Regulation

Equality Act: How Cultural Marxism conquered a delusional society

The UK government has unleashed its latest weapon ready to destroy any still surviving business – as well as whatever remains of our individual freedoms. The vicious new Equality Act came into force earlier this month.

The progressive Con-LibDem coalition decided to implement the draconian equality laws proposed by Labour’s Harriet Harman and championed by current Home Secretary and minister for women and equality Theresa May. (Note: Safest way to recognize a nation is doomed? Look for things like ministries for ‘women and equality’.) Undoubtedly David Cameron, our faux-conservative leader and champion of political correctness, is feeling all warm and fuzzy for having imposed on Britain the most radical-PC law to date.

The Equality Act introduces a myriad of ‘rights’ which will allow staff to sue for any perceived offense imaginable.

It also creates the concept of ‘third party harassment’, meaning an employee can overhear a joke which was not even directed at them, perceive it to be offensive and then sue the employer. Workers can sue if they feel any comments ‘violate their dignity’, create an ‘intimidating, hostile, degrading, humiliating or offensive environment’, etc. A one-off incident is enough – the ‘victim’ doesn’t need to have warned the ‘offender’ that their comments were unwelcome.

As if that wasn’t bad enough, the legislation extends to everyone in the workplace; hence staff can sue their employer even if they were offended by something said by a vendor, customer or contractor.

Basically, the law aims to prevent anyone being offended by anything and any person, and allows workers to sue if their fragile feelings do get hurt. And as the years of rampant political correctness have already created a nation ready to take offense at even the most trivial remark, the lawyers and employment tribunals will undoubtedly soon find themselves very busy.

But wait, there’s more. Questions about a prospective employee’s health are now banned; it is for example illegal to ask how much time off work a person has taken. ‘Discrimination’ of any sort based on health is also illegal – for instance, staff who take a large number of sick days or periodically miss work because they are looking after an elderly or disabled relative will find it easy to sue for discrimination if they feel they have been treated unfairly.

Employees will be able to claim they were discriminated against because of a disability of any nature. Worse still, they no longer have to prove they were treated less favorably than non-disabled colleagues – the employer is guilty until proven innocent! (For instance, dyslexic workers who have been barred from carrying out certain tasks because of their tendency to make spelling mistakes can sue under the legislation.)

Another new category introduced by the law is ‘discrimination by association’, which allows workers to sue if they feel they have been disadvantaged because of an employer’s perceived prejudice against a relative (e.g. a gay brother). Combined discrimination has also been introduced – workers can claim they were treated unfavorably because of a combination of factors, for instance age and gender… to make sure some will stick, in case one allegation fails.

Shocking enough? Well, we aren’t finished yet! It is also illegal to discriminate against someone for the ‘perception’ that they are one of the ‘protected’ groups (for instance gay) – even if they are not. As you can see, anyone can sue for discrimination on any ground, whether plausible or not, and the burden of proof is not on them but on the employer (who clearly has no way to prove his or her innocence in such cases.)

On top of that, employment tribunals will have power to ‘recommend’ changes to a company’s business practices, such as imposing diversity and equality standards, rather than just dealing with the case of the individual who brings a claim.

A small part of the Equality Act is yet to be implemented (but undoubtedly will soon be) – the requirements for larger companies to publish the differences in pay between male and female employees and take action to remove them; and affirmative action to recruit more female and ethnic minority staff (regardless of their suitability for the position).

Who will benefit from all this lunacy? Lawyers of course, and a (likely significant) number of people keen to extort money from their employers or exact revenge on their co-workers and bosses for perceived wrongs. One thing is certain – discrimination claims will skyrocket and the burden of red tape will increase exponentially. And if businesses – already struggling to recover from the recession – end up facing ruin, so be it. Who needs those evil, greedy capitalists anyway? (According to the British Chambers of Commerce the employment law ‘reforms’ will burden business with £11.3 billion in extra costs.)

The UK has already been one of the worst places to run a business (at least based on my experience from a handful of countries worldwide): the burden of an ever-growing stream of new rules and regulations, massive bureaucracy and red tape strangling companies of all sizes, constant changes (and rarely for the better) to the law including tax laws (which have already been among the most complex); not to mention the ever increasing tax burden (especially when one includes individual taxes).

Yet all that has not been enough for our progressive governments. And the madness will undoubtedly not end with the Equality Act either. Why would anyone in their right mind invest their money, time and hard work to build a business in such an insane anti-business environment?

One might have thought there would be some resistance to such disastrous ‘progressive’ experiments, especially at a time when we could use all the jobs and entrepreneurial activity we can get.

But, alas, it appears much of the country has been successfully infected with the equality/diversity/fairness disease and as such sees nothing wrong with the so-called Conservative party wholeheartedly embracing this highest of all ideals. Sadly, in a country that has long ago rejected and destroyed any traditional and moral values – along with last remnants of common sense – equality/diversity/fairness (i.e. the chief tenets of political correctness or, if you prefer, Cultural Marxism) have become the new, true religion.

In a culture where nobody takes any responsibility for their own actions and everyone is a victim, taking offense has become a national sport. People’s lives and livelihoods are routinely destroyed for falling foul of any of the myriad new laws, rules and regulations aimed at enforcing PC; freedom of speech and individual liberties have been stripped away.

Supposedly, this is all for our benefit – for we will create a fair and equal society and everyone will be happy in our new Utopia.

As a wise man once said: Marxism didn’t fail with the fall of the Soviet Union; it has instead been fully implemented in the West.

Having grown up in a formerly communist country, it seems the UK (and much of Western) population is far more brainwashed with political correctness than we ever were with communism. Worst of all, they don’t even realize it. Perhaps that’s what inevitably happens with complacent, comfortable, distracted peoples who have thrown away the values that once made them great. (Of course the mere concept of objective and true values is now rejected; everything, morality included, is relative. That which makes people feel good about themselves is good, everything else is judgmental and hence evil.)

I can see why imposing equality of outcome has proven so popular with the very many who benefit from it. And when it comes to those who are forced to pay dearly for such ‘progress’? That’s where indoctrination and coercion come into play. After all, who could ever object to the pursuit of “social justice” (code for forced equity), right?

Collectively as a society we are in complete denial of reality, having happily embraced our pretty illusion that we are all special, all equal, equally important, equally smart, equally valid.

Therefore, if some people earn more than others and wealth is not equally distributed, it is a clear sign we live in an ‘unfair’ society and some people are oppressed or discriminated against. Such injustice must therefore be rectified by government intervention. If women earn on average less than men it can only mean gender discrimination (you didn’t think the fact women take months or years off work to bear children, work far shorter hours, and tend to choose professions that are financially less lucrative could have anything to do with this, did you?). If certain groups of pupils do worse at schools than others, it must be racial discrimination, or class discrimination (how dare you think intellectual faculties, hard work or dedication could be the true reasons).

And so we have, step-by-step, legislated a perverted, delusional and coercive version of equality and increasingly made it a crime to treat (and pay) people according to their abilities, efforts and achievements.

Many consider this a good, ‘fair’ thing. As C. S. Lewis recognized, “The claim to equality, outside the strictly political field, is made only by those who feel themselves to be in some way inferior. What it expresses is precisely the itching, smarting, writhing awareness of an inferiority which the patient refuses to accept. And therefore resents. Yes, and therefore resents every kind of superiority in others; denigrates it; wishes its annihilation.”

Self-interest aside, for anyone who does believe such preposterous fairy-tales – it may be time to wake up from your Marxist dream. People are self-evidently unequal. Some are more virtuous, intelligent, attractive, fit, moral than others. Some are more apt for certain tasks and professions than others. Some work hard and others less so. There is nothing ‘unfair’ about them being employed and rewarded accordingly.

Everyone who wants to can be a valued member of society, in whatever role fits their God given and acquired abilities. But one can not force others to consider him or her a better man or woman than they are – it’s not something that can be legislated; it has to be earned.

When people are free, outcomes are naturally unequal. Whether you like it or not, human liberty results in economic and social inequality. You can have either equality or liberty, but not both.

And so it is of no surprise that these great ideals we like to worship are never reached by protecting individual freedoms. Quite the opposite; they are always achieved by removing rights and liberties. Equal outcome requires tyranny, forced suppression of the rights of some in order to enhance the rights of others, be it through progressive taxation and redistribution, affirmative action and special rights for certain protected groups, or rules and laws which restrict freedom of some for the benefit of others. Wherever you look, we’re enforcing equal outcomes rather than equal standards for all. (Of course this near absolute control over all aspects of life and business goes hand in hand with the creation of an ever-growing and all-powerful bureaucracy.)

And yet all that is apparently a price most people are more than willing to pay. For what were once (granted, a rather long time ago) proud, self-reliant and free people, decades of welfare state and ever expanding and intrusive government have transformed into mere slaves, dependent on the state for handouts and guidance. Indeed the only freedom many wish for now is freedom from any responsibility.

As Ben Franklin wisely said, “Those who give up essential liberty to obtain a little temporary safety deserve neither liberty nor safety, and will lose both.”

I shall leave you with the timeless words of C. S. Lewis…

“Democracy is the word with which you must lead them by the nose… You are to use the word purely as an incantation; if you like, purely for its selling power. It is a name they venerate. And of course it is connected with the political ideal that men should be equally treated. You then make a stealthy transition in their minds from this political ideal to a factual belief that all men are equal… You remember how one of the Greek Dictators (they called them “tyrants” then) sent an envoy to another Dictator to ask his advice about the principles of government. The second Dictator led the envoy into a field of grain, and there he snicked off with his cane the top of every stalk that rose an inch or so above the general level. The moral was plain. Allow no preeminence among your subjects. Let no man live who is wiser or better or more famous or even handsomer than the mass. Cut them all down to a level: all slaves, all ciphers, all nobodies. All equals. Thus Tyrants could practise, in a sense, “democracy.” But now “democracy” can do the same work without any tyranny other than her own. No one need now go through the field with a cane. The little stalks will now of themselves bite the tops off the big ones. The big ones are beginning to bite off their own in their desire to Be Like Stalks.” (C. S. Lewis; Screwtape Proposes a Toast)

Ban, tax, regulate – government vs. free market

Here we are again, back to the disturbing – but entirely unsurprising – war on the ‘free market’ (or whatever is left of it after decades of government interventionism).

The pattern of governments creating a mess and promptly laying the blame at the feet of the private sector is not at all new, so EU’s and Washington’s attacks on the markets and George Papandreou’s continuing threats against ‘evil speculators’ should not have caught anyone by surprise. In much the same manner, the coming (politically motivated) clampdowns and regulations of various market activities are being designed with the sole purpose of shifting blame – for excessive borrowing, overspending, harmful interventions and defective regulation – away from the policy makers.

Of course diversion of blame and responsibility is not a behavior exclusive to governments. It has come to characterize much of today’s society, and is largely responsible for the economic, social and moral decline we’re at present witnessing all around us. (More on that in an upcoming post.)

Let’s start with Greece. Prime Minister Papandreou has stepped up his rhetoric about his country being victimized and having problems servicing its debt, not as a result of irresponsible and fraudulent behavior over many years, but because of speculators’ bets to bring it down.

“Despite the deep reforms we are making, traders and speculators have forced interest rates on Greek bonds to record highs. Many believe there have been malicious rumors, endlessly repeated and tactically amplified, that have been used to manipulate normal market terms for our bonds.” He went on to say that as a result Greece was forced to borrow at rates almost twice as high as Germany, and that such ‘prohibitive’ interest rates would swallow all gains from the planned austerity measures.

Manipulate ‘normal’ market terms? ‘Prohibitive’ rates? Someone please show Mr. Papandreou the spread between Greek and German bonds pre-Maastricht Treaty – at multiples of what it is today! See for yourself in this astonishing chart: Club Med spreads (1992-2010).

Let’s not forget that the Greeks (and other fiscally shaky Southern European states) have only enjoyed – undeservedly – low rates thanks to the EMU. And, had Greece not lied about its finances, it would never have been admitted into the monetary union in the first place (it has never complied with the required fiscal discipline, preferring to falsify data). The current rates on Greek borrowing are more than appropriate (in fact, quite benevolent) for a country that carelessly jeopardized its own future by decades-long irresponsibility.

For a decade the markets have ignored the vast differences in fiscal policies between eurozone members; risk premiums on sovereign bonds were barely discernible. After the financial crisis investors started awakening to sovereign risk and spreads became far more aligned with reality. The bond markets are once again reflecting fiscal policies, as they should. Far from ‘market manipulation’, it’s simply a return of country risk.

Indeed the financial markets are now doing the job that politicians have failed at so miserably – forcing the countries to take measures that will lead to a return to fiscal sanity (or else face the consequences). It should also be obvious that any country’s funding costs will now increasingly reflect its own fundamentals, rather than those of say Germany, as investors are unlikely to be blinded by any implicit EMU guarantees again, at least for the foreseeable future.

The Greeks, who have over decades borrowed and squandered too much money, won’t admit that their 12.7% budget deficit (that being the official figure; the true deficit is estimated at 16%), 120% debt/GDP (135% estimate for 2011), out of control government spending (at over 50% of GDP), rampant tax evasion, among other problems, are the root-cause of their troubles and consequent risk pricing by the markets. (For an analysis of the Greek situation and possible solutions see recent article here.)

Given that Greece has defaulted on its debt 108 times in the last 200 years, showing no sign that it has learned fiscal responsibility, it is rather astonishing that the Greeks should be surprised at rising interest costs. Would any responsible lender extend credit to an over-leveraged borrower on the verge of bankruptcy, at extremely low rates?

Yet the Greeks appear to believe that threats and regulation will force the capital markets to supply them with unreasonably cheap credit. During a recent Washington visit to win President Obama’s support for the war against evil speculators, Mr. Papandreou said: “Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system not to mention the human consequences of lost jobs, foreclosed homes and decimated pensions.”

Therefore, investors should lend to Greece at ultra low rates, ignoring any default risk, in order to allow the Greek government and population to carry on with a spending binge, delaying the day of reckoning indefinitely. (Much like banks had been coerced by the US government into lending to unworthy borrowers with no deposits and insufficient income; and we know how that ended. But more on that later.)

The Greeks’ sense of entitlement to other people’s wealth, their perceived ‘right’ to borrow at low rates, is indeed quite disturbing. Though rather than being solely a Greek issue it appears to be a sign of our times.

But why the widespread hatred of market participants, be it speculators, traders or investors?

After all, it wasn’t speculators who had run up massive debts and a 13% deficit, but the Greek politicians (and population). Investors and traders have merely exposed the truth the Greeks, as well as EU authorities, would have preferred to keep hidden. It should be obvious that Greece only has itself to blame for not being able to borrow at the same rates as fiscally prudent Germany.

The much vilified short sellers, as well as CDS (credit default swap) buyers, perform a vital function by pointing to problems and deficiencies (whether in companies, industries or countries) and backing their opinion with their money. When they believe an entity may go bust, shouldn’t they be allowed to protect themselves and/or profit accordingly? When it comes to sovereign debt, if it wasn’t for the markets, politicians would never take the necessary action to put their house in order.

Papandreou’s argument that “unprincipled speculators are making billions every day by betting on a Greek default” misses the point entirely. If Greece’s fundamentals were less disastrous, anyone betting on a default would be losing billions. No speculators can bring down a healthy company, currency or country. In any case, there are always two sides to each trade. For everyone shorting Greek debt there is also someone on the long side.

As for the fallacy of speculators destabilizing the Greek bond market via CDS use: Germany’s financial regulator (BaFin) has found no evidence that CDS were used for large scale speculation against Greek government bonds, reporting (earlier this month) that the net volume of outstanding CDS contracts has barely changed since the beginning of the year. Some of the most active CDS traders are German and French banks, who happen to hold significant amount of Greek debt. If there were no CDS (essentially, insurance against default), who would take on the risk of financing Greek debt?

Ironically, it has just been uncovered that the biggest CDS speculator, holding 15% ($1.2 billion) of the total $8 billion of Greek CDS, has been the Greek state-owned Hellenic Post Bank! (Article here.)

And yet, despite his obvious delusion, Mr. Papandreou has been finding an attentive audience in other European leaders as well as President Obama. After all, Greece’s is not the only government that views the markets as a welcome scapegoat for their own mismanagement and incompetency.

Given bureaucrats’ readiness never to waste an opportunity to further restrict economic freedom, it isn’t particularly surprising that the European Commission is discussing regulation of the sovereign CDS market, and the US Justice Department has reportedly been looking into hedge funds’ short positions against the euro, to determine whether they colluded to drive down the value of the single currency.

European politicians, who have a long tradition of anti free market beliefs, have blamed speculators for the recent decline of the euro in the wake of the Greek crisis. They, much like the Greeks, feel entitled to low borrowing costs for EMU members and a stable euro, irrespective of the fiscal and economic mess of the EU.

Germany’s finance minister, Wolfgang Schaeuble, went as far as suggesting the use of anti-terrorism methods against financial speculators in order to protect the euro. He said the government might “set up surveillance of who is getting together with whom for which kinds of speculative processes, and where.”

What’s next? Will they start arresting traders for threatening ‘economic stability’ if they happen to dislike the fundamentals of a certain country or currency and vote against it with their money?

It would seem there is no better sign that an entity is in severe trouble than authorities starting to crack down on short bets against it. The truth is, if the euro was fundamentally sound, it would not have been ‘attacked’. (Not to mention that those who believe speculators have caused the euro to drop to unfairly low levels can always back their opinion by taking action in the forex market.)

What Greece and other nations need to learn is that one cannot go on indefinitely increasing government spending and borrowing without consequences. There comes a point when markets lose confidence in the country’s ability to pay and refuse to lend the money (at acceptable rates). That moment appears to be fast approaching for a number of countries.     

Of course when it comes to short term political gain, shifting the blame onto the private sector is an entirely valid strategy. We have seen its success in the aftermath of the 2008 crisis; the people have, without much questioning, accepted the official line: the crisis was caused by insufficient state intervention and regulation of the ‘free market’. Therefore, we have been told, a massive increase in government bureaucracy and regulation was necessary.

The threats against speculators in (Greek) sovereign debt are reminiscent of the attacks on banks, hedge funds and financial markets in general, over the last two years. Of course there was much that went wrong in the financial sector, but the blame game has been indicative of the failure of governments to admit their own mistakes.

Notice that any economic boom is always a result of ‘wise government policies’. When the inevitable collapse comes, a culprit must be found, fast, before anyone starts looking at possible policy makers’ faults. And so all crises are quickly declared to be a problem of the ‘free market’.

Such denunciations look particularly misplaced given the disastrous track record of public management, including the crucial role of the Fed and US policy makers in creating the recent crisis. It was the Fed’s loose monetary policy that had encouraged speculation and inflated a massive housing bubble, aided by vote grabbing policy makers’ interventions in the housing market (incl. coercing financial institutions into lending to unqualified, low income borrowers under such monstrosities as the Community Reinvestment Act).

And of course the government sponsored Fannie Mae and Freddie Mac were by far the worst offenders, likely to end up costing the US taxpayer some $400 billion. (They remain an ‘off-balance sheet’ – or so the politically convenient fiction goes – dumping ground for the debris of the housing crisis.) But don’t hold your breath waiting for Obama et al. to acknowledge any of this; they’re too busy pounding on the banks.

Bizarrely, our political elites appear to fully ignore the fact that highly expansionary monetary policies – and resulting unprecedented indebtedness – have been largely responsible for the current mess. It’s nothing new; interventions into (what was once) the free market have always brought unintended negative consequences. And yet the link between low interest rates, excessive credit growth and asset bubbles appears to evade policy makers’ understanding.

The slashing of interest rates in 2001, and keeping them at record low levels for several years, has led to the credit and housing bubble. Spiraling debt contributed, in a large part, to the apparent prosperity of the last 15-20 years (much as it had in the 1920s, ending, equally disastrously, in the Great Depression). Greenspan and Bernanke acted as cheerleaders of debt, while policy makers were busy identifying new targets for lending, in the name of democratization of access to credit.

And let’s not forget the essential role of greedy housing market participants, millions of whom have knowingly taken on mortgages and loans they couldn’t afford to pay back, in order to satisfy their irresponsible craving for a lifestyle beyond their means. (In the past 25 years the amount owed by US families has risen more than sevenfold, from less than $2 trillion in 1984 to nearly $14 trillion, according to the Fed.) Inevitably, cheap credit has also created huge imbalances and fueled speculation in the financial sector.

And yet, shockingly, no lessons seem to have been learned. Central banks and governments – in particular in the US and UK, considering a painful period of readjustment (perhaps a short depression) to be politically unacceptable, have embarked on massive quantitative easing (in other words money printing) and huge stimuli to restore economic growth. In the process they have loaded their countries with an unprecedented mountain of debt.

Indeed, blind to the fact that easy credit and excessive debt created the crisis in the first place, the Fed and the Obama administration are happily running up higher and higher debts. In an unprecedented printing press exercise the Fed has purchased over $1.2 trillion of toxic agency (Fannie, Freddie, Ginnie Mae) mortgage backed securities (MBS), creating a floor for housing prices and so delaying necessary corrections. Hence the massive burden of toxic assets now weighs down not only the private financial markets but also the Fed itself.

Numerous other government support measures have been masking the fundamental sickness of the housing market, including tax breaks for home buyers and government-mandated loan modifications (the majority of which end up in default again within six months). The Federal Housing Administration (FHA), with its aim to make homes more affordable, has underwritten hundreds of billions of dollars of mortgages in the last two years alone. Its support for the housing market is expected to double again – growing to $1.5 trillion – over the next five years. FHA foolishly continues to require down payments as low as 3.5%, when it should be obvious that a 15-20% deposit would allow home owners to better withstand any future crisis. (Unsurprisingly, a record number of FHA-insured loans are delinquent.)

Speaking of loose monetary policy… rates have been fixed at near zero. The resulting boost to the price of securities held by banks, as well as what are, in effect, zero interest loans from depositors, have translated into strong revenues for the sector, allowing banks to ignore the bad loans still on their books. It is clear that the irrational monetary policy with artificially low interest rates, plus monetization of debt, will continue for quite some time. A certain recipe for the next bubble and crisis.

And of course the government has also embarked on an unprecedented fiscal stimulus, a consequence of which is a massive increase in public sector debt. (The US national debt now stands at over $12 trillion. But add the ‘off-balance sheet’ unfunded liabilities and the total public debt comes to an estimated $60 trillion – an amount that can clearly never be paid off. We’ve discussed the impact of extreme debt levels in a recent post here.)

Despite the shocking debt and deficit we’re unlikely to see any serious attempt at spending cuts any time soon; quite the opposite, there seems to be a new US spending bill proposed almost every week. Crucially, at a time when existing entitlement programs are bankrupt, the Obama administration saw it fit to create a monstrous new $2 trillion health care entitlement.

In spite of the alleged temporary nature of the public spending boom, the expansion of government will likely be permanent. The price to pay is obvious – high deficit, high taxes, slower economic growth and less wealth. Unless, that is, you agree with Mr. Obama and the ‘leading’ economists that government spending creates wealth.

The belief we can cure a debt crisis with even more debt would also be rather comical, if the situation, and consequences, weren’t so tragic.

So what then is the solution?

Instead of the government attempting to micromanage the financial markets (and any other private industries) via further interventions, regulation, punitive taxation, bans and growing bureaucracy, we should simply allow the free market to work. The finance industry as well as borrowers should be let to suffer the consequences of their actions (be it bad lending or irresponsible borrowing). They also need to be allowed to make commercial decisions without coercion or interference from policy makers. In the absence of government intervention – that only creates distortions and moral hazard – the markets would curb bad behavior via defaults and bankruptcies, resulting in suitable risk adjustment by other participants.

US home owners should also be liable for any outstanding mortgage balances (as is common in virtually every other country), instead of simply being allowed to walk away from underwater mortgages. Naturally such policies would mean fewer home buyers taking on mortgages they can’t afford to repay, and that goes against the government’s idea of home ownership being a near universal ‘right’ – a notion which, bizarrely, still appears to be alive and well in Washington. But until people return to a suitably affordable lifestyle (whether that be renting instead of home ownership, or a more modest home) we are only kicking the problems down the road for a little longer.

It is natural that in a crisis, recession or period of high unemployment people are angry; they need to externalize the enemy. The markets, speculators, or Wall Street are a highly convenient (and sometimes justified) target when it comes to diverting blame away from policy makers, central banks and general population. They also provide a welcome opportunity for governments to expand and to regulate more, tax more and interfere more in private sector activities.

However, if any lessons are to be learned at all, we must acknowledge that it was the culture of living on (cheap) credit and spending beyond our means – spurred by disastrous monetary policies and interventions - that led to record indebtedness, housing bubble and collapse, and resulting financial and economic hardship. Only then will we be able to recognize that the current policies are simply setting the stage for a much larger crisis a few years from now.

House approves biggest overhaul of financial regulation

On Friday the House of Representatives passed the Wall Street Reform and Consumer Protection Act, a landmark legislation proposing sweeping changes to regulation of the financial system.

In a victory for the Obama administration, the 1,300-plus-page bill passed by a 223-202 margin (with all Republicans and 27 Democrats against). The Senate is working on its own measures to be debated early next year. Eventually, a final, compromise version will have to be negotiated between the two chambers.

The sprawling legislation will, in effect, regulate the financial services industry as well as most aspects of personal consumer banking. It covers everything from too-big-to-fail firms, banking regulation, hedge fund regulation, derivatives trading, executive compensation, to the simplest consumer financial products.

Republicans criticized the (Democratic) legislation, saying it could cause job losses, restrict the availability of credit and enable future bailouts of failing companies.

Let’s have a look at the main points of the reform bill.

Consumer protection

A central element of the bill is the creation of the Consumer Financial Protection Agency (CFPA), a new federal agency with far reaching powers to control all types of financial products offered to consumers (including a variety of loans, mortgages, credit cards, etc).

The bill also incorporates the mortgage reform and anti-predatory lending bill the House passed earlier this year. It prohibits lending to those consumers who shouldn’t be taking such financial risks and orders lenders to ensure that borrowers can repay the loans they are sold.

In a rare win for the banking industry, the House rejected an amendment that would have allowed bankruptcy judges to reduce mortgages of distressed borrowers. (A measure that, if adopted, would most likely have limited the willingness to lend.)

Financial Services Oversight Council

The inter-agency council, chaired by Treasury secretary, will identify and impose additional regulation on companies that are deemed ‘too big to fail’ and whose collapse would put the financial system at risk.

Dissolution of troubled companies

The bill aims to create a $200 billion ‘systemic dissolution fund’ (financed by fees to be levied on financial institutions) to cover the costs of dissolving firms that pose a threat to the economy. The government will have new powers to break up or dismantle large, failing financial institutions, in order to prevent a contagion to the rest of the system.

Fed audits

The bill will limit the power of the Federal Reserve, removing its consumer protection authority and limiting its ‘lender of last resort’ power.

It also includes a provision for Fed audits, subjecting its monetary policy and lending to financial firms to audits by congressional watchdogs. (The Fed argued this threatens its political independence, implies monetary policy will no longer be independent and decisions could be influenced by politics – all of which could unsettle the markets. Inflation and long term interest rates could also rise if investors believed the Fed to be under political pressure to keep growth going.)

Regulation of OTC derivatives

The legislation imposes, for the first time, regulation on the over-the-counter (OTC) derivatives market. It establishes a central clearing requirement for participants in the OTC derivatives market, aiming to increase transparency. Commercial end users, who use derivatives to hedge their price risk, will be exempt from the clearing requirement.

Regulators will also have powers to set capital and margin requirements, as well as position limits on financial and commodity-based derivatives.

Executive compensation

The bill takes on Wall Street compensation, giving shareholders a nonbinding vote on executive pay. It also requires financial firms to disclose any compensation structures that include incentive-based elements, and empowers regulators to ban inappropriate compensation practices.

Investor protection

SEC’s powers will be strengthened to allow for improved investor protection and regulation of the securities markets. A new study of the securities industry will identify necessary reforms, in response to the failure to detect the Madoff and Stanford Financial frauds.

Hedge funds & private equity regulation

Hedge funds, private equity firms and offshore funds will have to register with the SEC and will be subject to systemic risk regulation.

Federal Insurance Office

The Federal Insurance Office (FIO) will be set up to monitor, for the first time, the insurance industry, including identifying possible gaps in the regulation of insurers that could contribute to a systemic crisis.

Reform of credit rating agencies

The bill addresses the role rating agencies played in the economic crisis, aims to reduce conflicts of interest and impose a liability standard on the agencies.

Conclusion

Everyone agrees that some changes are necessary. But we have had plenty of government regulation, and it has failed in the past. Can new government agencies and more bureaucrats employed to oversee and regulate the industry stabilize the markets and avoid future crisis?

I fail to see how this (or any) regulation can really ‘prevent such crisis from ever happening again’ (as Obama stated). Unless the government bureaucracy manages to stifle competition and kill innovation in the financial markets, there will always be new products, risks and indeed, crisis.

After all, while the 2008 meltdown brought the world to the brink, it wasn’t the first time (remember how the Russian financial crisis and LTCM implosion led to near Armageddon in 1998?). And I suspect it won’t be the last.

Labour’s war on middle class and higher earners spelled out in Darling’s pre-budget report

Chancellor Alistair Darling unveiled his politically motivated pre-budget report today. Let’s look at the details.

Bonus super-tax and new higher earner taxes

A new temporary super-tax on bank bonuses comes into effect immediately. Banks (incl. UK subsidiaries of foreign banks) will pay 50% tax on bonuses over £25,000 (to include shares, options and temporary salary increases). The bankers will of course then still be hit with the new 50% income tax on earnings.

The bonus tax is estimated to raise just £550 million in revenue, so it’s clearly just a populist measure for Brown’s semi-socialist government to grab votes. Bankers are an easy target and the recent witch hunt has been entirely in tune with Labour’s politics of envy and class war.

Thousands more of higher earners will also be hit with the new 50% income tax rate as it is widened to include not only pay but also pensions. In essence it was extended to those earning £130,000 or more.

Middle class tax grab

But it’s not just higher earners who will suffer the consequences of Labour’s mismanagement of public finances and the economy.

The threshold for higher-rate (40%) income tax will be frozen. That means people earning just £43,000 will pay more tax, costing workers £400 million a year.

And, in an additional massive middle class tax grab, the announced National Insurance (NI; income tax in all but name) rise will hit anyone earning £20,000 a year or more.

At present 11% of workers’ wages go toward National Insurance. From 2011 NI contributions will go up to 12% for all workers earning more than £20,000 a year. Those on more than £44,000 also face a second hit, paying 2% rather than 1% on their pay above that threshold. The increase in NI is to raise £4.5 billion a year from 2011/12.

On top of the employee contributions, the employers pay 12.8% of their workers’ salaries in NI contributions. This will increase to 13.8%. The raise of NI is a tax on jobs, pure and simple. And it comes at the time when UK’s economic recovery is incredibly fragile.

Finally, the inheritance tax threshold will be frozen at £325,000, rather than raised to £350,000 as previously promised.

Balancing the budget?

Darling expects GDP to drop by 4.7% in 2009, the worst peacetime performance since 1921. (His last prediction earlier this year was of 3.5%.) He expects the economy to grow by 1-1.5% in 2010 and 3.75% in 2011 – extremely optimistic figures and likely to be proven wrong, as so many of his past forecasts.

The pre-budget report shows plans to borrow nearly £800 billion over 6 years, taking the 2014/15 national debt to just under £1.5 trillion. Of course the real number is far higher, as the government figures do not include the public sector pensions deficit estimated at £1.2 trillion.

In a further upward revision of earlier forecasts, the government will, in 2009/10, spend £178 billion more than it receives in tax – equal to 12.6% of GDP. Next year, the deficit is estimated at £176 billion.

The Chancellor aims to cut UK’s deficit to 5.5% of GDP by 2013-14. However, we’re yet to see any clear and viable plan for that to be achieved. Britain’s credibility and credit rating depend on that, so let’s see what Darling proposes to do to cut spending.

Where are the much needed public spending cuts?

While Ireland is slashing spending – by way of benefit and public sector pay cuts – to the tune of 4 billion euro, you would be hard pressed to find many meaningful measures in Darling’s pre-budget report. (Irish budget deficit of around 12% is comparable with that of the UK.)

The Chancellor plans to impose a 1% cap on public sector pay rises (as opposed to the Irish 6% cuts in public sector wages and up to 20% for highest earning public servants) for two years. Even that is postponed until 2011. From 2012, government contributions to public sector pensions will be frozen.

Worse still, the Chancellor insisted key services will be safe and ring fenced. NHS, schools, police are guaranteed to see their budgets rise at least in line with inflation.

VAT will return to 17.5% from 1 January 2010, as expected.

Cuts? It’s more spending instead!

While any sensible observer might have expected severe spending cuts in a country on the verge of bankruptcy, Darling has laid out Labour’s plans for 2010 and beyond: tax more and spend more.

To please the party’s core voters, child and disability benefits will be increased by 1.5% from next April. Basic state pension will be raised by 2.5%. And, bizarrely, bingo tax will be cut. In fact, Labour will be spending an extra £7.7 billion in 2011/12 and £6.9 billion the following year.

Conclusion

So there we have it. Instead of much needed spending cuts, more taxes. Instead of significantly paring back the gargantuan public sector (yes, including welfare and the bureaucratic, inefficient NHS), the government chooses to heavily penalize middle and higher rate tax payers.

The increase in NI contributions means it will be more expensive to keep and hire workers. Hardly a sensible move when economic recovery is closely tied with job creation.

The pointless and harmful bonus super-tax will not generate revenues, but, just as the previously announced, vengeful 50% income tax, is sending the wrong message. Uncertainty – and the notion that everything is up for grabs – will make businesses and enterprising individuals think twice before coming to (or staying in) London.

The top 10% of earners already pay 54% of income tax and the top 1% pay 24%. But, no matter how much they are milked, it’s never enough for a socialist wealth redistribution agenda. From 2010 the UK will have one of the highest tax rates in the world. The state grabbing more than half of what the wealth- and job-creators make is certainly not a motivation to be ambitious and successful. And the paltry £500 million revenue is hardly worth the billions in investments and taxes the UK and the City of London is likely to lose as a consequence.

UK’s economic success depends on entrepreneurs, highly skilled workers, as well as a profitable financial services industry. Yet the signal the government is sending, by labeling such people as elitist & (bad) “rich” and imposing punitive taxation, is that the country neither values nor wants them here. And they may well listen, choosing a more welcoming destination for their efforts and money.

EU to extend witch hunt to hedge funds and PE

The EU plans to snatch significant supervisory powers away from national regulators. The European Directive on Alternative Investment Fund Managers would see current exemptions for smaller funds scrapped, meaning a majority of hedge funds and private equity funds would come under the new, highly restrictive regulation.

The Directive will impose limits on leverage for funds, as well as restrict where European investors can put their money in.

The EU also plans to bring in tough measures to curb hedge fund and private equity managers’ pay. At the same time the European Parliament recommends the European Securities and Markets Authority to be handed powers to regulate short-selling.

The proposals are a setback for London, base of 80% of the alternative investment industry.

6 further reasons why the Directive should be scrapped.