Because a strong form of market efficiency such as this view espouses has never been proven, we, at top business schools admit that a market can display even within a day all shades ranging from professionally based prices to chaotic or “collective madness”.
Another explanation lies in games theory summarised in the phrase “it is a zero sum game”. That is some win while others lose. For every seller there is a buyer who profits and vice versa.
However what those theories did not cover was the fact that the market for shares and commodities can be used to launder monies, if there is a lack of transparency and a failure in the supervision of disclosure. Also if certain markets are conducted transnationally, across borders, such as the by the International Commodities Exchange then normal rules can be aborted. Such as sufficient margining. Such as demanding that trade in derivatives of scarce and essential commodities be related to an underlying physical transaction.
It appears that market manipulation has occurred in Australia, supposedly one of the best regulated of markets. The use of nominee companies (National Bank Custodians) and self managed superannuation companies let alone hedge funds incorporated in tax havens can permit the buying and selling of stocks, bonds, oil, gold, corn, US dollars or in fact any type of commodity, without knowing the true identity of the counterparty.
In a little discussed headline which subliminally hit the press and evaporated into the nanosphere it was announced that “the Mafia has made US$44 billion from the sub prime crisis”. How? Meanwhile in Senate hearings of the United States Government, claims have been made that oil and commodity prices are being manipulated as 46% of all futures contracts in those markets are being traded on ICE, the International Commodities Exchange, which is outside the supervision of the United States Government.
In fact witnesses at this June committee claimed that we may not really have the food and oil shortages that appear to exist by virtue of “oligopolistic buying of future contracts”. Translated, this means that individuals or groups in incorporated or unincorporated form, acting across transnational boundaries are rorting the market. Their modus operandum is to create rumours to depress prices, borrow stock from superannuation and pension funds, and corner the market for futures.
Meanwhile trillions shifted out of high tax regimes into low tax regimes.
Why does this happen in the most powerful nation on earth?
It is strange that the USA despite having started the Financial Action Task Force to monitor tax evasion across nation’s boundaries, is non compliant in many areas. A notable sign of corruption in such tax monitoring systems is a rapidly depreciating currency. While the Federal Reserve may attribute this to their own low interest rate regime, not so specialistis in transnational crime.
One of these specialists is Professor, John Broom, Managing Director for Milgrove Consulting Group Pty Ltd and a Visiting Professor at the Centre for Transnational Crime Prevention (CTCP). The University of Wollongong established this centre in 2000 to tackle the ever progressive threat of transborder crime. Professor Broom was also head of Australia’s National Crime Authority in the 1990s.
In response to a question, “Are unregulated financial institutions now the new home for the transnational criminal through unregulated activities such as margin lending and short selling which permit money laundering and outright theft of public funds?” Professor John Broome replied,
“The problem is that we tend to use the ‘organised crime’ label to refer to drug dealing, people smuggling, sex slavery and so on and do not use this label to refer to market manipulation, bid rigging, insider trading, fraud and other financial crimes. It may be that some traditional criminals are entering financial markets but what we tend to forget is that some of those involved in these markets have been ‘organised criminals’ for many years.”
He added,“In fact, while criminals have used financial transactions for money laundering purposes for many years (eg false invoicing, faked off shore loans to justify movements off shore etc) the actual market based crimes such as insider trading are the essential predicate offence which generates funds which are then laundered through other transactions. In addition, the largest source of funds that need to be laundered has to be tax fraud. This is often done through the use of market transactions that are difficult to police.”
How and why can transnational crime continue to exist? Why might it shelter behind hedge funds investing in subprime credits, or finance companies raising monies from the public for property investment? Or even in the specialised mortgage houses themselves?
Professor Broome explains.
“We are seeing a repeat of the behaviour which led to the establishment of the Australian Securities Commission (ASC), at the end of the 1980’s. Have we (governments and regulators) learned nothing? The regulators tend to come in after the event and investigate what went wrong when they should be in the business of detecting wrong doing while it is occurring. That of course requires strong and interventionist regulation – something which is an anathema to the ‘markets’ and to the economists in Treasury. We have to protect investors and consumers because they operate in a vacuum of information in many cases.”
In a globalised market place competition extends to the tax system, so that transactions with a tax havens can often be used to avoid paying tax elsewhere. A tax haven is defined by the OECD according to three criteria – none, or only nominal taxes, lack of effective exchange of information, and lack of transparency. The OECD recognises a total of 38 tax havens, three of which have committed to eliminating harmful tax practices. There are also countries which are not tax havens, but by virtue of their bank secrecy arrangements may be exploited for tax haven purposes.
Despite a number of treaties to reduce bank secrecy and tax havens, the Financial Action Task Force, found that in 2002-3, A$3.8billion flowed from Australia to tax havens. The fact that many of the hedge funds, and other Non Bank Financial Institutions, which are not regulated entities, use tax havens as their corporate base, means that the checks and balances on them are deficient.
At the same time as Australia is examining its current regulatory model in protecting consumers, should it also be examining whether unregulated financial institutions have been used by transnational criminals to not only perpetuate crimes but to destabilize financial systems for their own advantage? Professor Broome, with a huge pedigree of publications in the areas of ethics and morality as applied to economics, agrees.
“It’s the holes in the tax system which really allows the profit from criminal activity in the markets to be moved offshore. We have to address both the problem of poor regulation and the major criminal activity within markets and also look at how much revenue is escaping our tax net.”
Moreover he also blames the sub prime crisis on bad banking practices:
“The sub prime loans were self evidently unsustainable. How could the experts running the major institutions which seemed to fund these get it so wrong? Stupidity, ignorance, greed or deliberate fraud? They made money with the knowledge that others would eventually take the ’hit’. Surely we need to exercise greater control over some of these participants. Most of the sub prime loans were sold to homeowners who could not afford the high rates when the honeymoon period finished. But the people who sold these got paid a commission up front. The solution is obvious. Don’t let mortgage brokers get their commissions up front. If the loan has to be maintained fro them to get their cut see how much more diligent the will be.”
For Australia where to now? Look at the saga of Rams. Floated in June 2007, by November Westpac had to take over the RAMS brand name, its 53 franchises, 92 stores, and all the new business RAMS as a rescue operation.
Broome attributes such fiascos as RAMS, Opes Prime, Westpoint, and other collapses or sell downs of listed non bank financial institutions to an incorrect regulatory model.
“When the ASX was given regulatory powers over the market under the Corporations Law it was because it was seen as a neutral player able to exercise some regulatory power. These powers might have otherwise gone to the ASC. Now it is a listed entity on its own exchange how can it be neutral? Doesn’t it now have a clear conflict of interest? It is in the exchanges interest fro the market to be perceived to be functioning well as this will increase its share price. Therefore it has an incentive NOT to take action to identify serious irregularities which might undermine confidence”.
Due to a poorly designed regulatory model will Australia squander its wealth and join the other mineral rich emerging nations in becoming a target for transnational crime? Or can we as an intelligent nation steer our financial architecture back on course to fulfill its true purpose?
Professor Broome must have the last word, having just attended a conference on this topic in London.
“I think there is a dawning realisation that there may be a lot more organised fraud and other types of illegal behaviour involved in the ‘sub prime crisis’ than we originally ever imagined. All of this is assisted by poor financial sector scrutiny of suspect transactions. It’s the holes in the tax system which really allows the profit from criminal activity in the markets to be moved offshore. We have to address both the problem of poor regulation and the major criminal activity within markets and also look at how much revenue is escaping our tax net.”