and I doubt the majority of who are holding guns today are doing so to protect it, otherwise I am ready to jump and pass those walls. I am sure the people you know are reasonable people like yourself. My problem sometimes is that I do not target my audience. So usually when I try to make a point, I am denouncing another type and deeper sense of complacency and clichés that I see around me.Lastly, one should wonder how much is it ethical to provide help and give to ethos when one of my immediate or subsequent motives to is feel others are liable to me. And how much ethical my donation is when I know that part of each dollar I donate goes to the financing of illegitimate wars, other part to (directly or indirectly) to finance (presumed) terrorism, another to bailout reckless bankers and the rest backed by the full faith of my neighbor to pay back his mortgage. I am mistaking my audience again.