I have just read Daniel Amman’s excellent biography of Marc Rich - the oil trader notoriously pardoned by Bill Clinton. I don’t want to get into the politics and ethics of the pardon other than to note that few things in it are black-and-white when you finished reading the book.
But the way Marc Rich made his money is fascinating and says a lot about the current re-regulation debate.
Marc Rich exploited price fixing/import/export controls to make simply unbelievable profits trading oil. Marc Rich & Co (the Swiss vehicle) was started with just over $1 million in capital and a couple of years later was making in excess of $200 million in profit. This level of profitability exceeds - by far - any other trading operation I have ever seen - and was probably the most profitable trading operation in history. Marc Rich & Co (since renamed Glencore) is possibly the most valuable business in Switzerland within the lifetime of its founder.
A typical Marc Rich & Co trade involved Iran (under the Shah), Israel, Communist Albania and Fascist Spain. The Shah needed a path to export oil probably produced in excess of OPEC quotas and one which was unaudited and hence could be skimmed to support the Shah’s personal fortune. Israel - a pariah state in the Middle East - wanted oil. Spain had rising oil demand and limited foreign currency but was happy to buy oil (slightly) on the cheap. Spain however did not recognise Israel and hence would not buy oil from Israel - so it needed to be washed through a third country. Albania openly traded with both Israel and Spain. Oh, and there is an old oil pipeline which goes from Iran through Israel to the sea.
So what is the deal? The Shah sells his non-quota oil down the pipeline through Israel and skims his take of the proceeds. Israel skim their take of the oil. Someone doing lading and unlading in Albania gets their take and hence make it - from the Spanish perspective - Albanian, not Israeli oil. The Spanish ask few questions. The margins are mouth-watering - and they all come from giving people what they really want rather than what they say they want. We know what the Shah wanted (folding stuff). We know what Israel wanted (oil). We know what Spain wanted (cheap oil). Who cares that Spain was publicly spouting anti-Israel rhetoric. [Similar trades allowed South Africa to break the anti-Apartheid trade embargoes.]
It also helped that Marc Rich & Co was a (highly) multilingual firm. Rich is fluent in Spanish (it is the language he talks to his children in). He speaks English, German, Yiddish and presumably Hebrew. His business partner (Pincus Green - pardoned the same day as Rich) speaks Farsi amongst many other languages. They could do this deal because they could negotiate it and - deep in their heart they hold the Ayn Rand view that trade is a moral virtue and hence they do not need to be concerned with other morality. [The only line that matters is the law - and then it might not be the law of his adopted country - Switzerland - rather than the United States where he was resident.]
And when the Shah fell? Oh well - Pincus Green - an American Jewish businessman - gets on the plane to Iran and does a similar deal with the Mullahs - who - despite their rhetoric will sell oil down a pipeline through Israel - and will allow Israel to skim their take. Trading through the American embargo - well that is just another instance of getting around restrictions and profiting (very) handsomely. [Rich would argue that the trades were done by the Swiss company which was not subject to the American restrictions.]
The regulatory regime for domestic American oil was also perverse. Old oil (meaning wells drilled before the first oil crisis) received one price. New oil (wells drilled after the crisis) received a higher price. Squeeze oil (oil that was extracted from wells that ran less than 10 barrels per day) received a higher price still. The oil could be chemically identical and the price difference over $20 per barrel. Obviously a trader with a method (any method) of changing the oil source could make a fortune. Again I am not commenting on legality or morality. That was just plain fact. Ayn Rand applies - you give a value and you receive a value.
What all this regulation did was that it allowed people to make simply grotesque profits by thwarting regulation. The regulation thus worked less well and it was socially unfair. Pincus Green was good at negotiating in Farsi. He was astoundingly brave going to Iran immediately after the Shah fell. He was good at organising shipping. He worked really hard - but he did not invent something that changed the world and he wound up a billionaire. Traders make money by intermediating real business solutions - but these were real business solutions to problems made by legislation. Bad regulation, moral indignation about “trading with the enemy” or “trading with Israel” or with racists in South Africa made people with Ayn Rand morals exceedingly wealthy because you could arbitrage your way around any of these regulations.
If you read the Marc Rich book you will understand why lots of people who were generally left-of-center became ardent deregulation advocates. Plenty written by Krugman look like it advocates deregulation. (Not convinced: see his review of Laura Tyson’s book on trade theory in Pop Internationalism. Indeed see most of Pop Internationalism as favorably reviewed by - of all people - the Cato institute.)
Crank forward to the current crisis: what we see are the problems of deregulation and complexity. We see traders and investment bankers who get rich - not as rich as Marc Rich and Pincus Green - but still frighteningly rich. And they get there by taking risks that are ultimately absorbed by taxpayers or mutual fund holders (particularly taxpayers). We see agency problems everywhere - where management enrich themselves at the expense of others - and they do so by capturing upside but (in part) socializing the downside. Regulation in this case is about controlling agency problems - about stopping people privatizing the profit and socializing the losses.
As a plea then I want a debate about the right form of regulation - a regulation that controls agency problems but does not allow arbitrage opportunities to people with “Ayn Rand morals”.
We are not going to get that from the current Tea Party Republicans. They simply argue that regulation (they say but do not mean all regulation) impinges on “freedom” (something that is clearly a good but hard to define). However many of the same people want planning regulations to ban a mosque in downtown New York because it is an insult to the victims of 9/11 (and banning mosques is not a restriction on “freedom”).
If that is the level of debate we are not going to get good re-regulation - we are just going to get pandering to whichever lobby group manages to garner most support. And that is a real risk because we will leave agency problems in place (they benefit the rich and powerful) and we will introduce the same sort of (dumb) regulation that made Marc Rich and Pincus Green astoundingly wealthy. That sort of regulation also benefits the rich and powerful - especially those with “Ayn Rand morals”. [The rich and powerful - if you have not noticed - are good lobbyists. Unless we are careful many amongst them will get their way.]
I don’t know how to do this well - but I thought I would state the obvious. The most obvious things that need regulation are things with a government guarantee (implicit or explicit). If you have an implicit guarantee (as we now know almost all large financial institutions have) then regulation really matters. If there are large agency problems (small shareholders, large management) then regulation should be deliberately biased to put power in the hands of shareholders not managers (eg banning staggered board elections).
Likewise other agency problems should be strongly policed and the regulation should be of the form that allows that policing. When Elliot Spitzer found that Marsh - a large insurance broker - was participating in bid rigging against schools buying insurance that was shocking - and is precisely the sort of thing in financial markets that should be policed strongly. But it took Elliot considerable effort to find and prove his case. The rules should be established so that sort of behaviour is really difficult to hide.
And I do not think that I need to explain to anyone how much mortgage brokers contributed to the crisis by (a) deliberately misleading borrowers about conditions on their mortgage and (b) participating in the faking of borrowers income/assets/education level when they on-sold the loans to Wall Street. Agency problems were at the core of the crisis.
On the other side if there is no agency problem then deregulation should remain the order of the day. Trade restrictions create arbitrageurs - and the arbitrageurs ensure the trade restrictions don’t work anyway.
There are obviously going to be extensions to this rough rule - and this post is really to garner discussion. But for a start I expect agents who benefit from their agency (and the abuse of their agency) to join the Tea Party.
It is difficult to get policy right. And when and if the policy is got right we are in for a very long fight to implement it.