SECTION TWO, PART ONE

Children of a Lesser God: One of the intriguing things about the wash-up of the last few years is the capacity to try to shift blame/ responsibility to others to cover up for failings. The concept is not unique, unfortunately, because to admit some form of culpability either suggests indifference, incompetence, lack of understanding about the true nature of the occupation, or lack of professional gravitas. One or all of these may apply, but the blame shifting allows some economic effect to be passed to those who don't know better, and they don't know how to respond to the impost on them: they become children of lesser gods for the exercise of the impost. I'll focus on a US example next week, and a Euro special the week after, but let me give a home grown example to further the cause. Australia has its own special called Trio Capital...as close to a Madoff moment as we could deliver. [As an initial comment, can we climb over "how well" Australian did during the GFC....I do not think two cash splashes, and grossly ill-devised pink-batts insulation, and schools' canteen building programme, saved the economy. How about ginormous cash splash in China, and totally mis-understood bank guarantee, wholesale and retail, without proper guarantee payment, or bank-conscience for the taxpayer supported largesse, were the true heroes]. Australia's "Madoff" has some particular resonances. A quick re-cap. Trio offered some range of financial products to a number of market segments. It offered some pooled superannuation funds ( which are regulated by APRA ) , and also offered some pooled investment vehicles, called Managed Investment Schemes, which are available to the general public ( the licensing of these are regulated by ASIC ) . Both of APRA and ASIC have received prior references in these pamphlets: some laudatory, some more like lavatory. Superannuation/pension funds in Australia are divided into the institutional funds, under APRA's guidance; or effectively private individual arrangements, called Self Managed Superannuation Funds(SMSF's). These latter ones are really not regulated, but rather fall under the umbrella of the Australian Taxation Office, which has extremely rudimentary oversight of this ( now ) huge body of monies. It gets somewhat complicated, but let's reduce it to the fundamentals...... Trio had a fund which had fraudulently overstated market values. No matter that it involved Bear Stearns securities. BS went into pathetically terminal decline in February and March 2008, and arguably acted as the bell-wether for the GFC with its leveraged funds immolation in July 2007. ANYONE in the business would have doubts about ANYTHING with Bear Stearns. Well, maybe not everybody.....APRA and ASIC? Well, when did the regulators start to really pull Trio's chain? What, one and a half years later in late 2009, and then because of a whistle-blower.....it was only around $200 million; chump change in the oversight of a business which has the same value as the nominal economy. Who pays? Well, quaint rules allow fraud to be re-compensed for APRA regulated entities, but not for ATO regulated entities. So, institutional fools were made whole, but individual fools were not. BUT THERE IS MORE. The institutional make-good was by way of a levy on ALL APRA REGULATED superannuation funds, whereas the individual SMSF's investor lost the lot. Let's recap again: some institutional punter invests in something fraudulent, and most superannuation members will bear this totally hidden tax ( ? Wonder if they think this is fair/if they knew to form a view? What happens if it was a really big fraud, where the impost becomes very significant?). Some individual investor invests their superannuation in Trio, and they dust the lot. Obviously, the policy principle here is: individual care/individual beware. In Insto land, the regulators worry about their tardy culpability, but have hidden taxation powers. AMAZING !!!! No amounts of Parliamentary enquiries, or Departmental Review hoboken can cover this morass. There was only one fraud, but look how many ways the financial cost can be spread! Now, where did we,the population, agree to this style of bespoke regulation, you win or lose through powers/responsibilities that you cannot fathom, let alone influence.

DIGRESSION ONE - LEADERSHIP

In the movie, "the Prestige", magic performers use their bag of tricks to reveal an object, turn that object into something extraordinary, and then return the object back to its rightful place. One element in re-thinking the Social Contract is that some element of leadership will be required to re-galvanise the debate about justice as fairness, and any number of other equivalents to describe the debate. Before we move on to some further parts to the search for justice, we need to examine the state of leadership which will act as an element in helping correct-thinking. Unfortunately, the landscape here is not too encouraging. Authority is meant to act to facilitate the drive towards equivalence, and I have already tried to supply some examples of how arbitrariness has been used to protect elites, rather than chasten them. But the state of politics in Australia hopefully provides an example of how the Will to Power has become more important than proper leadership. Australia, like a number of countries, has seen an embarrassing rise in wedge politics, designed to identify, and isolate, a minority of "aliens" or "others" who can be vilified and scorned by the majority. The Co-alition government from the mid-1990's to 2007 played to a whole range of bogeymen, from the universally Allied-against Muslim-as-terrorist, to the legitimate refugee-as-claim jumper boat arrivee. All quite tawdry. But it played to the genuine "fears" of the general population, and therefore had an immediacy, and currency, to the debate e.g. No matter how many historical transgressions could be evidenced, the bombing of the World Trade Centre raised the stakes; no matter how illegitimate white man invasion might have historically been, the current population can have some control over immigration policies/routes of entry. The escalation in the wedge has also been an almost universal feature in a number of countries, but the form of the escalation in Australia is illustrative of a peculiar form of nastiness. To try to wedge 50% of the population against the other 50%, by way of gender wars, is politics in extremis. Ignoring the historical merits, read Gillard's misogyny tirade as a deflecting technique against the following-day release of misogynistic comments by a supporting member of her tight-as-drum hung parliamentary majority; read the announcement of a particularly long period of time to the election date as deflecting tactic to the following-day arrest of another member upon who's vote the Gillard government requires. Read the policies and administrative arrangements which have been put in place to assist Gillard's union-based support network as the ultimate deflecting tactic to ensure that those same unions don't use their connections to ( yet at least) move a vote to remove her as leader. All cosy-network tactics, with the dupes being the fools who think that Gillard is being authentic over the last seven to eight months. The Will to Power has produced a bizarre political framework not unlike the juvenality that emerges in the Student Representative Councils at university. What is just as disappointing is that the Opposition in the forthcoming election will have a mandate to wind back those policies, but nothing else. More useless Will to Power politics based around nothing more than saying "no".and the forthcoming period will be dominated by the spectre of Revenge, not unlike "The Carnival in Romans" where Emmanuel Roy de Ladurie described how the town's elite opportunistically and cynically extracted revenge on workers who had used the shortage of labourers arising due to the Black Death to claim higher rewards and status for themselves. Strong leadership is required to recognise the challenges that the GFC has both posed, and the opportunities that exist, to wrest some of the arbitrariness, and "elites" position-protecting that now needs to be wound back. This epoch will be squandered if the politics of recidivism, and revenge, becomes the only paradigm which is adopted by elected officials. It is as if the world has become too complex for our politicians to rise to the role that they so covetously seek.

Section One, Part Four

MONEY FOR NOTHING - Farmers Markets While I would like to talk about the slow food movement, this is about the fast money movement. The markets being farmed are not lovingly cared for plots, but cynical manipulation via things called dark pools and high frequency trading. Money is being farmed, as assiduously as the best lettuce. In fact, " let us " is the true homily launched by the brokers and investment banks. To re-cap, dark pools are portfolios of securities to be bought and sold which represent an aggregation of customer orders across , usually, the larger brokers. They are never traded on the exchanges, but are matched in some back office, at prices which will almost inevitably see both buyer and seller pay an inordinate advantage to the broker. High frequency trading is using technology to effectively front-run normal market orders. We won't deign to give any credibility to the usual reasons which attempt to justify, or lionise, these practices, but anyone who says that there is an improvement in market efficiency is probably a liar. The only efficiency dividend here flows to the brokers, not the clients. Where does this fit the social contract? One of the un-recognised support packages exercised during the GFC was that given to the stock exchanges, and by extension, the brokers. In part, the form of this was through the suspension of short selling, particularly in an environment where many companies needed to re-capitalise ( brokers love stock issuance ), in part, it was because policies were designed to drive asset prices higher, presumably on the mistaken belief that asset prices/wealth effects are desireable targets for both monetary and fiscal policy. Bernanke's research notoriously made observations about asset prices.....an outrageous target for a central bank, which even under Greenspan, knew that they shouldn't create asset price bubbles ( then again, didn't both Paulson and Bernanke have some past association with Goldman Sachs? Or was that Geithner?) What is truly outrageous is that brokers rely on exchanges; try their best to manipulate policy to their advantage; and yet dark pools, and to some extent high frequency trading, are designed to circumvent those same exchanges. Regulators like ASIC look at these practices, and adopt a "warm lettuce" version of supervision-we have the absurdity in Australia where recent policy reviews have said that both dark pools and HFT don't need further restrictions placed upon them because, GET THIS, volumes in both seem to have declined recently. HANG ON...if you were a broker manipulating a market, wouldn't you maintain a low profile during a regulatory review. What a farce! The real farce is that the practices are remote enough that the general population does not have enough information to form a view about fairness, or justice, here. And the rule makers either don't understand the nuances of some of the practices, or are captive to a biased voice. During the GFC, it was ASIC who banned short-selling, but it was the ASX who were having its members, and friends, carted out via forced margin calls, etc. It was exchanges who let senior executives not have to provide details on how margined some holdings had become.....placing a lot of small investors in the invidious position of having insiders effectively destroying the share prices that they were supposed to be shepherding.( nothing was noble in the fall of Allco, or Babcock and Brown.) Farmers markets are reasonably small, intimate, sites. So too are exchanges. Only the first mentioned doesn't normally get government support to maintain its monopolistic ability to generously line the pockets of a small coterie. And they don't even have to justify themselves through a formal guarantee, it's all friend's here...money for nothing, the friends are free.

Section One, Part Three

MONEY FOR NOTHING - Central Banks In the late 1980's and early 1990's, the central bank of Malaysia operated a particularly active currency trading operation, ostensibly designed to make significant profits. It succeeded for a while, before inevitably failing. Trading is always about knowing that a win:loss ratio of 60:40 will put you into the very wealthy category, but most inevitably go through the 40, and then the ruler comes down and says " no more ". What was laughable was that Alan Greenspan frowned upon the Bank Negara, on the basis that it was falsely distorting the market for short term gain. ( must have been a bit anti-Muslim here, the Malaysian's contention was quite correct that the Plaza and Louvre Accords were (1) deliberately designed to distort currency relationships; (2) a policy development without consultation with groups that would be affected by it; and (3) a form of "gentlemen's club" between USD, YEN and Deutschemark, who thought that the rest of the world would thank them for imposing a financial loss on the non-consulted countries.) Central banks have also operated the same way, the beneficiaries refusing to recognise the debt owed to benevolence should be to the whole community, and again violating the social contract. But let us build the argument. Firstly, central banks already exist in the money-for-nothing world. The rights that accrue to seigniorage guarantee that central banks are highly profitable entities. They print money, and the actual printing cost is much less that the face value of the notes. ( unless you are Germany in the 1920's, in which case the value of the paper was worthless, because of no confidence in the central bank). The primary role of the central bank is to maintain confidence in the currency that they have just printed. That one should be self-evident. Everything else is secondary.....but may include supervising, and monitoring, the banking system ( this is systemic support, not focused on particular organisations, or other mates), and some are even given a economic stabilisation role, as well. This last one is absurd, it should never be the role of a special interest entity to look after the greater community....especially one which is unaccountable to that community. Greenspan might have pooh-poohed the Malaysians, but he should at least have been even-handed, and apply equal measure to the Bernanke's Fed performance. Bernanke's attributed research pieces into zero interest rates show you should avoid them, the outcome is unknown/unknowable, and their reversal has had no successfully demonstrated examples ( his research case was Japan, which has never emerged from their post-1989 funk). And yet, we have had QE1,QE2, QE3, and no repentance. The sole beneficiaries are the bank's carry trades.....no different to the prime broker role.....and still no knowable exit path. WHO PAYS IF THEY ARE WRONG about the path that will emerge from their unforecastable modelling. Amazing!!! Total unaccountability to those who will bear the cost for any downside ...to the 40 instead of the 60 in the trade-off ratio. Closer to home, we at least have a central bank which is universally owned, not like the US system, where the central bank is owned by the very banks it supervises/licenses.. BUT, what did the banks pay for the stability of the central bank guarantee for deposits( the taxpayers were allocated the moral hazard here). What did the banks do when they placed paper with the Future Fund in 2008 ( again the taxpayers have the effective moral hazard here ). Where is the supervision/ monitoring here. Was it the same supervision which allowed those same banks to arbitrarily decide to reduce the credit lines of highly viable organisations, and cause all sorts of real affects to those businesses activities, but still continue to ensure sufficient lobbying to maintain bank executive salaries. Just when did stability of the banking system become defined as " maintain our salaries, while we cut back on our obligation to customers, while making sure the moral hazard rests on the taxpayers". Truly, Money for Nothing. Least of all, responsibility.

Section One, Part two

MONEY FOR NOTHING - Investment Banks There was a very bad movie starring Kris Kristofferson, called " Rollover " , where the premise/denouement was that a non-reinvestment of a large amount of petro-dollars would cause the collapse of the US financial system.. While this played to the broader thematic of the US dislike for other/aliens from the Middle East ( in this case caused by the build up of financial balances arising from the high price of petrol in the 1970's ), the real distemper in this movie was that the non-rollover of a deposit was somehow malicious, and designed to cause hurt. Oh, that this theme wasn't highlighted during 2007 and 2008, as the possibly viable cause of the start of the problems. Let's do a very brief stocktake of a couple of instances from the period. As an example, assume I am in charge of an investment portfolio, whose main clients are a few wealthy individuals; some savings balances of key executives in my operation, and some wholesale/professional investors introduced by my prime broker. I will also assume that I will not have to define all of these terms, but suffice to say the prime broker relationship is one in which some other investment bank acts as the account keeper/market broker for the purchase of securities/administrator of the account/and financier when I need to borrow to fund my purchasers. I have set it up like this because it keeps both internal and external scrutiny to a minimum. Now, the purpose of my investment portfolio is to make money. I can get financing at , say 4%. I can invest in securities that my models tell me will pay 7%. My prime broker will allow me to borrow over $ 1 billion, even though my clients have only put in , say $ 50 million. This fund is very leveraged at twenty times, but this is, strangely, not excessive for the time. Since I get paid to simply make money, nobody objects to my fund structure, because on the face of it, it is like " shooting fish in a barrel" , I get a three percent carry for every dollar I have invested.....and because I get three percent on an extremely large amount of money, I can pay myself really outrageous amounts of money, and still " deliver" a good return to my clients. I will even be conservative, by assuming that I am earning this carry on a simple basis every month that goes by. My prime broker is not going to stop me: not yet anyway. Remember the prime's role is multiple: they get paid to service my account, they also probably find/package together the securities that I have bought( for which they would have earned a fee ) , they also introduce some of their clients to my portfolio ( for which they get a capital introduction fee) , they also arrange my finance, for which they will also probably earn some fee......they probably borrow at 3.85%, and so giving it to me at 4%, means they also get some slice of an interest carry. And as a capital market competitor to me, they will buy and sell very similar securities to me, because they assume/know that I will be buying and selling in the markets, and therefore have fore-knowledge of the likely demand/supply for my type of securities. It is only the latter ( the ability to illegally front run my purchases and sales ) which is perceived as against the law. There are any number of ways that this can play out badly, but let's assume that it plays as follows: my prime broker suddenly develops a dis-like for me ( maybe I was arrogantly offensive at a social baseball game, by being abusive in front of some women and children.......no sexism here - the industry is largely male ). The prime, who values my securities and reports my Net Asset Value ( NAV ) of my portfolio to me on the 14th of the month, decides that some of my securities are only worth 85c, not $1. They know that this will probably force me to sell some, and they have probably short sold some securities ahead of giving me the NAV. I have got some really big problems now.....I have been telling my clients that their investments have been performing well, and now I will have to make a significant re-statement of the value of my portfolio. Not only that, the prime, who asks me to lodge a percent of my total portfolio with them, will probably ask me to increase that percent if I have some notional loss position that I will need to cover, or failing that, to significantly shrink my portfolio. That would cause me to sell at the artificially lowly set price, turning notional losses into " real " ones. Of course, the easy way out for the prime is simply to do a " rollover " and say that they will not let me have borrowings of $950 million any more, saying that if they only lend me $850 million now, I need to reduce my portfolio by $100 million all of a sudden. [ a number of mainstream banks did these facility reductions for a whole range of high quality companies in 2008 , so the concept of egregious facility reductions was not an unknown behaviour ]. My business is now in a death spiral, and my clients, who did not expect to lose money, or for that matter did not understand what I was really doing in the first place, now require all similar activities to either restate their NAV's or to reduce their loan amounts/demand higher margins. Now the industry is in a death spiral, because banks will reduce what they lend to investment banks, who will reduce what they lend to their clients, including all prime broker relationships. As an aside, I, as an investment bank, is staring at my own business mortality , unless of course I get re-classified as a bank ( I.e. get my banking license approved ) or have access to an internally managed cash management trust which I can coerce into buying my head company loan securities as a way of tiding over any shortfall I have from Main Street banks. Both of these " solutions " were invoked by a few organisations in 2008 and 2009. The speedy banking license, and therefore access to central bank " support/protection " was probably the most offensive, in the implied taxpayer underwriting that is then generated by the acquisition of the license. I shouldn't need to point out where is the " money for nothing " theme here. What might surprise is that, for over-the-counter securities, the nature of market value is so arbitrary, and so contingent. And that the consequences are so profound. It is interesting that there are now a number of re-imaginings that says that the GFC was essentially an investment banking problem. The solutions adopted by the central banks are therefore flawed, and the impacts felt on the real economy have therefore been unwarranted. Arbitrariness has again interfered with normal relations between the populace, and trust further undermined.

Section one, Part one

Theme: MONEY FOR NOTHING ( apologies to Dire Straits ....good name for a rock group, in hindsight). Social contract allows for full, and reciprocal, obligation." I will allow you to operate, provided you recognise and agree, and comply with your part of that obligation." Money for nothing has so many manifestations since 2007, but let's concentrate on three main examples: redemption freeze; investment bank behaviour; central bank behaviour. REDEMPTION FREEZE We need to establish the ground rules. Caveat emptor says if I am stupid , I deserve to lose my money. If I am a professional investor, then it should be a battle of equals, and if you win this one, then I will get a chance to get you back on the next deal, to equal the equation. Good, totally professional game, giving full credence to the Darwinism that is financial markets....only the best survive. The "balance of the scales" is appropriate. Provided that we are playing , and supported , by the same contract. We can and should differentiate between professional, and retail based investors, with the latter having a higher duty of care...but we will come back to that shortly. To complicate matters, there are a number of forms of redemption freeze: a redemption freeze forced on the investing entity by their total inability to fund client payouts.....think Elderslie ( was that you, John Hewson? ) ; maybe a whole series of debenture funds who got caught on the illiquidity of bad investments ; maybe a whole series of funds who are designed to funnel money from unsuspecting punters into a promoter's pockets. Lots of manifestations.....the actual real effect is...I will not give you back your investment money because I can't ( as opposed to won't). This may be borderline criminal, but it is not amoral. Crooks are crooks, and these funds get shut down. These group of activities are based on making an offering to investors, and ultimately disappointing those investors. Totally supported by the system, almost validated by ASIC ( Australian audience, other jurisdictions can insert your own inert regulatory body ) , and fundamentally flawed....promoters should either go to gaol, or at the very least never work in the business again. Such penalties seem to be too seldom invoked. Criminal seems to apply to the detinue of candlesticks, not $10,000. White collar sounds so much more innocent, doesn't it? What about the " won't" . Well, this is not criminal.....well yes it is. If I told you you cannot have your money back, because I have decided not to give it back to you....for no other reason than that is my decision, well I reckon I have breached the social contract which is formed on the basis of honesty and trust. Notable examples of a few years ago: State Street Bank, in the USA. Closer to home, a whole series of funds operated by Perpetual, some property trusts, including one operated by Investa, not to mention a number of superannuation funds under the oversight of APRA. There will be a whole range of reasons adduced to justify the action...the usual bastion of the scoundrel is to claim that to keep the trust open is " not acting in the best interests of all beneficiaries ". What is galling here is that the people who made the bad decisions on how to set the fund up, or where to invest in the first place, now arbitrarily determine that they will suspend normal operations, because in effect it would be commercially inconvenient to operate. Usually, the business can continue.....the reality is that the business proponent does not want their assets effectively "scored" or "marked" at the new ruling prices.....not for the clients benefit, mind, but having the assets marked at proper transaction prices will probably mean that the business will suffer some mortal form of brand damage. Have you noticed however that the asset pool is usually not so illiquid that the proponent has to forgo their fees during the freeze. They always seem to find the money to pay themselves, while at the same time denying access to money by their clients. Arbitrary detention of money is no different to the arbitrary detention of any asset. Arbitrary detention of your money, while I continue to pay myself (usually) full freight in the form of my fees, is tantamount to theft. Again, very little formal punishment flows to these promoters, some indeed continue to pretend to be scions of society. So what is required here. Let's set the parameters of the argument. For society to operate, I need to be able to form bonds of trust. Moral obligations exist to treat people honestly, and without fraud. We have developed finely tuned judicial systems to punish thieves and fraudsters, but not so finely tuned that these do not have to be rethought in the light of the advancement in commercial practices which introduces arbitrary decision-making, which creates opportunities for me to withhold an obligation to you, for an arbitrarily determined period of time, whilst I still reward myself for doing a job on you by making those decisions, and continuing to pay myself. At the very least, I should be forced to disgorge any earnings during the suspension period, and this can be enforced as a condition of my operating license. There would be no point suing me....I can always revert to the assets of the trust to fund any actionable against me, and the fraud I am talking about is not formal fraud, but an inconvenient type of business practice which amounts to a fraud against the social contract.....the condition that I can create an set of arbitrary decisions , against your true interests, without me also suffering some commensurate financial disadvantage. The GFC exposed a number of key decision makers to some strains and pressures they had never previously experienced. What emerged was a large number of ill-thought arbitrary decisions which will continue to erode , or at least delay, the re-belief in trust. Too many persons have still not been punished for their practices, and the general public, because the decision making was so varied, vast, and manifest, did not have time to respond with their full range of preferences. Redemption freezes took a range of forms, from the obvious freeze within wholesale and retail trusts, to the style of redemption freeze implicit in the banning of short-selling listed equities. These were all decisions made where some decision-maker creates an asymmetric relationship between commercial actors, without first asking both sides. Trying to hold inquiries after the event to seek support to justify prior actions is just not good enough. We need to learn lessons, and ensure that practices re-inforce trust, not undermine it.