Tag Archives: wealth

Why did auditors fail to blow the whistle on the banks?

1. Audit Failure

2. Why does the failure of large concerns matter?

3. Why false accounting happens

4. The incestuous relationship between auditor and audited

5. How collusion may arise between the auditor and their client

6. Is it possible to audit companies meaningfully?

7. The scarcity of IT skills

8. The responsibilities of directors

9. Non-executive directors

10. What can be done to improve matters?

1. Audit Failure

The failure of the massive US energy company Enron in the early years of the century and the incestuous relationship between the company and its auditors Arthur Anderson gave a graphic public example of the dangers of relying on company accounts to provide a true picture of the financial state of a company. Enron went from being worth $80 billion to virtually nothing in a year, yet Arthur Anderson kept on giving them a clean bill of financial health right up to the end.

Since the Enron crash, a series of major private enterprise failures has occurred culminating in the catastrophic financial implosion of major banks and their ilk, most notably those in the USA and Britain. Much has been written about the failures of formal regulatory regimes for banks and their ilk, but surprisingly little media and political attention has been given to the failure of the part played by the general regulatory rules for business – the audit of business accounts- in preventing the excesses of the banks, for example, how did the banks’ auditors persistently accept the value placed on the exotic financial instruments which underpinned the sub-prime debt or time and again fail to uncover fraudulent trading positions of dealers like Nick Leeson?

It is this aspect of failed regulation – the audit of companies – upon which I shall concentrate, an examination which will address the general problems of auditing rather than just those associated with banks.

What is the audit? Any limited liability company in Britain has by law to be inspected to some degree (the level of audit for very small companies is much less onerous than for the larger ones) once a year by a qualified accountant or firm of accountants. The auditors must either certify the annual accounts as a fair representation of the company’s business or certify the accounts with reservations. Where the accounts are blatantly and seriously flawed, the auditors will refuse to sign the accounts and resign as auditors. Such events are very rare indeed in the case of the largest companies.

The audit regimes of different jurisdictions vary in detail, for example, British companies are required to divulge substantially more financial information than their US counterparts. Nonetheless, the regimes in any advanced country are similar enough for statements about auditing problems to be generally pertinent.

2. Why does the failure of large concerns matter?

Before I turn to the practical difficulties of producing honest and accurate audits, there is a prior question to answer, namely, why is the audit necessary? after all, private enterprises which do not take public money for government contract work are simply risking the money of their shareholders and those who extend credit to them.  Pathological free marketers would say that even a large business failure it is merely the market at work and that all will come out in the competitive wash.  Those not afflicted with this quasi-religious belief will see things rather differently. However, the free market case does need to be answered because of its present dominance in politics. So, why is the failure of a large company so important?

Obviously those who lose money or their jobs through the collapse of a large company suffer, but what about the general population? Why should they care? Indeed, many people  shrug their shoulders when they hear of  business failures, thinking “I own no shares, I have no pension with them. I do not work for them. I am not a creditor. It will not affect me.” In the special case of banks they may be concerned about money deposited, but that fear soon evaporates in a country such as Britain as they discover that the government underwrites either all or a large proportion of their deposits.

Those with this I’m-all-right-Jack mentality dwell in a fool’s paradise. In aggregate, business failures of any size are important to an economy, but a large company going bust is particularly bad news, both immediately and in the longer term. To begin with there is a strong possibility that it will have most of its staff concentrated in a few areas or even in one area. If so, it will cause a local crisis. Structural unemployment on the heroic scale of the 1930s or even of the 1980s and early 90s,  when British industries such as coal and steel were rationalised” almost out of existence, may be a thing of the past in Britain  because the country has been cleansed of most of its great manpower demanding manufacturing and extractive industries,  but a company can still employ sufficient people in an area to cause severe economic and social dislocation if it stops trading for it puts out of work its own employees and the employees of firms dependent upon its orders and the  local economy as a whole shrinks as purchasing power is reduced. Beyond the local economy, the taxpayer generally suffers because those now redundant pay no income tax and have to rely on taxpayer funded benefits while the tax take generally in the area is reduced as demand shrinks.

Less tangibly, the failure of a company as large as Enron affects the general confidence of the population.  They think, not unnaturally, that if a company that big can go down the pan, what company is safe?  When people are unsure about the future they tend to reduce their spending. That deflates the economy. but not only do they fear for their immediate jobs. If they have  a private or occupational pension, they begin to ask awkward questions such as “Is it safe?” Those without pensions as yet ask “What is the point of paying into a pension if it goes the way of Enron’s pension scheme?”

These are very pertinent questions to ask.  Private and occupational pensions are heavily linked to the stock market because pension funds tend to hold much of their investment capital in shares. Any large pension fund will be likely to hold shares in  many  major companies. If a large company fails completely or even does very badly, non-state pensions  will suffer. Even state pensions may indirectly feel the pinch because  reduced tax revenues due to a slowing economy means that state funding cannot be so generous.  Moreover, the failure of large companies has a depressive effect on the stock market generally, which again is to the general disadvantage of pension funds, which hold a large proportion of their funds in equities.  

But the ripples spread even further. Companies rely directly and indirectly on the reliability of their audited accounts and the accounts of others. So do credit rating agencies and market analysts. Once confidence in audited accounts falls, then the cost of doing business rises as companies take steps to try to safeguard themselves against losses from honest business failures or outright fraud. They will become more cautious in their business dealings generally. They will attempt to insure against losses. The general cost of borrowing money will almost certainly rise as banks become warier. New investment may become impossible. This is what caused the Asian Crash in the late nineties. Far Eastern companies looked a good bet from their accounts, but many were far from sound in reality. Once the accounts of a few big companies were exposed as works of fiction, a general collapse in confidence followed and even companies which on a trading level were perfectly sound found their supply of new capital drying up.

Finally, there is the loss of the capacity to provide of goods and services . A  large company may fail through incompetence or fraud rather than a decline in demand for their products or competition from other at home and abroad. If that  happens the country and its people lose the opportunity to purchase the goods and services. This may mean either no goods or more probably imported goods  at a higher price. In the case of strategic industries, such as microchips or energy, it can also mean a dangerous dependence on foreign suppliers.

A single large failure will not capsize a first world economy on its own, although it can do a great deal of trouble – Wall Street lost 2% of its value after Enron collapsed.  But often one large failure will signal others. There is a good reason for this: such failures almost invariably occur in difficult economic times, either at the very end of overheated boom or on the downturn.  In boom times, incompetence and even fraud can be hidden by a company because confidence is high, money is plentiful and cheap and customers  easy  to  find,  legal regulation  becomes  lax  and self-regulation next to non-existent. Financial castles in the air can be  and are happily and rapidly constructed.  Come recession, the fruits of incompetence and fraud rapidly ripen to the point of collapse and exposure. If one large company has been caught by incompetence or fraud, you may bet the farm on a number of others having fallen into the same trap.

If audits are fair and accurate, the chances for reckless or criminal behaviour are greatly reduced. That is why they are essential to the efficient functioning of economies which are predominantly capitalist. The problem is that time and again audits fail to be either fair or accurate. To understand why this is so we need to understand the reasons and methods of those within companies who would  act dishonestly or incompetently, the process of auditing and what practical steps can be taken to prevent abuses by both directors and auditors.

3. Why false accounting happens

 False accounting occurs for two general reasons. The first is the “honest” reason: accounts are falsified simply to keep a  company afloat. This is very common. It may often have a moral slant to it as many employers who own the companies they run have a genuine sense of responsibility towards their staff as well as their own interests.

The other reason why accounts are falsified is fraud for the direct benefit of the individual.  This has three basic forms. The first is when the directors of a company dishonestly influence the price of shares through the provision of false information, directly or indirectly,  to the  markets to hide the poor performance of a company and persuade shareholders and suppliers that it is still a viable and attractive going concern. Higher share prices and misleadingly favourable accounts can also trigger very large bonuses and share options.  

The second form of fraud is the direct attempt to steal the assets of a company.  This often occurs in cases where directors are all in the know and have started off falsifying the accounts to keep a company afloat. They get to a stage where it is obvious the company is going under and the directors suddenly take what they can and run. However, it can also be fraud which consists simply of taking money or assets by one or more people – who need not be directors – without the directors as a whole knowing that fraud is being perpetrated.

4. The incestuous relationship between auditor and audited

The relationship between auditor and audited can be very close regardless of the size of a company (private limited companies with few shareholders are very prone to having a tame auditor, especially family owned businesses), In the case of very large companies the relationship between company and auditor becomes very incestuous. Very few firms of accountants have the capacity to perform such audits – in Britain, perhaps three could handle a company the size of Enron.  This means that the same handful of accountancy firms carry on auditing the larger companies more or  less regardless of their performance, simply because there is no one else to do it. For the same reason governments are reluctant to act against such audit firms no matter how they behave, because to do so could result in audits for the largest companies becoming a practical impossibility. There is probably not one large firm of auditors in Britain which has in the past 30 years not been involved in some serious failure to uncover financial wrongdoing.

The primary problem with the audit as a regulatory instrument is that the auditor has a vested interest in keeping the company audited sweet because there is money in “them thar audits”. Auditors go from year to year or  even  decade  to decade with the  same  companies, happily drawing their auditing fees, which can be very substantial in a large company – Enron paid Arthur Anderson $25 million for their last audit. The incentive not to kill the goose that lays the golden egg is obvious,  and the auditor may be tempted to turn a blind  eye  to irregularities ranging from trading whilst insolvent to outright and wilful criminality.

Accountants will often tell you there is no money in auditing. Well, up to a point, Lord Copper. As auditing is a statutory requirement and qualified accountants have a monopoly of the work, there is little excuse for auditing not to be profitable. Indeed, at the smaller end of the trade auditing is a staple of an accountant’s practice. The larger the company, the more complicated matters become. Small companies frequently have their accounts audited by their accountant and little else done. Large companies commonly purchase a range of non-audit related services from their auditors, for example, management consultancy and sophisticated accounting and financial services software. (Enron paid more in consultancy fees ($27 million) to Arthur Anderson than they paid for their audit.) Auditors will drop the  price of the audit to entice the customer to buy the non-audit services. The audit may even appear as a “loss leader” in the audit house’s ledgers. But of course it would not be offered at a “loss leader” price if the other non-audit fees were not forthcoming. It does not require much imagination to see that such non-audit fees are going to end if the accounts being audited are not passed as satisfactory. It is worth adding that amounts paid by large companies to auditors for non-audit services are small compared to the value of the businesses they audit and the financial resources they command.  What after all was the $27 million Enron paid Arthur Anderson for consultancy work in their last trading year when compared to the billions Enron commanded?

Why is this laxness tolerated? Because the government cannot act, even in a purely legislative sense, too harshly against auditors for they know that if they make the rules for auditing too onerous, it may dissuade so many accountants from undertaking audits as to make the legal requirement to have accounts audited a practical impossibility. In the case of those accountants auditing the largest companies, there is a particular problem because none of the accountancy practices which have the capacity to undertake such audits has clean hands.  If the largest audit firms were brought to book for their failures to audit meaningfully, the government might as well relieve the largest companies of their obligation to be audited for there would be no one left to do it.  

The sad truth is that whatever regulatory legislation a government might pass to improve audits would be virtually a dead letter in practice if the audit profession does not wish to play  ball.   Government  does  not have the  capacity to meaningfully police auditing and could not in practice acquire it.  Because of the technical expertise required, the only people who could do it are accountants and they are never going to work as paid government employees in any numbers. That is so because accountants in private practice can both earn much more than public service could possibly offer and be their own masters – this is a general problem for public service with jobs which require expertise with a high value in the private market.

But even if sharp accountants could be persuaded to work for the government, their numbers would always be vastly less than the numbers needed to police audits meaningfully. In fact, the active policing of any law involving a fraud is always something of a confidence trick because the numbers of fraudsters are invariably vastly greater than the forces the state can muster against them.

5. How collusion may arise between the auditor and their client

The turning of a blind eye to irregularities may happen tacitly, that is, both auditor and the company to be audited understand what the “deal” is without anything being said – you get the fees, we get the clean bill of financial health. However, outright conspiracy between the auditor and the audited to suppress the true financial state of the company must happen reasonably frequently because apart from those instances which result in criminal charges, there are  any cases of publicly reported company failure which involve such dramatic  failures of auditors to qualify accounts that it is difficult to imagine they are down to simple negligence or incompetence. In Britain, think of the failure of auditors to unmask the corrupt behaviour of Robert Maxwell (Mirror Group), Asil Nadir (Polly Peck) and BCCI.

Such a conspiracy might include all the partners in a accountancy firm or just one. Where a large company is audited, the number of people  required to carry out the audit is substantial.  There is consequently a good chance that irregularities will be known to quite a number of people and a conspiracy might seem impossible to keep within the conspirators.  However, most of the people who do the physical auditing are not partners or even qualified accountants, accountancy trainees being commonly used as the auditing footsoldiers. Such people have a vested interest – progressing their careers – in keeping quiet if  they think the audit is being conducted dishonestly and also lack both the expertise to unravel fraud and the access to the overall audit data, which access often may be necessary to see a fraud.

6. Is it possible to audit companies meaningfully?

he problem for the auditor is how to balance the time available for the audit with the amount of data to be audited. As the data for a company of any size always vastly exceeds the time available all an auditor can do is sample the data. But that is only the start of his difficulties. Take the most basic act of auditing, comparing one document with another to verify that a transaction has taken place. The auditor checks one against another, say an electronic record against a paper invoice. One substantiates the other. What then? Does the auditor simply take the records at face value or does he institute further checks such as contacting a supplier of the audited company to see whether an invoice ostensibly from the supplier was actually issued by the supplier? The norm is that records which seemingly corroborate one another will be taken as genuine because the auditor simply does not have the time to check further all of the documents he inspects. The  best that can be done is to investigate more fully a sample of the documents the auditor  has chosen for inspection. But that means he is down to investigating a sample of a sample, and even if he does it rigorously, the chances of discovering that data has been falsified are pretty slight because most frauds will only affect a small part of a company’s records.

Interrogation software can be used go “data mining” on computerised records, but the best one can ever do with the manual data (which is probably the most easily identifiable source of irregularities) is sampling. Moreover, even where computer files can be interrogated efficiently – something dependent upon the IT skills of the user – that produces another sort of problem: the large volume of extracted data to be scrutinised. There is only so much time and effort that can be put into an audit.

If the directors are determined to obstruct an audit by supplying false or incomplete data as Enron routinely did in the most complicated and opaque manner,  I doubt whether it is possible to meaningfully audit a company of any real size, let alone one as enormous and as complicated as Enron. Their main accounting trick  was the creation of fictitious revenue  by setting up a complex chain of dummy companies, that is, companies owned and controlled surreptitiously by Enron,  which pretended to trade with Enron as independent customers and the hiding of debt in those companies.  A satirical email which did the rounds at the time of the Enron collapse was perhaps not far short of the mark:

Capitalism – You have two cows. You sell one and    buy a bull. Your herd multiplies, and the economy    grows. You sell them and retire on the income.

Enron Venture Capitalism – You have two cows. You sell three of them to your publicly listed company,  using  letters  of  credit  opened  by  your   brother-in-law  at the bank,  then execute  a   debt/equity swap with an associated general offer so that you get all four cows back, with a tax  exemption for five cows. The milk rights of the six cows are transferred via an intermediary to a Cayman  Island company secretly owned by the majority shareholder who sells the rights to all  seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more.

But whatever the size of company, the auditor is always at the mercy of his client in the sense that he can only work from the data the client gives him. A false set of plausible “books” is presented and there is not much an auditor can do in practice because of the constraints of time and money. And a false set of “books” is all too possible these days because computers have made the business of falsifying records a doddle. Keeping two sets of books manually involves considerable effort, with computers all that needs to be done is keep two separate accounts programs running. one truthful, one bogus, Moreover, with computerised systems changes to hide fraud can be made without leaving the obvious tell-tale signs of alteration commonly found within manual systems such as rubbings out, pages torn from ledgers, obvious attempts to change data and other evidence of human interference.

Computers also affect the veracity of paper documents. As a reasonable stab at counterfeiting banknotes can be made using run of the mill IT equipment, it is not difficult to imagine how easy it is to forge other documents which have no security features built into them.

Suppose I want to forge an invoice from a regular supplier to account for money which in reality has been siphoned off illegally. I take an actual invoice from the company. I scan it in and then use a graphics package to remove the original sales data and to put in the false data. I then print out the forged invoice (using similar paper to the original) which for all the world looks like the other genuine invoices I have from the supplier.  

There is also the problem of the auditors ability as an investigator. Investigators like salesmen, are born not made. You can make a natural investigator better by training and giving him experience, but you can never make someone without the natural talent a good investigator. That is because an investigator must be someone with initiative, someone who does not require a textbook to tell them what to do. Many auditors frankly do not have that quality in any great degree and are literally incapable of conducting a serious investigation rather than a “tick and turn” inspection, that is merely satisfying an audit by taking things at face value. . Indeed, the type of personality which makes a good technical accountant – attention to detail, accuracy in small things and so on – may mitigate against him being an efficient investigator. As already mentioned, it is also true that the least able and experienced members of an accountancy firm are put to audit work, while the more able and experienced do the consultancy work.

7. The scarcity of IT skills

Even after 25-30 years of computerised accounting systems being the norm, auditors all too often lack the computer skills needed to interrogate electronic data in a sufficiently sophisticated manner, something which is far from simple for even someone with good IT skills when they are dealing an unfamiliar computerised records and accounting system. It could be argued that such skills should be made mandatory for auditors dealing with large companies with complex computerised accounting systems. That idea like many a legislative wheeze sounds attractive at first glance. The problem is that people with such skills are thin on the ground and very costly. If the employment of such people were made mandatory, large firms of auditors might well be unable to employ the staff they need. That  in turn could lead to the auditing of all  limited companies becoming impractical.

But let us assume for the sake of argument that there were sufficient people with IT skills and they could be enticed to work for  auditing firms, what then? Very few of those IT competent people will also have the accountancy skills needed to properly perform an audit. Nor is it probable that sufficient people could be trained to have both at a high level, because the dual training would simply take too long and be too costly. Consequently, auditors without high level IT skills would often have to work through IT specialists without accountancy skills. Apart from the immense cost implications of this, there is also the problem of meshing the IT specialist and the accountant together. As any systems analyst will tell you, the point in the creation of a new system where things are most likely to go wrong is the process of the computer illiterate customer telling the systems analyst what he wants of the system he is asking the systems analyst to design. Accountants without advanced IT knowledge are all too likely to ask for things which do not produce the data they want.

8. The responsibilities of directors

Directors, both executive and non-executive have legal obligations to take all reasonable steps to ensure that their company trades within the law. That obligation includes the presentation of an honest set of accounts.

Directors cannot be passive and automatically escape the consequences of any criminality or gross incompetence. Ignorance of wilful criminality or of gross incompetence in maintaining records adequate to show the true financial position of a company, does not excuse directors from their obligation, although it may be enough to save them from criminal charges.

Directors have limited liability in normal circumstances. However, if it can be shown that the directors have not met their legal obligations as directors, for example criminality is proven or inadequate records have resulted in a company making a loss, their limited liability can be removed. However that is  extraordinarily rare, which suggests that either the law is inadequate or there is a tacit understanding amongst those with the power to take action to remove their limited liability, especially the large pension and other managed funds, that pursuing individual directors would not be playing the game. As we shall see the law would appear to be adequate if it were only enforced. .

Nowhere is this reluctance to act  better seen than in the aftermath of the banking crisis which caused the present recession. Not one of the directors of the Royal Bank of Scotland or HBOS has been subject to criminal or civil action. Being a banker is a small-risk occupation for those at the top. As the Government almost invariably steps in when it is a bank going bust, being a banker is a one way bet: the bank makes money you get the vast remuneration: the bank fails the taxpayer steps in and you do not suffer any punishment such as summary dismissal, the removal of limited liability if you are a director or criminal proceedings, but instead leave with a massive pay-off at worst

Section 174 of the 2006 Companies Act details the duties of the directors as follows :

(1) A director of a company must exercise reasonable care, skill and diligence.

(2) This means the care, skill and diligence that would be exercised by a reasonably diligent person with—

(a) the general knowledge, skill and experience that may reasonably be

expected of a person carrying out the functions carried out by the director

in relation to the company, and

(b) the general knowledge, skill and experience that the director has.

How can the directors of the nationalised or partly nationalized British banks –  RBS, HBOS, Lloyds TSB and Northern Rock – be said to have met these requirements? Lloyds TSB have even admitted that inadequate due diligence was done before the takeover of HBOS. Yet there has been no suggestion of taking criminal or civil action against them. .

There is also the question of general competence. The alarming truth is that the executive directors of the banks almost certainly did not understand the complex financial packages being devised by their investment arms which led to the crisis. On 10 February 2009 the recently removed executive directors of the RBS and the HBOS appeared before the Commons Treasury Select Committee: Sir Fred Goodwin (ex-RBS chief executive) and Sir Tom McKillop (ex-RBS Chairman),e Andy Hornby (ex-HBOS chief executive) and Lord Steveson of Conandsham (ex-HBOS Chairman).

During their examination by the committee, each of the four directors on show was asked to detail their formal banking qualifications. All four had to admit that they had none. I am generally an enemy of credentialitis, but in this case technical qualifications are necessary to ensure that the directors understand the very complex financial instruments being used and the exotic accounting practices employed by large corporations. If failure to understand such things does not amount to gross negligence what does?

The Companies Act allows shareholders, subject to the agreement of a court, to sue directors for negligence, default, breach of duty or breach of trust. No attempt has been made to removed their limited liability to allow this to happen. Nor, as far as I can discover, has any attempt has been made to get bank directors banned from holding directorships in the future. Why have the institutional shareholders not started such legal action to remove limited liability from directors so they can be sued? Why has no politician raised the possibility of banning ex-bank directors from being directors in the future? The only plausible reason is the tacit class interest encompassing politicians, bankers and large institutional investors, the last being the only non-governmental people generally with the financial muscle to fund actions to remove the limited liability of directors. There is a simple legal way to stop them enjoying the fruits of their ill-gotten gains: remove their limited liability and ban them from holding directorships for life.

As for criminal charges, I wonder if something could not be done under the laws relating to fraud. There must come a point where recklessness behaviour becomes fraud because the director knows they are taking chances which will most probably not come off. For the future we need a law of reckless endangerment which would make any director who endangered a bank or allied institution through their criminally reckless behaviour to be punished by the criminal law.

Far from being punished, bankers who have left the banks they have helped ruin have received  gigantic pay-offs to reward them for their incompetence. The case best known to the public is that of Sir Fred Goodwin of RBS who originally was to receive an immediately payable pension of more than £700,000 per annum,(since reduced to a more modest £400,000 odd ) but he does not stand alone. To take a couple of other examples, according to the Telegraph (27 Feb 2009) “Eric Daniels, the chief executive of Lloyds Bank, which has accepted tens of billions of pounds from the Government, could receive almost £10 million in pay, perks and bonuses this year”, while Adam Applegarth, the chief executive of Northern Rock when it failed, a bank so badly damaged that it is now wholly owned by the British taxpayer, reportedly  trousered £760.000 (Northern Rock boss to get £760,000 payoff Telegraph Tony Undercastle 31/03/2008).

When it comes to human behaviour, it is always risky to say that something has never happened, but I will stick my neck and say that there is no instance of a director of a large public company audited in Britain ever publicly blowing the whistle on criminality or recklessness verging on criminal irresponsibility and getting the backing of their board to publicly expose what was going on. I think one would even be hard pressed to find a director of such a company who has publicly exposed breaches of the law or recklessness on his own authority whilst still sitting on the board.  In the case of Enron a so-called whistle blower, Sherron Watkins, was not in fact a public whistleblower. She merely told senior Enron executives that massive debt was being hidden. When the senior executives did nothing, she followed their lead and kept quiet until after the company collapsed.

9. Non-executive directors

The sinecure is alive and well in boardrooms. Non-executive directors (or their foreign equivalents) are meant to bring some particular benefit, for example contacts or expertise, and a certain independence of mind to a board. That is the theory,  In practice, and especially with large companies, non-execs have a pretty dismal record of bringing neither particular benefit nor independence of mind to their position. Where were  Enron’s non-execs when what appears to have been outright fraud was being practised? How did Robert Maxwell manage to perpetrate the frauds that he did within the context of public limited companies  packed with non-execs? What were Marconi’s non-execs doing as the management  through sheer recklessness reduced a company worth £30 billion with a cash balance of £3 billion to one worth less than £1 billion with £4 billion of debt within 18 months in the 1990s? More dramatically why did the bank non-execs fail so spectacularly to raise concerns about the exotic financial instruments and other reckless behaviour which led to the banking collapse of 2008 They were  at best simply drawing their salaries whilst doing as little as possible .

The truth is that non-execs in the vast majority of cases are no more than PR wallpaper. The case of the former Tory Minster, John Wakeham, is instructive. Wakeham is an accountant by training with considerable commercial experience before he went into politics. Not only did he accept a non-exec directorship with Enron, he also agreed to chair  Enron’s audit committee.

In theory, Wakeham was the ideal non-exec. He had particular expertise (accountancy), contacts (politics) and was not dependent on Enron for his main remuneration – apart from his then position of Press Complaints Commission chairman (for which he received £150,000) Wakeham also held 16 other non-exec directorships. Yet it did not make a blind bit of difference. Enron and their auditors were able to do what they did without a peep from Wakeham. I will leave readers to judge why Wakeham behaved as he did.

Wakerham’s situation when he was with Enron also raises a very interesting question: how it is possible for any person to head the PCC and hold as many directorships as he did (and Wakeham is far from being the champion in terms of numbers of directorships) and meaningfully satisfy his obligations as a director. Commonsense says it is not possible, even for the most conscientious and able man.

But non-execs are all too often not conscientious or able. They sit on boards to lend their names (a title is always very useful on the letterhead) and to give the illusion that a company is being properly scrutinised by those not involved with its  day-to-day management. The non-exec in return gets handsomely rewarded for doing very little and causing even fewer waves.

How are non-execs appointed? The Old Pals Act is the answer often enough. In the case of very large public companies there is a magic circle of non-execs who circulate around the companies.

10. What can be done to improve matters?

When one contemplates the practical difficulties involved in policing fraudulent or grossly incompetent behaviour by directors and auditors, the temptation is to throw up one’s hands in despair, yet something radical clearly needs to be done for at present, directors can act negligently or even fraudulently with near impunity. If you want to be a fraudster with little chance of going to prison, go into business on your own account. If you maintain at least the semblance of attempting to trade normally, generally you will be safe from criminal prosecution. If action is taken, the worst that can happen is normally a ban for a few years from being a director of a company, although in practice this is often a dead letter for very little check is made on their future employment. They may not formally be directors, but all too often they are to be found controlling companies through nominees (if the companies are small) or are employed as consultants.

How can matters be improved? Consider the practical restrictions within which any state-prescribed audit must exist. The state could never undertake the business of auditing itself because it would be impossible for the state to employ accountants in sufficient numbers to undertake the auditing. Nor, for the same reason, can the state police auditing even to the degree that it can make checks on the reduction of VAT or income tax under PAYE.  The best the state can do is investigate after the damage is done and even then the lack of accountancy expertise directly employed by the state means that the state has to rely largely  on accountants  in  private  practice to undertake the work of investigation.

If a regulatory system is reliant on private individuals – the directors, auditors and suchlike – to behave honestly and competently but cannot make any meaningful general check on them, the only course left is to work on the minds of such people. The most potent way to do that is to make the penalties for fraud and incompetence by directors and auditors severe and their application exemplary, which means prison, heavyweight fines and banning them from any position of responsibility within a company for substantial periods, including life in the worst cases and any director who has liquidated three companies. The same willingness to prosecute should apply to any other person involved in a gross misrepresentation or outright fraud connected to a company, for example lawyers, credit agencies, financial journalists, and politicians. In addition, the state should provide the means to pursue civil actions for damages against those who defraud or act with. The strongest incentives they can have to behave properly are convincing threats of imprisonment and personal financial ruin.

If the removal of limited liability is to be effective, the ability to recover of assets passed to family members and any other third party by a director must be greatly improved.  At present all that can be done is to try to show that the assets passed to a third party were passed simply to keep the assets from the director’s creditors, something which in practice is the devil‘s own job. What is required is a law that would allow assets to be seized if the third party could not show they had acquired them in a manner other than by receiving them from the director in question either directly or indirectly – a frequent ploy by directors who own all or much of a business is to pay a third party, normally the wife, substantial remuneration for work they do not do.

I would also advocate a new criminal offence to deal with situations where a prosecution is presently difficult or impossible because the directors are claiming gross incompetence to explain the collapse of a company or the unexplained vanishing of company assets. Directors should face criminal charges for such failures as inadequate or missing records as and the inability to account for missing company assets. These should be strict liability offences, that is, offences where intent does not have to be proved merely the fact that something has or has not been done. 

The position of non-executive directors needs to be tightened. As many of them do little more than lend their names (and sometimes their titles) in the manner described by Trollope in “The Way we live now”, the complete banning of non-execs would be no great loss. Any particular expertise a company needs can be brought in at non-directorial level. The same applies to people with contacts. The same applies to general independent advice on running the company.

The argument that non-execs provide oversight is unsustainable because they rarely if ever blow the whistle on corporate misbehaviour. Nor, as the example of British banks has recently shown, do they often have the expertise to understand the business they are supposedly overseeing. There might be a case of a small number of independent non-execs voted for by the smaller shareholders (to exclude the class interest between directors and the big managed funds), but the problem there would be whether sufficient people with the right expertise could be found to fill such roles. I would very much doubt whether they could be.

It might seem logical for audit firms to be restricted to auditing work. That sounds fine in theory but it raises two severe practical problems. The first is obvious: what if insufficient accountants are willing to set up audit-only firms? Obviously the system of audit as we know it would collapse.  That problem could conceivably be overcome by the government using taxpayers’ money to pay audit-only firms a substantial retainer to add to their audit fees to make the work worthwhile.  However, even if that did work, such a solution is unlikely to overcome the second problem, at least for the larger audit firms. Bright young would-be accountants, particularly with the larger accountancy practices, join because of the variety of work which is available. This provides them with not merely a good accountancy background but also valuable general management and business skills.  An audit-only company would not provide such a background. It is also true that audit work is pretty dull.

What could be done instead of having audit-only firms? A halfway house is possible. Auditors could be forbidden by law to offer other services to a company they are auditing. That will mean they have to adjust their audit and non-audit fees, but it is a practical suggestion in the sense that it could be done. It could reasonably be objected that faced with such rules accountancy firms, especially the large ones, might drop auditing.  In theory they might, but the majority of firms undertaking audits either have that as their main business or it is profitable for them. Even the larger firms would find auditing profitable if they stopped using it as a loss leader to entice clients to buy other services. If no auditor was allowed to do this, all would be forced to raise the cost of audits.

Whatever is done would of course leave the problem that only a small group of audit firms can handle very large companies. That can to a degree be addressed by especially strict oversight of the auditors of such companies, but it will always be a problem. The application of penalties should be auspiciously rigorous where collusion or fraud occurs in such companies and audit firms.

Insolvency law needs to enforced more strictly. However, that does present difficulties. In theory, a company unable to meet its debts is insolvent and should cease trading,  but few if any companies have not been technically insolvent at some time, not least because trade is often strongly seasonal. But if that was the standard by which businesses operated the economy would collapse. What businesses do is trade while they have reasonable expectations that debts will be met in the course of normal trading fluctuations or they believe they have the ability to raise fresh capital through such devices as bond and rights issues.  Of course, what constitutes a reasonable expectation is debatable and that gives great scope for interpretation by auditors as well as directors.  The line between fraudulent trading and misjudgement of a company’s circumstances is not always an easy one to discern. However, there are many blatant examples of companies going into administration or liquidation with debts which are simply so overwhelming that it stretches credulity well past breaking point to imagine that the directors had any reasonable belief that they could trade or borrow themselves out of an insolvent situation. (Think Portsmouth FC).

It is also important to realise that the audit at present is a narrow exercise designed to assess the past financial year. It is not meant to judge the broader viability of a company such as its longer term potential to trade legally. There is a case for giving the auditor responsibility for making broader judgements, for example, whether a company‘s borrowing is such as to overwhelm it with a slight change in circumstances, for example, a hike in Bank Rate. 

But no matter what steps are taken to enforce penalties against directors or to improve oversight, the policing of private business like all other policing in any society with pretensions to be free, involves a large dollop of public consent. It relies on the honesty and good will of both those running a company and those with the duty to check the financial state of a company. Consequently, the general moral tenor of a society will to a considerable extent determine the volume of dishonesty in business.

The fact that at present directors rightly believe that they have little chance of being held responsible for their incompetence or criminality means, quite naturally, that they are more likely to behave in such ways. But their propensity for doing so is also bolstered by thirty years of laissez faire propaganda by businessmen, academics, politicians and much of the mainstream media which has promoted the idea that state regulation is an evil, that the “free market” will police itself in a way ultimately benign to society as a whole and that Gordon Gecko’s “Greed is good” is by implication a worthy aspiration for everybody. That has created a moral vacuum which desperately needs to be filled. We need to get back to the idea that honesty is not merely a moral virtue but a necessity for a stable and prosperous society. Enforcing the law more assiduously and creating new laws where necessary, is one way to achieve that. Another is for politicians to stop their uncritical acceptance of so-called free markets (in reality, state controlled markets through anti-monopoly laws and privileges such as patents and limited liability) and start advocating a more pragmatic and broader approach to economic policy based on what actually happens rather than what an ideology tells them will happen.

Film reviews – Inside Job

Documentary

Director Charles Ferguson

Narrator Matt Damon

Released 2010

Run time 1 hour 48 minutes

http://www.sonyclassics.com/insidejob/site/#/cast

The last time I felt so angry coming out of a cinema was after a viewing of  The Smartest Guys In the Room, the story of the Enron scandal.   In the case of the Inside Job,  it was not that I was  given much by way of new facts, for I know the story it told  only too well.  Rather, I became angry simply by watching the grotesque drama which led to the present global financial disaster unravel from its beginnings; a  story well flavoured with recordings of the main players in the catastrophe either showing their reckless disregard for society at large before the recession arrived or trying to justify their behaviour afterwards in the most contemptible  and frequently risible fashion. (Watch out  for Prof  Frederick Miskin  explaining why he resigned as Governor of the Federal Reserve Board when the going got tough. His reason?  That he had to go back to his university to revise a textbook).  To that was added the dismaying knowledge that nothing has really changed since Lehmann Bros went down in 2008, with  the bankers who caused the financial disaster  still pocketing vast amounts of money, most of it provided by taxpayers.  There are some outrages which never  cease to shock no matter how familiar they become. This is one of them.

Those who have seen The Smartest Guys in the Room  will have a good idea of the approach and tenor of Inside Job. For those who have not, imagine a Michael Moore documentary without Michael Moore.  There are no cheap tricks, no exhibitionist presenter; just  mercifully jargon-free explanations of technical financial instruments and interviews quietly conducted by the director which allow the virtuous to express their outrage and the guilty to hang themselves with their own words and behaviour.

The film concentrates primarily on the American experience,  but there is no harm in that because the USA  is both an exemplar for what happened in much of the developed world and was arguably the prime driver of the global crash because of its globally dominant economy, although Thatcherite Britain needed no encouragement to tread the same criminally reckless path.

The film leads us through the story of the wilful creation of instability in the global financial system.   Jimmy Carter  began the process with the Deregulation and Monetary Control Act  (1980) and  Reagan followed it  up with the Garn–St. Germain Depository Institutions Act (1982). These  Acts allowed  Savings and Loans associations  (equivalent to British Building Societies) to behave like banks without being subject to the then  tight regulations  (the Glass-Steagall Act from the Depression) which divided investment banking from institutions taking deposits on a retail basis.  This resulted in colossal losses in the late 1980s and early 1990s with a great deal of US taxpayers’  money being used to rescue to rescue the situation.  This  gave the green light to the unscrupulous who believed, broadly rightly, that if any financial institution was large enough, it would be bailed out by the US taxpayer.

The experience of  the Savings and Loans scandal did produce  legislation to regulate anew the homes loans industry with   the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA).  That Act had one great flaw: it gave the two quasi-state mortgage granting bodies  Freddie Mac and Fannie Mae a  responsibility to support mortgages for low to  moderate-income families. That drove  the sub-prime lending.

The greatest  breach in the regulatory wall occurred in 1999. In 1998 Citi Group was formed by the merger of the bank  Citicorp and financial conglomerate Travelers Group . The only problem was that the merger was illegal under the remaining provisions of the Glass-Steagall Act which forbade any one institution from acting as any combination of an investment bank, a commercial bank and an insurance company.  Citi Group did all three . But  Citi Group were given a temporary waiver to allow them to dispose of their conflicting business in an orderly fashion.  Happily for them and sadly for the rest of the world, they were never required to make the disposals because in 1999 the  Gramm–Leach–Bliley Act (GLB )  repealed the parts  of the Glass–Steagall Act of 1933 which regularised Citi Group’s position and opened the way for any other US financial institutions to follow suit.

The final nail in the economic coffin was the failure of the regulatory bodies  such as the Securities and Exchange Commission (SEC)  to take any meaningful action against the newly freed  financial monsters .

The film does two other things well.  It explains the complicated  method by which deregulation was exploited by banks and their ilk and graphically shows the incestuous traffic between  politics and finance  and the way that academic economists have been all too willing to compromise their integrity by becoming hired pens for whoever is willing to pay them.  

How did sub-prime lending  and the general derivative mania become so rampant? Well,  there was the boost given by  the Recovery and Enforcement Act of 1989 mentioned above, but that  could not  cause the reckless lending to spiral  completely out of control. That required  the  Gramm–Leach–Bliley Act. After that anything went.  Dealers could create derivatives to effectively make a bet on anything.  

Most devastating to economies was the creation of Collateral  Default Obligations (CDOs)  and Credit  Default  Swaps (CDSs). The beauty of these  for financiers was that they effectively allowed a seemingly unending shuffling of responsibility and risk to someone else. With CDOs the relationship between borrower and lender changed dramatically. In the old days the borrower obtained a loan and paid it back to the person who made the loan. With CDOs the lender sold on the debt to a third party who bundled up various loans –  be it a mortgage, credit card spending or some other loan – with of widely varying quality and called it a CDO. This CDO could be sold on to investors, frequently with an AAA rating by one of the main credit ratings agency who were paid by – yes you have guessed it – the people selling the CDOs to investors.  To make the business even more opaque, CDSs were created to insure against losses arising from defaulting CDOs, effectively a form of reinsurance.   The final act in this fantasy world was institutions insuring CDOs they thought were junk with CDSs.  This meant they were compensated  when the CDOs failed while the buyer of the CDOs lost.   

Eventually the game of financial musical chairs had to stop and Lehman Bros  came crashing down to signal the advent of the worst global recession since the 1930s.  An interesting claim in the film is that Lehman’s was allowed by the US government to fail because the financial officers of the Bush Government did not understand the international implications of Lehman’s failure, most notably in Britain where the administration rules are radically different from those  in the USA and resulted in Lehman’s London offices being immediately closed. .

As for the nexus of  vested influence, this includes politicians, bankers, lobbyists, academics and credit rating agencies. One of the most telling sequences in the film is battery of senior personnel from the three largest credit rating agencies Standard  and Poor, Moody’s and Fitches – who consistently valued worthless or near to worthless  derivatives as AAA – testifying before Congress that their ratings are “only opinions”.  Closely running them up for dissimulation, is Scott Talbott, leading lobbyist for the Financial Services Roundtable, a man sharing with Dr Pangloss a belief that everything is for the best in the best of all possible worlds.  Particularly striking is the predominance of ex-Goldman Sachs employees in US government posts, men such as Henry Paulson,  Larry Summers and Robert Reubin.  It is worth wondering what the US government’s response would have been if Goldman’s not Lehman Bros had been the first US banking bottle to fall off the wall.

If you think Obama has made a difference, think again. He has employed a host of people from the financial world with  hands still dirty from their involvement in the genesis of the financial mess,  many of whom have served in the previous administrations which presided over deregulation.  This went right to the top of his financial administration. He chose as his Secretary to the Treasury  Timothy  Geithner , a protégé  of George W Bush’s  Secretary of the Treasury Hank Paulson, a  man who was up to his armpits in the ideological swamp of deregulation, while  the current director of the White House National Economic Council is Larry Summers who was Clinton’s Secretary of the Treasury when the  Gramm-Leach-Bliley Act was passed  – Summers greeted the Act by saying  “This historic legislation will better enable American companies to compete in the new economy.” In addition,  Obama  successfully nominated Bush’s choice for  Chairman of the Federal Ben Bernanke  for a second term as Chairman.  Plus ca change….

The most contemptible  excuse given by politicians around the developed world for the present financial debacle is that no one saw it coming. This is a blatant lie.  The film parades a baker’s dozen of people  in positions prominent enough to have  their voice heard by those in power who did warn of what was coming;  people like Nouriel Roubini (Professor of Economics at the Stern School of Business),  Raghuran  Rajan (when he was chief economist of the IMF) and  Christine Lagrade (French Minister of Economy, Finance, Industry and Employment). 

The coda to the film is the stark fact that none of the people chiefly responsible for the financial meltdown  have either faced criminal charges or had the vast fortunes they made during the period removed.  That applies not only in the USA but Britain, where provision exists to remove limited liability from company directors where they have failed to behave responsibly. The only people who have lost are as usual the less well off.

Market economies and the illusion of choice

One of the prime arguments for introducing business practices, private money and private business into public provision is that it improves choice. British citizens, increasingly referred to as consumers or customers rather than patients, passengers or any other appellation which emphasises the public nature of the provision, supposedly want choices of schools for their children and to go to the “best” hospital or to enjoy the “superior” service coming from private companies with public provision contracts such as those running the railways or utilities such as water or gas.

Take the case of the privatised railways. Before privatisation all a passenger had to do was buy a ticket and get on a train. The only thing the passenger had to consider was whether there was a time or date restriction on the ticket. Now, the passenger has to not merely worry about time and date, but whether he or she is getting on a train run by a particular company – how many people have been on an intercity train when the ticket inspector has got into a dispute with someone who has bought a ticket for the train’s destination but it is the wrong ticket for that particular train? The customer is also besieged by a bewildering array of pricing, far more than was on offer when the railway was state owned.

I doubt whether the average passenger welcomes either the multiplicity of carriers or ticket prices. A person can have too much choice. Human beings want some but not a vast amount, which merely becomes confusing. If you want to travel somewhere you do not want it to be a demanding exercise in both finding out what the cheapest fare is and ensuring that the terms of the ticket are not inadvertently breached.

Does market competition produce greater choice even in a “free market”? There is a good argument to say it does not. The natural tendency of a free market is to produce reduced competition. Governments of all colours in countries which have a large free enterprise component to their economy recognise this by maintaining anti-monopoly legislation. (What are called free market economies are in fact state regulated economies and regulated in the most fundamental way, ie the prevention of increase of market share beyond a certain point).

But anti-monopoly legislation only prevents the worst anti-competitive excesses. There is still very wide scope for anti-competitive forces, especially in capital intensive and technologically advanced industries – think Microsoft and operating systems or airliners in a market of two or three suppliers.

But the process is a general one. Even enterprises which are not innately capital intensive are affected. Retailing is a good example. A hundred years ago department stores were still in their infancy. Supermarkets and shopping Malls unknown. The vast majority of purchases were made from small, privately owned shops or from open air markets. Most of the shops specialised in a narrow trade.

Today we have far fewer shops and markets. Supermarkets and Shopping Malls abound. The chain stores of at most a few dozen companies become ever more pervasive. There are many fewer specialist shops. The private retailer is assaulted from all sides by the large multiple-store retailers and increasingly succumbs as the public is seduced by the immediate temptations of price and convenience without regard to the social long-term consequences of what they do. The privately owned shop does not even have to be in the immediate vicinity of a giant chain store to suffer. It merely has to be within reasonable driving distance of the chain store. The consequence is that the poorer areas of larger towns and cities and country villages and small towns are denuded of their shops. The choice of the poorer residents of such places is tremendously reduced. The wealthier do not of course care about this because it has no direct effect on them. They have the wherewithal to either live in areas well serviced by stores and services or can afford to drive to the large supermarkets or have goods delivered from far afield. Such developments fall within the remit of government. It is not for Government to operate supermarkets but it is within their remit to prevent commercial behaviour which is anti-social.

What constitutes choice anyway? Is it, for example, having more shops offering a smaller range of products or fewer shops offering a greater range of product? In practice fewer shops will mean reduced variety of product as well as service. But what of all the choice in giant supermarkets you say? Do they not have a much greater range of product? Surely they provide more choice. They may provide a greater range in one place but that is all.

The advent of industrial-style agri-farming, the bringing in of increased amounts of imported food from around the world and introduction of new manufactured foods may give the impression of greater choice, but is an illusion. The number of varieties of staple fruits and vegetables has been massively reduced, as have the various breeds of farm animals.

Of course, the providers of anything which sells can always say “If people didn’t want it they wouldn’t buy it”. But that begs the question of what alternatives are available. If only three types of washing powder were available doubtless they would sell massively more than any one brand does now. That does not mean they are more popular merely that people have to have such a product and were forced to buy one of the three brands available. Such restriction of choice is increasingly commonplace . We fool ourselves if we buy into the laissez faire economics  = more choice.

Most people cannot make provision for the future

Cameron’s  Big Society is predicated on the idea that people are generally able to provide for  themselves.  This is clearly not the case in vital  areas such as healthcare, education and pensions, not least because most people do not earn enough to pay for such things for themselves and their dependants.  Nor, particularly in the case of saving for old age, is it reasonable to expect most people to do so wisely even if they can afford to invest.

To expect the vast majority of human beings to be expert enough in financial matters to make wise private investment decisions is absurd,as absurd as expecting every man to be his own lawyer. Therefore, all but a few of us will turn to supposedly expert advisors for advice. The problem with such people is twofold: they often have a vested interest  in selling or promoting a particular product and even when they do not, they are frequently bad judges of the financial future. (If investing was easy and certain for the so-called experts, all financial institutions would be permanently hugely successful).

When someone sells you a private pension plan or insurance, he does not do it out of the goodness of his heart. He does it because he earns a commission or fee from it. As the pensions mis-selling scandal of the Thatcher years showed, that incentive drives many, probably most, financial service consultants to sell the product most beneficial to their income rather than to the customer.

The customer can also get misled if he takes reputedly independent advice, whether this be from a self-described independent financial adviser or out of the financial pages of newspapers and magazines or investment newsletters. The advice given may be anything but independent. Unbeknown to the client, an advisor may get a commission for recommending an investment and media share tipsters often have no scruples about recommending shares which they know to be poor performers, either because of direct inducements from the companies or because they work for a company which gets business from the sharetipped. Share tipsters can also make a profit by “ramping up” a price in shares they hold by recommending it or depress a share by criticising it and then buying at the depressed price.

Those recommending shares or financial products are in a wonderful position: they can tip to their heart’s content without taking any responsibility for their tips. No tipster has a consistent record of predicting successful investments. Quite a few have utterly dismal records over years. Indeed, so poor is their general performance that one might ask whether it is any worse than randomly selecting investments. It may even be worse. As Woody Allen once remarked, “A stockbroker is someone who invests your money until it is gone”.

The Daily Telegraph put the matter of share tipping to a sort of test in 2001. It employed a professional tipster, an astrologer and a four year old child to notionally invest £5000 in the stock market. The professional tipster applied his supposed expertise. The astrologer selected her shares using her star charts. The four year old child chose by repeatedly tossing (at the same time) a number of pieces of

paper in the air with the names of shares written on them. At each toss she caught one. After a year all the investments had lost money, but the four-year-old-child lost least, followed by the astrologer with the supposed financial expert bringing up the rear quite some way behind.

A rational examination of the actual performance of tipsters and advisors could only lead to the conclusion that predicting the future economy is a mug’s game. Why would an expert do worse than a four-year-old child and an astrologer? Well, it could have been a fluke, but an unlikely one as both the child and the astrologer did better. More probably the financial advisor’s knowledge is a positive hindrance. A parallel is with the football pools. Many people have a very considerable knowledge of the form and general state of professional football clubs. Yet these people do not appear to be any better at predicting results than the punter who knows nothing about football and does the pools by putting a pin in the matches or has fixed numbers.

The truth is that no one can guarantee investment for a secure future or even come anywhere near to it. All calls for private provision replacing public in whole or part should be placed in that context.  Not only that but account has to be taken of the great variety of abilities found in a population.   IQ is distributed so that around ten per cent of the British population have IQs of 80 or less.  An IQ of 80 is the level which most psychologists working in the field of intelligence testing judge that a person will struggle to live an independent life in a sophisticated modern society.  Add in the differences in education, social status and wealth and the idea that most people can make their own provision for a pension becomes unreasonable. Take into account the high cost of living, especially the ever rising cost of housing and raising children, and falling pay and  it becomes farcical. 

As for the broader  idea that  individuals should, if they have the means,   pay for their healthcare, education and   insurance to cover periods when they are not working,  to expect all but a small part of the population to do is clearly nonsense when the average annual pre-tax UK  income is around £26,000 with many earning below £15,000.

All British banks are “too big to fail”

The media is alive with politicians, bankers and economic commentators saying British banks must be broken up so they are not “too big to fail”.  The Governor  of the bank of England  Mervyn  Kingof England Mervyn King was at it last week (htttp://www.thisislondon.co.uk/standard/article-23927727-well-let-banks-fail-says-mervyn-king.do) and the new chief executive of Barclays, Bob Diamond, has had his say today. (http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8365101/Barclays-chief-Bob-Diamond-says-let-banks-fail.html)

The idea is a literal nonsense statement. To begin with the whole of economic history shows that a run on any bank above the size of a local bank with one or two branches is likely to spread the contagion to other banks. Indeed, even runs on small banks can have a snowball effect bringing ever larger banks to default as the nexus of borrowing and lending unravels. This is what happened in the USA during the Great Depression when their highly fragmented banking system saw the phenomenal number of approximately 9,000 banks fail before the America’s entry into the second World War in 1941 finally broke the economic spell with the sudden need for vast amounts of servicemen and war-related materials driving down unemployment.

Britain’s present position is different from that of the USA in 1929. None of her banks are really small for even the smallest building societies which converted to banks in the past twenty-five are far removed from a local bank with half a dozen or fewer branches. Not only that, but the ten largest banks control 90% of the UK banking market (http://www.economicshelp.org/blog/uk-economy/top-10-british-banks/). This produces two difficulties: the danger of a wholesale collapse of confidence in banks is greatly amplified because of their size and the damage done by a failure of any of them would be both great and immediate. For example, suppose Barclays was simply allowed to fail. It is inconceivable that the failure would not lead to a run on all the UK banks.

Those saying banks should be reduced in size so they are not “too big to fail” have a further hurdle to pass beyond that of the lessons of economic history. The internationalisation of banks makes the idea of governments forcing banks to become “small enough to fail” impractical. For example, how would a government force an international bank to split off its British banking from the international business? Unless this could be done, the contagion might well start overseas and spread to the British banking end. The same general objection applies to the idea of splitting retail from investment banking. If an international bank refuses to do it there would be little a British government could do because they could not afford to say do this or cease trading in Britain. But even if the international problem could be miraculously overcome, it is difficult to see how the UK parts of banks such as Barclays could be split into different parts small enough to be “allowed to fail”. Divide Barclays into ten separate companies and each part would still be large.

It is also difficult to envisage a situation whereby a British government would cease to guarantee deposits up to a sizeable or withdraw entirely from its position as lender of the last resort. The continuation of those two engagements would amount to a great deal of moral hazard remaining.

Most fundamentally, whatever system was put in place; whatever political commitments were given, if a run did begin on a British bank it is most improbable that a government faced with the reality of such a failure, with the threat of contagion spreading to other banks, would fail to step in. The only way to stop the bankers running riot again is to nationalise the banks. Fail to do that and we are likely to have a re-run of the present disaster in the not too far distant future because already the banks and their ilk are behaving , as far as present circumstances allow, much as they did before the failure of Lehman Bros in 2008, dreaming up new types of complicated derivatives, paying themselves grotesque amounts of money and laughing at those outside their magic insiders’ circle.

Does the Welfare State corrupt?

One of the favourite arguments against social provision is that it corrupts the receiver by making them dependent and ultimately damages society by significantly reducing initiative and making people selfish. The facts do not bear this out as a general proposition although naturally  there will always be some free riders in a welfare state. Today we have a society in which the self-help gospel is constantly preached, people work longer and longer hours and most mothers work at least part time. This has produced a society in which the birthrate has dropped well below replacement rate. During the period when state provision was most heartily endorsed as part of the national furniture (1945-1979) the birthrate was above replacement rate. The ability and willingness to breed is surely the ultimate indicator of the health of a society.

But that is not to say all social provision is benign. It is one thing for a society to provide those things which most cannot be reasonably be expected to provide for themselves, but quite another to build dependency into the system. That is what has happened in Britain where more than half the population now draw some sort of public monetary support. Some of those benefits are part of the legitimate armoury of social provision, for example, child benefit, unemployment benefit, sickness benefit and old age pensions. Others are not.

The most pernicious of the current benefits is Working Families Tax Credit, which can be drawn by families with a household income of over £50,000. This is a scheme in a long line of similar ones dating back to the old Poor Law of 1601. It is the granting of state money to those in work. The best known Poor Law example was the Speenhamland System  of the 18th century which allowed outdoor relief to those (primarily agricultural labourers) whose wages fell below a certain level. The result was predictable. Where the scheme operated employers dropped the wages they paid to the level where the Parish (which administered the  Poor Law) made up the wages through outdoor relief to those whose wages were lowered.

The Speenhamland System was a subsidy to employers. So is the Working Families Tax Credit. All it results in is employers paying lower wages. That is not because they are all evil grasping men or women.

Lower wages are forced on all employers because there will always be a substantial number of employers who will take advantage of opportunity offered by any government subsidy to lower their wages. That means all employers must do so to compete.

Apart from the fact that it siphons off  large amounts of taxpayers money, Working Families Tax Credit is a pernicious form of subsidy because it makes employers who employ many low wage workers dependent on its continuance, which obviously cannot be guaranteed. Either a future British Government may decide to abolish it of their own free will or tax harmonisation within the EU may force them to do so.

If it is abolished, such companies will be left stranded because they will have to pay higher wages. Moreover, the subsidy they are receiving now will cause them to be less efficient than they would have been without it. On the other side of the employment coin, families receiving the benefit will also be left high and dry if it ends, for they will have altered their lives according to the income they have received. 

This type of structural dependency has evil effects beyond the economic because it can distort the democratic process. If sufficient people become dependent on a benefit such as tax credits they may make it next to impossible for any party wishing to be elected to propose its abolition because to have such a policy will drive anyone in receipt of the benefit to another party which supports its continuance.

The welfare state is a good deal

The essentials of life are food, water, clothing, shelter, healthcare and a livable income in times when a person cannot work through want of a job, disability, illness or old age. Most people most of the time can afford to pay for shelter, food, water, heating and clothing from their private resources.  Most could not afford the rest of the essentials  and very few indeed could survive long term unemployment without state aid.

It is important to realise what small incomes the majority of Britons have. Take these figures from the Government’s Regional Household Income Comparison 2004:

“Inner London had the highest disposable household income (after tax) per head of population (£16,500) in 2004. The area continued the trend of previous years and in 2004 was 29 per cent above the UK average of

£12,800. This was lower than in earlier years. In 2000 it was 36 per cent higher than the UK average. Tees Valley and Durham in the North East had the lowest household income per head at £10,800. This was 16 per cent below the UK average in 2004.” (http://www.statistics.gov.uk).

The uncomfortable truth is that even the average disposable  British household income is insufficient to comfortably bring up a couple of children,  pay an average mortgage and make  substantial pension contributions.  Worse, much of the population has less than average household incomes, many very substantially less. But even those with household incomes substantially above the average – many of whom support the idea of private provision for those “who can afford it” – would find themselves deeply embarrassed if they did have to meet the cost of everything they now receive from the state.

To take a concrete example, that of a middle class husband and wife with two children with a net annual household income of £40,000. At present they can, if they choose, educate their children free at state schools.  The entire family can be treated under the NHS. Until they are sixteen, the children will not even pay prescription charges. If their children go to university, as they probably will being middle class, much of the cost of the education will still be met out of taxes (tuition fees even at their new levels do not come near to meeting the full cost of a university education). If either parent falls ill or is injured, the taxpayer will provide basic support.  The same applies in the case of unemployment. If  any member of the family isunfortunate enough to be the subject of a criminal assault, the Criminal Injuries Board will compensate them. The family will receive child benefit which is not a means tested benefit.

Just imagine what it would cost to either provide such services by buying them directly or through insurance if one could find an insurer willing to issue cover.  A decent private day school education would be at least £12,000 for two children and could well be a good deal more.  A university education would cost tens of thousands of pounds.

Private health insurance for a family to cover everything covered by the NHS cannot be obtained, but even the best that could be purchased – and it will provide a much inferior cover to that of the NHS – would cost several thousand pounds a year and will not cover existing conditions either at all or for several years – those who doubt this should check out the BUPA website and see what even their most expensive plan does not cover (you will get a very nasty shock). Drugs, including prescription drugs, will have to be purchased at their full cost.  If the family has a member with a chronic condition requiring regular  treatment  or a condition requiring  expensive  one-off treatment, they will soon find their private insurance will not cover the treatment  or will do so for only a restricted period.  Mental health problems and long term nursing care are rarely if ever adequately covered by private insurance.  Where private insurance will not pay,  the family will be left with bills which  at best will severely constrain their lives and at worst bankrupt them. (The most common cause of personal bankruptcy in the United States is medical bills.)

Private insurance for sick pay and unemployment pay is both very expensive and strictly limited in the time it is paid – a year is normally  the longest period covered. The same applies to  mortgage insurance cover. There would be no child benefit or criminal injuries compensation available without public provision.

If the cost of providing for the family is restricted to just  the items discussed above the family would be hamstrung by the bills even if no major disaster such as a serious operation hit them. A mortgage to purchase even a modest house in most areas would be out of the question. University education would become a very big gamble for the children.  If a major disaster did hit the family, they would not be able to cope for an extended period because any private insurance they could  purchase would soon run out.

The family I have described is by normal standards comfortably off. It might be able to struggle along provided it did not hit a catastrophe which robbed the household of its breadwinner(s) or an emergency such as a serious medical condition which swallowed up vast amounts of money, but it would not be a materially comfortable or psychologically secure family.  Most families (and individuals) have considerably less income than this fictional family and a substantial minority live on an income well below the average, while half the British adult population have no meaningful savings or occupational pensions. The large majority of the population would be utterly unable to provide for themselves in times of hardship such as sickness, old age and enforced unemployment.

Those who claim that all the poor in Britain are only relatively poor should reflect on this stark statistic: the latest Inland Revenue figures for marketable wealth distribution ( 2002) show the top 1 per cent own 23% of national wealth and the bottom fifty per cent of the population have a staggeringly small 6% (Office of  National Statistics (ONS) website – published 2004).

In short, the majority of the British population live as they have always lived:  from one pay packet to the next.  They do not have the resources to withstand the withdrawal of state provision and are very vulnerable to  the competition of immigrants and offshoring,  which either destroy their employment or reduce their pay.

What applies to what might be termed social provision applies to all other public charges – such as defence, policing and  the justice system. Most individuals do not have to bear the full cost of these because they pay far less tax, direct and indirect,  than is needed to finance a per capita share of total public expenditure.  A quick calculation will demonstrate this. The projected public expenditure for 2006/7 is £488 billion.  There are approximately 45 million adults in Britain. £488 billion divided equally between them runs out at nearly £11,000 per adult head.

The future is even bleaker because of the absurd cost of housing, the rising cost of a university education and the likely high cost of energy and water supplies. There are even suggestions in current price movements that cheap food may be a thing of the past and the price  of manufactured goods from China and its Asian cohorts is also showing signs of inflation as their populations’ wages and living standards rise and they consume more of what they make.

The effect of everyone “paying their way” just for things such as education and healthcare would have a severely depressive effect on already dangerously low Western breeding rates as people had fewer children because of the increased costs falling on the individual.

The moral value of general provision

If public provision is necessary should it be available to all? Why should it not be granted only to those who through a means test show that they cannot support themselves from their own resources?  The answer is threefold: personal dignity, practicality and the engendering of social cohesion.

Anyone who has had the misfortune to claim means tested benefits  or who has assisted someone to claim will know what a frustrating  and degrading experience it can be.  The rules relating to claiming are Byzantine  in their complexity and a simple error on a form (which can run to 20 pages or more) can result in benefit being withheld or delayed.  But even when the forms are correctly completed and the criteria  for the benefit are met,  the delivery of the benefit is frequently  seriously delayed because the  volume of claims  and their  complexity simply overwhelms the administrative capacity of the public servants dealing with them.

If all public provision was means-tested, including NHS treatment and education,  the administrative cost would be massive and  the efficiency of the delivery of the provision  greatly reduced.  The additional administrative costs would have to be set against any saving gained by denying provision to people.

General provision also underpins social provision. Where all  are eligible, all feel that they have a stake in the Welfare State. That improves social cohesion.  Exclude the better off and the odds are that eventually  political circumstances will arise which allow those with the power to reduce or even destroy utterly public provision.  At best, if social provision is seen as only for the poor, it will gain a stigma  and the quality of the provision will be of little or no account to those who do not benefit from it.

The provision of public services gives everyone rich or poor  the assurance that if the worst comes to the worst they will not be utterly without the means to live.  That is the bottom line of having the privilege of being a British citizen.

Apart from simply making life more pleasant and secure, a socially cohesive society  has considerable cost benefits, because it will experience  less anti-social behaviour. That translates into fewer police, fewer trials, fewer people in prison and, indeed,  fewer laws to moderate social behaviour to administer – regrettably many laws are passed in response to moral panics.

Why should the haves pay for the have-nots?

The most obvious reason for not allowing anyone to opt-out from that part of taxation which is devoted to public provision is that no one can be absolutely certain that they will not meet some calamity in the future which will leave them unable to pay. The experience of medical care in the USA shows how easy it is even for the rich to find their wealth shrinking to a point where they cannot get all the treatment they need – the Superman actor, Christopher Reeve, one of the highest paid Hollywood actors,  found his resources exhausted within a few years of suffering the injury which paralysed him.

But there is a more subtle reason. The wealthier members of society should  always remember that they owe their privileged position to  the restraint of the have-nots and the power structures  of society which are overwhelmingly weighted in favour of the haves. Individual  effort and talent do of course play a significant role

in  the lives of everyone,  but it is also true that most people’s lives are to a large degree determined by the circumstances of their birth. If you are born into a wealthy family, the odds are you will live  the life of the wealthy throughout your life. A person born into poverty will probably remain at the bottom end of the social spectrum.  The same applies in varying degrees to those born between the top and bottom of the social pile.

No one needs academic studies to prove the truth  and potency  of inherited advantage. All people require is the evidence of their own experience. Let any man examine the lives of all those he knows  and he will find that most will occupy a similar social position to their parents.

A simple  way of understanding how much inherited social position determines lives is to consider crime. Proportionately,  the working-class  commit crime much more often than the middle classes (and even within the working class the frequency of offending rises with the degree of poverty).  That cannot be because the working class  are innately less able, intelligent or self-controlled, because we know that many of the middle class are also dim, incompetent and socially inept, yet they rarely end up with a criminal record.

The only plausible explanation for the greater criminality of the working  class can  be  their different  material  and  social circumstances. These  are much more precarious than those of the better  off.  They lack money and the social network which eases access to better jobs, while the opportunities to intellectually develop that are commonly open to the middle class are denied them. Give every person the means to live a middle class life and crime would drop  dramatically  simply because the press of  material necessity would not be there and because the alienation of the poor through being poor would have been removed.

The better-off also need to admit to themselves that there is no moral basis for inherited wealth. The person who inherits  money and possessions has by definition done nothing to earn it. The person who earned the wealth,  if it has been gained through moral means – and often wealth, particularly great wealth,  has not been so gained -has a moral right to it, but no one else.  The same applies to non-material advantages such as social connections.

There are, of course, those who attempt to treat inherited wealth as a moral matter. They claim that a person has the right through the consequence of ownership to pass on what he or she has  to whoever they choose. That, of course, begs the question of how the wealth was obtained. But let us assume it was achieved entirely morally and by the direct efforts of the person – the best possible case for the supporters of inherited wealth.  Even in that instance the effect of the transfer of wealth to others is to  create a situation which is manifestly unfair, namely, the establishment of privilege for someone who has done nothing to earn it. Taken at the level of a society, that rapidly results in a permanent class privilege for the haves and their descendants.  The fact that the development of hierarchies is  an inevitable consequence of human society is neither here nor there when considering whether the consequences of a hierarchy is moral. Clearly  the deliberate disadvantaging of some to the advantage of others is  not a moral act, any more than enslaving a man is (the group now living who have by far the greatest moral claim to reparations are not the descendants of slaves but the descendants of the poor).

The American philosopher John Rawls in his book A theory of justice resurrected the idea of the social contract which was much in favour in the 17th and 18th centuries.  He posed, in so many words, the question “Suppose a group of people were to form a society from scratch, what society would they favour if each person knew nothing about the other people and had no idea where they personally would fit, socially  and economically, into the society?”  He concluded that the only rational choice would be one in which people had equality because no rational man would chose an inferior position for himself  and no agreement would ever be reached  which created an unequal society, whether in terms of social status, rights and duties or material circumstances. Note that Rawls did not rule out a man or woman choosing an unequal state –  some might do so thinking it would be worth the gamble to have a chance of gaining one of the favoured positions in an unequal society – he merely thought that it would not be a rational or normal decision.

Although Rawls’  hypothetical state (“The Original Position”) was not realistic, his thought experiment does demonstrate that what we have now as a result of the organic development of society is not what many, if any, would risk for themselves if they had the choice Rawls’ offered them.

Why not take away all inherited wealth? All of historical experience shows that such a cure is worse than the disease. Where the state controls (at least in theory) the totality of people’s lives, such as in the Soviet Union, the consequence is privilege and abuse not by the possession of money but by the wielding of state power.  There is also something peculiarly degrading about the idea that everything a person does is to be ordered and permitted by the state.  A degree of private wealth is a bulwark against state power. The trick is to ensure that wealth does not become too concentrated in the hands of the few, producing an uncaring and oppressive plutocracy.

As for the wealth which individuals create for themselves,  to tax to produce material equality would plausibly have a deleterious  effect on society generally. If a person is not to benefit from their own legitimate enterprise, why should they bother to make any extra effort or take risks? The obvious answer is they have no incentive to do so. However, that is to take to nakedly a material view of humanity. Even in circumstances where what someone did had no effect on their income, people would vary considerably in their willingness to work regardlessof the material outcome because personalities differ and there are rewards other than material ones such as the approval of others and celebrity.  Nonetheless,  it is reasonable to assume  from  the experience of communist societies that the overall effect would be to substantially reduce the individual will to work and take risk.

Of course, absolute material equality is improbable in any society, but the disincentive effect applies incrementally as the personal tax burden grows.  Once tax reaches a certain level people either work less or become dishonest and evade the tax. That applies not only to the obvious case of the entrepreneur but  to jobs generally, for people will be generally disinclined to take the more demading jobs if  the material rewards they offer are not significantly better than those for unskilled and easy employment.

It is also true that Man being a social animal will always form hierarchies because social animals necessarily organise themselves in that way (if they did not, sociality would never arise because the members of a species would be in constant antagonism to one another and could never reach the point of sociality).  Even if all material advantage was removed there would still be  the advantages and disadvantages of genetic inheritance, the differing qualities of  individual parents and pure accidental circumstances, such as the work available at a particular time and place, to create a socially layered society with patterns of dominance and dependence.

But  that does not mean that societies should simply be allowed to develop  without any state intervention to ameliorate  socially determined disadvantage.  Without social provision  of necessities the poor are left to live hopeless  lives which  struggle from day-to-day,  while untaxed or very lightly taxed wealth of the most successful results in a plutocracy within a few generations.

Plutocracy at best produces wider private charity – which is always inadequate –  and at worst an uncaring attitude towards the masses which sees nothing wrong in allowing them to starve if that  is a consequence of the economic circumstances of the society and times or even simply God’s will.  Plutocracy is in fact one of the most oppressive forms of society and one of the most difficult to end because it cunningly  presents itself as being the society  of individual opportunity (“the Ritz is open to all”) and is not nakedly oppressive in the same way that, say, Nazi Germany or Stalin’s  Russia was oppressive.  Consequently, there is no obvious focus for  discontent, no single hate figure and it has a much greater enduring power than an overt dictatorship.

What a society can safely do to narrow the  differences in life chances  at  birth is to act to ensure that all have access to education, healthcare and the means to live in a decent manner. That is the minimum.  A society can go further with the greatest public resources being directed at those in the poorest circumstances, for example, more money for schools in “sink” areas.  It would even be possible to devise a scheme for those who inherit little or  nothing by way of money or possessions to receive a payment from the state to remove to a degree the disadvantage of inheriting nothing.

The consequences of an end to mass immigration

 The liberal internationalists tell   us  that   the woes  of  the  world would come upon  us  should we end mass immigration into Britain,  although,  like  Lear threatening retribution, (“I will do such things–   What they are, yet I know not: but they shall be   The terrors of the earth.”)   they are unable  to  say  exactly what the woes  will be.  In fact, I cannot recall ever having seen an article in the British media which goes beyond lazy generalisation about “competing in a global market” or  “driving private enterprise abroad”.    Let me see if I can make a better fist of analysing what would happen.

To stop mass immigration would require Britain’s withdrawal from  the  EU,  the repudiation of other treaties such as the UN Convention  on Refugees (UNCR) and the European Convention on Human Rights (ECHR),  the repeal of the Human Rights Act (HRA) and the ending  of the rules which make it easy for new immigrants to settle in Britain for the purpose of joining  relatives already here, for marriage and on compassionate grounds.  Consequently,  the consideration of the effects of mass immigration has to take in both  the practical effects of  its cessation on the British labour market and its international repercussions.

The effects on the British labour market

There would be greatly improved employment  opportunities for the British.  The  labour market would tighten and wages would rise. That would place extra costs on employers but they could be offset by a reduction in taxation due to millions of people being employed who are currently unemployed. Nor would  wages rise uniformly. Labour   would  move    into  those   occupations  which  are essential   and  which   cannot  be provided  at    a   distance,   for  example     healthcare     and  education.  We  would   discover    how  occupations   rank in terms of  utility.  Wages  would  rise  in  those occupations which had most utility to  attract  staff from elsewhere. This could have surprising results. We might find that vital jobs considered menial now would pay much more once cheap labour could no longer be brought in.   This would be justice for the many who have seen their jobs undervalued  because of the ability of employers to use cheap immigrant labour.

Employers  would  respond  to labour  tightening   by   using    labour  more  efficiently.   Automation  would increase  and  employers   would  change their attitude  to  the employment of the long-term unemployed,  older  people  and  the disabled. Both  employers and government would  take vocational   training   more seriously.   Government  would  provide  incentives   to  employers  to train  their staff and  increase  the  training  of    public   service   professionals such as doctors and  dentists.  Government would also  be forced  to tackle the mess which is our public education to  ensure  an adequately educated workforce.  

Employers  who could not find the labour to run their business in  this country would have to accept they could not do so.   No one has a right to engage in an enterprise regardless of the effects on the welfare  of the community as a whole which is effectively the present position. Capital which cannot be used in this country can be invested  abroad.  The balance of payments would be improved by  a reduction in money being remitted abroad by immigrants.

The increase in employment of Britons would  be an immense social good beyond  reducing  the cost to the Exchequer  of  the  unemployed,  for people are generally happier and responsible  when employed .    

 The  pressure  on  public services,  transport   and housing would be lessened making  access  to them  easier  for Britons.   In particular, reduced demand for housing would reduce the cost of purchasing, leasing or renting property for private individuals, public bodies, charities  and private companies.   An ending of mass immigration would also curtail  the substantial cost of providing  the benefits of the welfare state to immigrants as soon as they gain the right to legal long term residence in Britain.

Fewer legal  immigrants would allow much greater supervision of visitors to Britain – a significant minority of whom are health tourists  or who are here for criminal purposes – and a proper control and investigation of illegal immigrants. No more sending suspected illegals to the Croydon reception office under their own speed or leaving ports and airfields with an inadequate or completely absent Borders Agency  presence.   IThe repeal of the HRA, our departure from the EU  and the repudiation of the ECHR and the UNCHR  would allow Britain to deport people at will.  We could then not only refuse new immigrants but  start removing the  illegal immigrants who are already here.

Would there be an unmanageable  labour shortage?

The  idea  that  Britain  is  short of  labour  for  most  purposes  is    demonstrably  absurd.   The official figure  for those of working  age who are economically inactive in the UK is  approximately 9.5 million, or nearly a quarter of the age group. http://www.statistics.gov.uk/cci/nugget.asp?id=12.  Clearly not all of those would be able or willing to work,  but equally clearly  a large proportion would be able and willing to work  if  the conditions  were  right, for example,   wages  rose,   employers  became  more accommodating  and the benefits system was tightened as the  number  of opportunities for work rose.    .

The   claim  that  the   indigenous   population   will  not   do   the jobs  immigrants take  is  demonstrably false.  In areas of the country with  few  immigrants  native  Britons  do  them  willingly.   In  many instances  where foreign workers are employed it is not because  native Britons will not work. Take  the case of the cockle-pickers who died in Morecombe  Bay  several years ago  it  was   widely  reported  in   the  media  that   the   Chinese  cockle  pickers   clashed  with    British  cockle  pickers   who resented  them  invading their  territory.  These   Chinese   were  not   filling  jobs  which  were  unfilled   by   the  British  but  competing with the British for the work.

More generally, one of the great lies of modern British politics is that employers are unable to recruit from the native population, especially for unskilled labour. Vast swathes of work have been effectively denied to the native population  by collusion between employers and those who supply labour.  This happens both within the indigenous ethnic minorities who only employ from their own ethnic group and within immigrant labour which commonly works through gangmasters who are immigrants themselves. This does not just work in areas such as fruit picking  and factory assembly work but in areas such as the NHS where we have the absurdity of doctors and nurses trained in Britain having to go abroad to find jobs because immigrants are employed here.

The other thing which prevents native Britons taking jobs in some parts of the country is the fact that the native Briton does not want to work for employers whose workforce is predominantly formed of  immigrants or native-born ethnic minorities. Like every other people,  native Britons do  not  wish to be  forced to work in their own land in  an  employment where they are in the minority, especially where they could find themselves in a situation where the workplace language is not English.

It is also important to understand  that the menial  jobs immigrants  take are worth far more to them than a native Briton.  If you earn as little as £200 a week net – many immigrants work cash in hand – and  live  in accommodation   either   supplied  by  an  employer   or   in   crowded accommodation for very little rent –   you will probably still be able to save a substantial amount, say,  £2,000 pa.

If  you  come from China where wages  even in the  big  cities are  50 pence an hour, you would earn £1,,000 pa for a 40 hour week.  Working at a  menial job in Britain allows you to save double the average  Chinese big  city annual wage in a year. That money remitted to China takes  on the  local purchasing power.  The multiplier for Eastern  Europeans  is less,  but even there £2,000 saved in a year would be a good professional salary in places such as Poland. Give native Britons the chance to save the  equivalent  of a British professional’s salary in a year  doing  a menial job and they will flock to the work and put up with basic living conditions.  Of course, no such employments are on offer to  Britons.

As for skilled workers,  there are few skills which cannot either be taught in a relatively short time or purchased from people working abroad.  There are far  fewer absolutely indispensible skills. In addition, many skilled Britons might decide to  return  because   the ending of mass  immigration would  signal that there was once again  a clear distinction between the  rights  of British citizens and the rights of foreigner. This would alter radically the  moral climate in Britain which could have a profound effect on the  way in which British émigrés view their homeland.

The international effect

There would almost certainly be a great uproar if Britain ended mass immigration. But  the roar would come from a paper tiger because those most affected would come from the Third World with which we have little trade and where Britain’s national interest is rarely if ever at risk.

As  a permanent member of the security council of the UN  Britain can veto any UN sanctions or even attempts to pass motions to censure her.  Britain is also an important member of institutions such as the IMF and  World Bank and could cause a good deal of trouble for the nations most likely to need the aid of  such organisations.

Then there is the inconvenient  fact  for critics  that no government in the world is officially for uncontrolled immigration.   Even more embarrassing, most of the members of the UN have immigration regimes incomparably harsher than Britain has at present.  A phrase including glass houses and stones comes to mind.

As for international  trade there is no reason to imagine that Britain would suffer. The vast majority of our trade is with the developed world.   It is in the self-interest of  our trading partners to prevent action against Britain because Britain is not only an important importer  but an important exporter.  To take just one example, and a very potent one, Britain’s arms industry is one of the largest  in the world.  The willingness to sell arms is a strong bargaining card with every country on the planet.  Britain is also tied into the economies of the developed world  through joint projects such as Airbus and the supply of parts to industries such as car-making (a great deal is supplied to German makes believe it or not).    The developed world, including the EU, would simply cut off their noses to spite their faces if they took action against Britain.  There are also the rules of the WTO agreements which would prevent such behaviour.

What of Britons who are living abroad? It is unlikely their host countries would act against them for the simple reason there are substantial communities of citizens from those host countries resident in Britain. It is also true that most Britons living abroad do so in the developed world, the countries of which are  much less likely to expel those legally resident en masse than a third world dictatorship.  Moreover, in most cases Britain would have more foreigners of a particular nationality living in Britain than any foreign country has of Britons living in their country. The balance of trade would be very much in Britain’s favour if reciprocal mass expulsions  resulted.

Do Britons want an end to mass immigration?

In these politically correct times where people have learnt that to speak against pc orthodoxy is a dangerous thing which can result in the loss of your job or criminal prosecution,  it is difficult to get an honest answer to a polling question such as “Do you think post-war immigration has been a good or bad thing?” or “Do you think immigration should be reduced?”, although even with such questions  a healthy minority give the non-pc answer.. To get at the truth one has to look at the responses to questions such as “Do you think Britain should be tougher on illegal immigrants?”. These type of questions invariably produces the sort of answer which would have brought a smile to a Soviet apparatchik,  commonly being above 80%  for tougher action, which is pretty astounding when around 10% of the British population is comprised of immigrants.

It is also noteworthy that concern about immigration has been at the top of issues concerning the British for years; this despite the fact that every mainstream British political party has  with the willing collusion of the British media, done  everything they can to suppress public debate about the issue.   

Anyone who believes that the British people welcomed the post-war immigration and want more of it is self-deluding to the point of imbecility.

*PPP and PFI = Buy now, pay later

 “Figures obtained by this newspaper [Daily Telegraph] through Freedom of Information requests reveal the full, mind-boggling cost of the Private Finance Initiative (PFI) upon which the last government relied to fund its public sector infrastructure projects. More than 900 schemes have been completed with a total capital value of £56 billion – yet the amount the taxpayer will have to repay currently stands at £229 billion. That is the kind of interest rate a sink-estate loan shark would be proud of. In one particularly egregious example of how not to negotiate a contract, the Princess Royal University Hospital in Bromley in Kent cost the contractor £118 million to build but the final cost to the NHS will be £1.2 billion.” (http://www.telegraph.co.uk/comment/telegraph-view/8279753/Gordon-Browns-poisoned-PFI-legacy.html 24 Jan 2011)

Startling as the figures above are, if it had not been for the recession they could have been considerably higher because  there is no reason to believe the Labour Government would not have kept on accelerating their PFI  spending at frightening pace if the economy had not all but capsized in 2008.  The Daily Telegraph reported in 2006 that:

 “The size of the Government’s controversial Private Finance Initiative scheme is expected to spiral from £53  billion to almost £80 billion in the next four years.

Treasury documents reveal that ministers have approved 200 new PFI deals worth £26 billion to start by 2010, and the amount involved in each has almost doubled. The average size of each contract awarded for the next            four years is £130 million, compared with £75 million between 1987 and 2005.” http://www.telegraph.co.uk/news/uknews/1517684/Whitehall-oversees-huge-increase-in-private-financing-of-public-projects.html

How did Britain develop such an almighty and dishonest mess?  The Private Public Partnership (PPP) began in earnest in the 1980s as the Thatcher Government sought to both satisfy its ideological dreams (public service = bad; private business = good) and reduce the headline figure of a burgeoning national debt. In 1992 the major Government introduced a new form of PPP the  Private Finance Initiative (PFI) which was primarily a way of keeping money off the national debt books. The Blair and Brown Governments greatly increased its use.  

The really frightening thing is the fact that the true cost of these schemes is unknown. The £229 billion cited by the Telegraph is speculative. That is not because the paper has false data or has guessed to cover gaps. It is simply because it is impossible to quantify eventual costs. Sometimes this is because the contracts are so long that renegotiation of terms is built into the contract at certain points. In others, the contracts are too tight for the private company to make a reasonable profit and provide a decent product or service. Private companies may even accept risks and obligations in their contracts which they know they cannot meet and go into the contract with the intent of holding the taxpayer to ransom by saying they will not honour the contract unless the terms are improved. (The experience of military procurement shows how often original quotes are wildly below the actual cost).

Whether the default on contract terms is intended or not, it leaves the public body with a real headache. If they do not give in to a company’s demands or simply offer more off their own bat to keep the show on the road, they may well have to pay a new contractor even more than is being asked by the existing contractor. Nor is it a given that there will be another company which can take on the contract, because many public contracts are so large few companies could handle them and some, for example, the maintenance of the railways, requires specialist skills which are not readily available.

Then there is the problem of what happens if a company goes bust. It is all very well saying that the contractor will bear the cost if things go wrong. They may not be able to or be unwilling to bear losses and in either case liquidate –liquidation will be relatively painless because a company will have been set up to administer the contract and losses will be limited to the assets of that company. That produces the colossal administrative problem of what to do if a contractor fails to fulfil a contract. The state will no longer own  the facilities or employ the staff to take over a failed contract. If the contractor is providing an essential service such as health provision or running a local authorities schools, the contract cannot simply be allowed to lapse and time taken to award another one because continuity is essential. Such a situation opens the way to Governments being willing to pay well over the odds to keep the service running.

The contract to maintain London Underground which ended in tears in 2008 is a classic example of the problems of PPP and PFI. Ignoring the shambles which are our privatised railways, the Labour Government forced a PPP on the London Underground, one of the largest Metro systems in the world and a transport conduit absolutely necessary to London’s functioning, carrying as it does millions of people a day. They added insult to injury by retaining the running of the trains in public hands while putting the maintenance of the infrastructure – track, stations, signalling and so on – in the hands of private companies.  The fact that it was the maintenance of the infrastructure which has caused the most serious of the problems  in the privatised overground railways was recklessly ignored. Just to make sure that it was a disaster, the contracts were divided between two groups. In addition, the contracts to set up the PPP ran to some two million words,  which  made it a lawyers’ golden egg as squabbling between contractors and Transport for London continued incessantly which undermined the executive efficiency of both Transport for London and the contract holders. Here is the Daily Telegraph in 2007:

“The PPP was a classic Labour fudge. Labour’s reformers at the Treasury wanted to privatise the Tube, but old Labour had promised not to. The result was a Third Way on wheels, which repeated the Railtrack mistake of separating responsibility for trains and track. Under the PPP, the trains remained in public hands, with London Mayor Ken Livingstone in charge via the capital’s transport authority, Transport for London. The tracks, tunnels and signals were carved up, with three private infrastructure companies (infracos) undertaking to maintain and upgrade them on 30-year leases, starting in 2003.

Metronet – a consortium of WS Atkins, Balfour Beatty, Bombardier, EDF Energy and Thames Water – won the bid for two of the infracos, agreeing to do the work for £17bn.(http://www.telegraph.co.uk/finance/2812424/Signal-failures-that-sent-PPP-down-the-tube.html)

In May 2008, after a Metronet had a  period in administration, the two Metronet infracos were transferred back into public hands to Transport for London.  

This PPP had just about every flaw that one could imagine. The contractwas very long. Even if everything had gone to plan, the eventual cost to the public was unknown.  Right from the start the taxpayer was paying a subsidy to the private consortia of £1 billion a year, despite assurances originally that no subsidies would be paid.

The contractors’ liability for cost overruns was capped, more or less, at £50 million for each quarter of the 30 year deal and there was a disclaimer for events such as flooding. If the private companies ran into trouble, the taxpayer had to take over responsibility for 95% of the loans taken out by the private companies. Just to put the cherry on the cake, the private companies were given a “guaranteed” rate of return on capital of almost 20%, a return twice that considered to be a good commercial profit.

Apart from overly favourable contracts, the cost of PPP and PFI projects are expensive because the private concerns financing the projects have to borrow  money at a higher rate of interest than the Government can, perhaps 1-2 per cent  more.  That is because the risk is greater for the lender. The borrower has to make a profit on the borrowed money so he must charge more than he is paying for the money to finance the scheme

There is also the problem of divided responsibilities. We now have hospitals where there are separate PFI contractors for the food, for the ward cleaning, for the laundry, for the cleaning and maintenance of multi-media installations (TV/Internet etc) and the general maintenance of the building. No one has overall control. Head teachers with PFI maintenance contracts find they cannot change as much as lightbulb without getting the PFI contractor in. To add insult to injury such services often result in offensively high charges, for example:

“George Osborne, the Chancellor, recently told how he was informed that under the Treasury’s PFI service contract signed by Labour, the cost of supplying a Christmas tree to the Treasury stood at £900, despite being sold by the retailer B&Q for only £40.

A few months earlier, he had been told that the PFI contractor would charge £148.58 to provide a fish and chip lunch for six in his private office.

In the end, Mr Osborne, Mervyn King, the Governor of the Bank of England, and their team ate the same lunch in the Treasury canteen for £32.88.

Hospitals have complained that PFI service contracts mean that they have to pay up to £333 to have a light bulb changed.

A hospital in Hereford was charged £963 to have a new television aerial, and a school £1,000 for a computer desk which normally retails at £200.” (Daily Telegraph Rosa Prince, Political Correspondent 8:00AM GMT 27 Dec 2010)

One of the things which strikes outsiders as odd about PPP/PFI is the constant granting of contracts to the same bidders  after the bidders have already run contracts in unsatisfactory fashion. Capita is an example which comes to mind with, for example, the Criminal Records  Bureau fiasco of September 2002 when schools were prevented from opening for the new term because those working in the schools had not been vetted for criminal convictions in time, the Individual Learning Accounts scheme which resulted in a loss of at least tens of millions of pounds.

Part of the explanation lies in the size of the undertaking. Many of the contracts being offered are of a size and complexity to reduce the number of realistic bidders to at best a few and at worst one.  The other possible reason for continued contract winning regardless of performance is corruption. That is not to suggest that corruption has occurred to date, merely that the possibility exists

In modern times, the British Civil Service has been remarkably free from corruption considering the vast amount of money it disposes of each year. There are two sound reasons for this. The first is the tradition of public service. This developed primarily from  the lifelong  working careers public servants, especially senior ones, have commonly had and the ethos of the Civil Service as an apolitical  institution which serves not political ideology  but politicians in power with disinterested advice. Government since the 1980s have attacked both of these pillars of public service. They are currently reducing  the terms of employment of new civil servants, especially  with regard to their pensions,  and have  increased recruitment of senior staff from outside the civil service.  The most contentious of these are the large number of “special advisers” who are classified as civil servants,  but are really  party  political appointees. The most notable has been Tony Blair’s erstwhile director of Communications, Alistair Campbell.

The second reason is lack of opportunity. If the Government is spending taxpayers’  money on its own employees to do a job, any serious fraud is difficult because the money is kept within the public body concerned and rigorous accounting procedures can be applied. Where serious corruption amongst public servants has been found in the past, it has been  almost invariably in those areas where Government contracts are granted to private companies, most notably in Defence Procurement and building contracts.  It is a reasonable assumption that the more public contracts offered to private companies, the greater the corruption will be sim[ply because the opportunity is increased.  The example of local government where public contracts have long been used freely is scarcely encouraging.

Corruption is more than people receiving money in brown envelopes  or the provision of material benefits in kind such as expensive holidays. It is also the provision of jobs years down the line, directorships for politicians and civil servants who have granted contracts. That is next to impossible to prevent. Even if a law was passed banning any civil servant or politician from accepting a post with any company which has been granted a contract which has passed through their hands, the politician  or  civil servant could simply be handed a directorship with another company – the linkage in personnel  between major companies is positively incestuous – on the basis that “you scratch my back and I’ll scratch yours”.  

If corruption does occur, you can bet your life that the contracts will be less advantageous for the taxpayer than honestly negotiated ones. 

 Because many of the contracts are for periods of 30 years or more there is no meaningful political responsibility. The life of politicians in Government is short on average, either because of election defeats or sacking by the PM of the day. Five continuous years as a cabinet minister is good going.  In the vast majority of cases the politicians who made the decision to go ahead with PFI will be out of office not merely long before the final bills are paid but in all probability by the next Parliament after a contract is signed. Once out of office, they can ignore any problem which arises and the sad truth of the  matter is that nothing can be done to make them take responsibility for their decisions as things stand. At worst, all that will happen is  the electorate throwing them out at the next election, which for an ex-minister is no great loss. It should be added that it  rarely happens that an individual MP is thrown out by the electorate  because of his personal failings because the power of party label is too great.

The introduction of private money into public projects by any form of PPP is a fraud on the public.  As Hire Purchase used to be advertised in my youth, it is “Buy now, pay later”, but with the added difficulty of not knowing what the final cost will be.

 The honest way for Governments to finance projects is to raise taxes or increase the national debt. Then the public can see clearly what is being done and judge the cost. With PFI and its ilk, the cost does not appear as government spending immediately. It is Enron accounting, the removal of expenditure from the balance sheet for the present but not the future.  The expenditure only appears gradually as the debt is met by charging the government for the services provided or alternatively by charging the customer directly. For example, if toll roads are built  and/or maintained by private capital, the contractors could charge the motorist directly to recoup their costs.

But the deceit goes beyond the hidden deferral of expenditure. Much of the  detail of the contracts made with private companies is not being made available to the public one the spurious grounds of “commercial confidentiality”. 

All public/private financing is a political con – it is either deferred taxation (because the taxpayer has to service the debt) or the taxpayer pays through direct charging, for example, road tolls. PFI does not equal competition or higher efficiency, merely the taxpayer being locked into a system where the PPP/PFI providers can hold the state to ransom.

 * The Government defines PPP and PFI thus:

“Private Finance Initiative (PFI) contracts are a form of public-private partnership (PPP). Other forms of PPP include:

 Strategic Service Delivery Partnerships (SSDPs)

 Concessions (e.g. toll roads)

 Strategic Infrastructure Partnerships, such as the NHS Local Improvement Finance Trust (LIFT) programme in the health sector, and Local Education Partnerships (LEPs) in the Building Schools for the Future programme

Some PPPs may involve setting up Joint Venture Companies.

 PFI contracts allow local authorities to gain access to new or improved capital assets (most commonly, but not always buildings). The public sector may or may not own the assets, but in either case will pays for its provision and use, together with associated services (for example, maintenance, management, security, cleaning, etc). Capital investment in the assets is made by the private sector which recovers its costs over a long contract period (often 25 years or more).”http://www.communities.gov.uk/localgovernment/localgovernmentfinance/pupprivatepartnership/

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