Highway robbery
I have just been watching again the excellent 60 minute programme. “The Super-Rich: The Greed Game”, shown on BBC4 on 7 October 2008. Unfortunately it is no longer available on the BBC website, but I strongly recommend watching it if it comes up again:
Robert Peston: More than 50 billionaires call Britain home. Not since the nineteenth century have there been such opportunities for so many to make quite so much money. At least 30,000 Brits now earn more than £0.5 million/year. In 2006, four thousand two hundred City executives took a bonus of £1 million or more. And among hedge funds alone, 150 people hve been earning more than £20 million a year.
Dr Philip Beresford (compiler of Sunday Times Rich List): The only other period we have seen similar accumulation was during the industrial revolution in the Victorian Age, when the whole raft of Victorian industrialists made massive fortunes quickly. But even that was over a period of forty or fifty years. This has been in the last ten years.
Many of my father’s generation were fellow-travellers. The idea of “from each according to his abilities to each according to his needs” seemed the perfect philosophy for the Humanist Age. Of course, those who did their homework were less tempted because Marxism was fairly explicit about the end justifying the means, and there was a natural caution about those prepared to use such apparently grubby means. Nonetheless, I think everyone was taken aback when the full failure of the Soviet economy was laid bare for all to see after the collapse of communism.
Certainly, I was deeply shocked by a visit to Irkutz, a modest-sized town on the shores of Lake Baikal, in the 1990s. It was best described as Third World with education. So it is clear that exhortations do not work. A market economy is needed to enrich the masses, or even to get them comfortably above subsistence level.
But it is not so clear that the markets should be entirely unrestrained. It is almost obvious, and certainly generally accepted, that the Rule of Law is needed. The state has to intervene to prevent fraud. It is also clear that it has to provide various common services such as infrastructure and defence, and to provide at least a modest safety-net in the form of social services. That requires taxation.
The argument used to be about how much tax rates should rise with income. Should income above £100,000 be taxed at 50 per cent, or at 80 per cent. Bizarrely, the former socialist party, New Labour, decided to tax most of the Super-Rich at around 10 per cent on income, substantially less than those on more modest incomes. There has always been a problem with tax avoidance and tax evasion by the rich. If you have an income of a million a year, you can easily afford to pay substantial legal fees for complex schemes which avoid tax. You can also afford to devise complex illegal schemes which are hard to uncover. But New Labour chose to make all that unnecessary. They made it easy for the richest members of society to pay little tax.
Ronald Cohen became a New Labour favourite, and an effective advocate for the Super-Rich. Listen to his justification from the same TV programme:
The reason private equity charge what are considered to be high levels of fees is that there are relatively few people in the private equity world, and there are relatively few new entrants into that world. It is quite a rare combination of skills, and the financial results that the industry is able to deliver to its investors means that the investors are continuing to pay those fees.
Now private equity is quite a different case from hedge funds. The fundamental market imperfection here is the inadequate control and guidance provided by non-executive directors and shareholders on the activities of executive directors in quoted companies. One consequence of this lack of control is that executives are typically reluctant to allow much debt, because debt tends to make the company’s quarterly results more volatile and hence the executives’ job of managing the company and explaining its results to shareholders more difficult. So there is an opportunity to acquire businesses on a highly-leveraged basis and then to resell a few years later when some of the debt has been paid down.
Clearly this process is not in shareholders’ interests. They would be much better served if the same restructuring and managing whilst they still owned the shares. However, it is strongly in the interests of the top management, because they have a de facto monopoly on the detailed information needed to plan the deal and hence can cut themselves highly attractive deals, often involving a substantial share in the huge gains. So in practice shareholders are usually faced with a modest gain from selling to the private equity company or no gain at all, and hence often go along with the scheme.
It can be argued that this is of net benefit to the economy, but it is clearly absurd to claim that the only way this benefit can be delivered is by enriching a few individuals beyond the dreams of avarice.
The case of hedge funds is even worse. They are just playing a zero-sum game - gambling on the world’s markets. They are better at it than the employees of the typical bank, insurance company or pension fund, so they make money at the expense of the masses. There is arguably a modest benefit from the increase in liquidity which they bring to the world’s markets - they account, for example, for a substantial proportion of turnover on the New York Stock Exchange - but that is completely insignificant compared to the riches they have piled up for a few individuals.
The world is simply mad to allow this kind of legalized highway robbery. The sooner the politicians grasp that and outlaw it the better.
