Those were the days... Scams define end of an era

The sub-prime fiasco was a pyramid scheme of its own, argues Thomas Friedman
Ronald Reagan is dead and Margaret Thatcher is a remote and, through advanced illness, a figure far removed from the world stage.
The revolution they jointly led in the ’80s of ever-advancing markets based on light regulation, easy credit, distrust of the state and unleashing of the “animal spirits” of capitalist accumulation have been discredited as the world faces the worst economic crisis since the Great Depression.
Perhaps it is no coincidence that the cardiac arrest suffered by world markets, including our own, since the collapse of Lehman Brothers on Wall Street last September has brought to light a series of mega-sized Ponzi schemes in the US and, more recently, in South Africa. The lure of easy, outsize pickings and staggeringly high rates of return explains the existence of pyramid schemes, such as those operated by Bernard Madoff, Allen Stanford and our own alleged Ponzi king, Barry Tannenbaum, now conveniently resident in Australia.
Ponzi schemes — named after the eponymous Italian immigrant to the US in the early 20th century who arbitraged the value of postage stamps — essentially pay back early investors with either the proceeds acquired from later investors or even with their own money. The scheme collapses and the fraud is finally revealed when people stop investing and there is no more loot to pay out the creditors. As author Michael Lewis explains, “something for nothing — it never loses its charm”.
Madoff, who apparently embezzled a staggering 50-billion from the rich and even banks and top charitable institutions, kept his operation going for over 30 years by offering consistently above-market rates of return, but not by such a wide margin as to attract either undue suspicion or to be unsustainable — until the unprecedented credit crunch last year caused a mass of withdrawals, which Madoff could not meet, since he had never invested most of the deposits originally received.
Tannenbaum, in contrast, is alleged to have lured hundreds of South African and overseas investors with the promise of a rate of return of between 90% and 200% per annum. Instead of postage stamps, his investors were invited to help buy active pharmaceutical ingredients (APIs), allegedly on behalf of South African drug-makers, and then shared in the proceeds of the profits when the APIs were sold to the drug companies.
The neatness of the scheme is that it fell outside the watch of the Financial Services Board. But when one creditor sought to recoup his investment, plus interest, well, the bird had flown the coop — and the personal cheques which Tannenbaum had issued were dishonoured.
These schemes usually involve high-level fraud, including cooking the books, and financial techniques to make actual losses look like bumper profits, or simply invent non-existent investments or sales. But the detail is less significant than the result. Not only are investors — the greedy, the gullible and innocent third parties — ruined, but the system itself gets discredited.
Last December, when the Madoff scandal broke, I was living temporarily in Washington DC. Two of the city’s most thoughtful commentators saw a much wider implication for the future of free enterprise.
Anne Applebaum described how difficult it was for her to acquire an apartment in Warsaw in the early ’90s — endless form-filling, visits to notaries and the seller requiring to be paid in hard currency and in cash. She described a culture of “low trust”, in which the market and its mechanisms are treated with suspicion.
In contrast, when she bought a car in Washington, she could drive it out of the showroom simply by providing a personal cheque, without any identification. It was this “high trust” culture, which both fuelled American capitalism and allowed its dark underside, in the form of Madoff and the like, to operate. As she put it, “Madoff’s pyramid scheme may have been made possible by our tradition of trust and lawfulness. And now he will bring that tradition down.”
Thomas Friedman was more damning. He saw in Madoff a scheme only slightly more outrageous than the “legal” one Wall Street was running, fuelled by easy credit, low standards and high greed. For him, the sub-prime fiasco was a pyramid scheme of its own: “What do you call giving a worker who makes 14000 a year, a nothing-down and nothing-to-pay-for-two-years mortgage to buy a 750000 home and then bundling that mortgage with hundreds of others into bonds that Moody’s or Standard & Poor’s rate AAA — and then selling them to banks and pension funds the world over. This is what the financial industry was doing. If that isn’t a pyramid scheme, what is?”
Friedman’s fury found an answer last week, when President Barack Obama produced plans for regulatory reform, including an expanded role for government. Clearly, the era of Reagan-Thatcher has ended. The age of exuberance has yielded to an era of control. Let’s just hope that the new medicine doesn’t amount to a treatment that kills the patient.


*Published Sunday Times 28 June 2009

The New Secretary of State

Washington’s worst-kept secret was made official on Monday. President-elect Barack Obama announced – from Chicago, that his one-time deadly rival, Senator Hillary Clinton would be the next US Secretary of State. The furious flurry of chatter and swirl of speculation which preceded the announcement gave way, after momentary pause, to a renewed flurry and swirl: was this a master-stroke of inclusivity? A case of inspanning of a “team of rivals” to borrow the title of a much-touted new book on the cabinet of Obama’s distinguished predecessor, Abraham Lincoln. Coincidentally, he also hailed from Illinois and like Obama, was a little-known Senator until his presidency, and the American Civil War which defined it, marked him out as an all-time great.
Or would the apparent enmity and distrust between Obama and Clinton, and the unfulfilled presidential ambitions of “Madam Secretary-elect” as we must now call her, doom the relationship?
The betting, at the moment, inclines to the masterstroke explanation. But the media immediately noted the apparent incongruity of this pick of the ultimate Washington insider by the man who promised to be the tribune of change. The simultaneous announcement of former NATO Commander and Marine Corps Commandant, General James L Jones, as Obama’s Security Adviser and his retention of President Bush’s Defence Secretary, the Republican Robert M Gates, means the untested President-Elect has surrounded himself with “two Cold War warriors” plus Clinton, all of whose records are far more hawkish than the liberal, change-oriented Obama.
Obama batted away the apparent contradiction (and his record of campaign disagreements with Clinton) by advising, “I’m a strong believer in strong debate and strong opinions”. Indeed to most, the selection signalled a president who is self-confident enough to surround himself with smart and capable people: a study in contrast to the incumbent Bush, whose moral certitude and the blind faith of his key advisers landed America (and the world) in many of its current travails.
Although Obama mocked Clinton during the campaign for a foreign policy resume obtained by osmosis through her presidential husband while First Lady, and chastised her judgement as a Senator for supporting Bush to go to war in Iraq, foreign opinion apparently reacted with optimism to her selection. In some circles this was not because of her record: during the primaries she warned that Iran risked “obliteration” in the event of nuclear attack in Israel – and also dismissed as “reckless and naive” her new boss’s plan to engage in talks with the dread Iranian leadership. She announced herself in favour of “coercive diplomacy” – whatever that might mean or entail.
But the global welcome to her appointment is attributable in part to her star power: “she’s a global brand”, gushed the New York Times. Even its waspish columnist, Maureen Dowd – a well-chronicled Hillary-hater – who had previously warned Obama not to pick Clinton as Vice President. (“She’ll put poison in your tea”, she wrote back in August) recanted. Last week she approvingly quoted another Clinton critic who concluded “she’s smart and tough and a lot better than any of those old hacks like Richard Holbrooke and Madeleine Albright.”
However, I think the real clue to the apparent American and world receptivity to Clinton’s new incarnation probably lies in the acronym “ABBC” (“Anything Is Better Than Bush and Co”). A senior Russian MP was quoted this week as saying, “the most important thing is not who is coming in, but who is leaving.”
But Hillary Clinton, star wattage and stellar intellect aside, is weighed down with a lot of baggage. I was advised at a recent dinner by a veteran of her husband’s administration that “most of it is carried by Bill”. My informant was scathing on the excesses of the soon-to-return Clinton soap opera: the paranoia, the infidelities, the leaks, the volcanic tantrums. All of this seemed ill suited to the discipline and thoughtfulness of the “No Drama Obama” regime. Globalisation guru and veteran foreign policy watcher, Thomas Friedman opined that if the relationship between the president and his secretary of state sours or becomes remote (as it became between the much-admired Colin Powell and President George W Bush) then “foreign leaders will spot the daylight between them from a thousand miles”. And here the “big dog”, as Bill Clinton has been dubbed by some, enters the frame. He practically has his own foreign policy apparatus: his global philanthropy foundation employs 800 people. He earns R100 million in speaking fees annually, many of which are apparently thinly-disguised influence-peddling events sponsored by doubtful foreign potentates. He also has 200 000 (actual number) donors to his presidential library whose identity have never been publicly disclosed. But at the time of Hillary Clinton’s nomination, it was mentioned that he received a $10 million gift from the Saudi Royal family.
No doubt the new administration will resolve these conflicts of interest. But a conflict of interest of a different sort potentially looms between the new administration in Washington and the next government in Pretoria. This is the hangover from Thabo Mbeki’s penchant for temporising with African tyrants. If this pattern persists going forward then the Union Buildings can expect a serious early collision with another appointee announced here on Monday. Susan Rice, a close Obama confidante has now been elevated, with cabinet status, to the US ambassadorship at the United Nations. In contrast to Mbeki’s shielding of the Sudanese dictator and oppressor Omar al-Bashir from indictment by the International Criminal Court, Rice is a vehement and committed adherent to using “America’s muscle to protect human rights in Africa.” When Jacob Zuma recently visited Washington I suggested to him that we should change course away from the Mbeki approach of “never meeting a dictator he didn’t like”. I hardly expect our wannabe president to accept my unsolicited counsel .But as South Africa’s rights-delinquent term of office on the Security Council is about to expire, Pretoria might have consideration for the fact that many key people in the new administration in Washington consider our performance there to be more befitting of a “rogue democracy”.

* Written for the Weekender, to be published 6 December 2008.

A view from Washington DC - Financial meltdown

Tuesday’s lunch with an old friend (of South Africa’s and mine), Walter Kannsteiner, former US Assistant Secretary of State for African Affairs, yielded a useful insider insight. Walter observed that Washington DC is “the only city in America where entrée to power is more important than access to money”.

Ironically, a stone’s throw away from our downtown restaurant a drama was underway that very afternoon, which saw the fusion of power and money in a scene unwitnessed here since the Great Depression. The CEO’s of the nine largest banks were in conclave in the marbled conference room of the Treasury Department. They were presented with a one-page document by Treasury Secretary Hank Paulson that said they agreed to sell shares in their banks to the Federal Government. According to the New York Times, Paulson told them they had to sign it before they left. They duly obliged. This part nationalization of the American banking system was seen by a clearly reluctant Paulson as the only key to unlocking what had become a global financial crisis headquartered in, but by no means confined to, America. His $250 billion bank recapitalisation scheme clearly stuck in his Republican craw. As he justified it afterward: “Government owning a stake at any private US company is objectionable to most Americans, me included. Yet, the alternative of leaving businesses and consumers without access to financing is totally unacceptable.”

What Paulson failed to disclose was how strenuously he had initially opposed the very step the markets forced him to take. Because by Friday of the preceding week ,the Dow industrial average had recorded its worst decline in a week, percentage wise, in its 112 year history. On that day alone, it lurched on a rollercoaster ride of more than a thousand points. Since J M Keynes has now elbowed out Milton Friedman as the reigning intellectual prophet here, Paulson no doubt decided that Keynesian adage: “when the facts change I change my mind” was the best philosophical straw to grasp.

Whatever the explanation for the turnaround, anticipation of the step had, by Monday, seen the Dow rebound by an extraordinary 936 points (11%), the largest single day-gain since, you guessed it, the Great Depression.

The one person, however, who was having no positive effect on market sentiment (and even less bounce, except of the dead-cat sort, on the fortunes of his fast-fading presidential standard bearer John McCain) was President Bush. Somewhat gleefully, Dana Milbank wrote in the Washington Post that “for the twentieth time in recent days Bush tried to calm the markets. The previous nineteen times the markets ignored him and continued their downward plunge, and this time would be no different.” The columnist was referring to Bush’s Rose Garden speech last Friday when the President said “the American people can be confident on our economic future”. A few minutes later, 300 points were shaved off the Dow.

Given the distrust, and ineffectiveness of the political classes around here, it seemed a better bet to soak some wisdom from the intellectual sponge of the globalization guru, Thomas L. Friedman (author of the award-winning “The World is Flat”). I went to hear him speak at the Washington launch of his new work, “Hot, Flat and Crowded”, a critical look at the unsustainability of a rising world population coupled with global energy demands and the destruction of our biodiversity.

But Freidman wasn’t simply interesting on the convergence of global warming, global flattening and global crowding. He was also apt on the current financial crisis. As he put it, “in some ways we‘ve become a subprime nation that thinks it can just borrow its way to prosperity – putting nothing down and making no payments for two years. Subprime lenders told us we could have the American dream – a home of our own – without the discipline or sacrifice that home-ownership requires”. A welter of evidence supports his thesis: Since the 1980s, Americans have consumed more than they produced but made up the difference by borrowing. (South Africans, incidentally, do precisely the same – only in America, like the food, it’s all super-sized).

Two decades of easy money and innovative financial products (including the dark and unfathomable ones like the derivatives that caused all the trouble) has seen household debt balloon in this country from $680 billion in 1974 to $14 trillion today. And the government has mirrored (or led) the consumer trend by ringing up a budget deficit of $454 billion in the current financial year. Freidman noted that the worst message Bush sent out after 9/11 was to tell Americans, immediately after that disaster, to “go shopping”. A nation addicted to consumption, not saving, hardly needed any presidential encouragement.

Instead of retail therapy, a much better strategy, he suggests, would have been to promote investment in energy efficiency, cut America’s dependence on energy-guzzling fossil fuels and the “petro- dictatorships” on which American oil imports depend.

Understandably, various American doomsayers have triumphalised about “a shattering moment of America’s fall from power”, to quote the Guardian of London. But its ideological opposite, the Wall Street Journal, suggests that despite current travails, America will remain a superpower. Two figures were striking in their analysis: its staggeringly large bailout of nearly a trillion dollars constitutes only 5% of U.S. Gross Domestic Product (whereas Britain’s slightly more expensive version amounts to a whopping 30% of its GDP). And last week’s historic plunge in the Dow still meant that the U.S. bourse outperformed nearly every single major stock exchange throughout the world, from Germany to China.

As the old Nedbank advert used to say, “It makes you think, doesn’t it?”