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

Circling back to Tiananmen Square in a failing western light

A VOGUE word now in play is “decoupling”. It is shorthand for the view that China, and other emerging markets, will be the economic locomotives to pull the world through the global economic recession — the worst on record since the Great Depression of the 1930s.
The markets certainly reflect this sentiment: last month, for example the FTSE emerging markets index outperformed the developed markets index by 48,8%. Hard statistics support the disposition of the bourses. For example, China’s aggressive domestic stimulus saw its purchasing managers index surge above 50 , suggesting that almost alone, of the significant economies, it was enjoying growth while the world, especially the west, contracts. The equivalent index in the US measured 42,8 , while SA posted just 37,3 . Little wonder Goldman Sachs is predicting more than 8% gross domestic product (GDP) growth for China. Its extraordinarily low levels of household spending (less than 33% of GDP, about half SA’s, and a third of the US ), and its accumulation of more than 200bn in foreign reserves, suggest it has room for manoeuvre and expansion, denied to the overborrowed, underperforming developed economies.
Last week saw another instance of decoupling. Last Saturday, the Allied leaders of the US, Britain, France and Russia gathered in Normandy to mark the 65th anniversary of the D-Day landings in nearby Colville-Sur-Mer. History records this event as the decisive moment of Europe’s liberation from the Nazis. Two days before that, last Thursday, another anniversary was commemorated, or more accurately smothered at the site of its occurrence, the marking of 20 years since the Tiananmen Square massacre in Beijing.
While the events and outcome of the Second World War are beyond contestation, the import and consequence of Tiananmen Square remain contested. No figures have ever been released of the number of protesters shot and killed by Chinese soldiers on June 4 1989 — the figures range from hundreds to over 2500. In any event, the square itself was closed last Thursday — and Chinese officials erected what one wag called “the Great Firewall of China”, blocking internet sites, the BBC, and even the anodyne CNN, alongside Twitter, from informing the Chinese of the epic events of two decades ago, when student protestors confronted the fist of Chinese authoritarianism.
However, decoupling applies within China as well: the enclave of Hong Kong, which under its basic law enjoys civil liberties denied to the mainland, allowed hundreds of thousands of protesters to hold a candlelit vigil.
But 1989, the year of Tiananmen Square, was reckoned at the time to be a unique moment, the arrival of unipolarity, not decoupling. The fall of the Berlin Wall, the end of the Cold War and, here at home, the ascendancy of FW de Klerk and his reform agenda were famously — or fatuously — described by Francis Fukuyama as “the end of history”. The liberal, or Washington, economic and political consensus appeared ascendant and unchallengeable.
But China, and far less successfully Russia, challenged that consensus by adopting what Israeli academic Azar Gat describes as “authoritarian capitalism”. By shifting their economies from communism to capitalism, they switched to a “far more efficient brand of authoritarianism”. Ironically, the two defeated powers of the Second World War, Japan and Germany, with far smaller economies and with incomparably worse predations of human rights, had attempted something similar, and failed. But the ability of the west, in the wake of the current financial crisis, to continue to define and influence the course of economic and democratic events has been damaged. Globalisation guru Martin Wolf suggests that “the collapse of the western financial system, while China flourishes, marks a humiliating end to the unipolar moment”.
Last week, the New York Times thundered: “Beijing may be able to repress the memory of Tiananmen, but the yearning for freedom remains.” But, in fact, a number of influential commentators, who acknowledge the suppression of freedom, question this assumption. And it’s not simply the fact that, according to the World Bank, Chinese economic growth and planning have seen the fastest reduction of people living in absolute poverty in recent economic history, accounting for over 75% of the developing world’s total. James Kunge, who witnessed the events of 20 years ago, wrote in the Financial Times last week: “In a world of moral fluidity, Tiananmen is a gratifyingly fixed reference for our judgment of others... (but) I question the western assumption that the demonstrators were ‘pro-democracy’. The reality was less coherent.”
Perhaps in 20 years’ time, on the 40th anniversary of Tiananmen and the 85th commemoration of D-Day, we will know just how ascendant the Chinese alternative to liberal democratic capitalism has become.

*Published Friday 2 June 2009 in Business Day