SKY Can Pay For NZ On Air

I don’t think SKY should be regulated because of the enormous alternative sources of TV available to anyone with broadband and a torrent client.

I’m also not a fan of direct regulation like making SKY offer individual channel selection so people don’t have do buy a basic package if they only want to watch the rugby.

But all monopolies eventually attract the attention of regulators. When the National government eventually exits, SKY regulation is definitely on the cards.

When regulators see a big monopoly, they act almost out of a compulsion to justify their existence.

One of the concerns about massive media companies is the difficulty of funding public broadcasting because a lot of great content has lower commercial value and small audiences.

The truth is a lot of public broadcasting is rubbish, but the diamonds in the rough are worth the trouble of maintaining public funding of music, television and radio.

When the SKY regulation negotiations begin, offer them the opportunity to underwrite part of NZ On Air in exchange for less aggressive regulation.

That way two birds are killed with one stone. According to the NZ On Air Annual Report their funding expenditure in 2011 was $130 million.

SKY obviously can’t underwrite all of that, that would be ridiculous. But for each commitment to more public broadcasting funding, they can get less regulation.

The current “hands off” policy taken by the National government ignores the opportunity for a quick win. Even SKY subscribers don’t like SKY and moan about the lack of quality content and how everything good is on SOHO all the time.

I’m not going to talk about how SKY needs to earn a return for the network it has built. It clearly is recovering the cost of building a network. This isn’t about SKY making money, it’s about shifting a chunk of government expenditure to an industry that consistently lowers the quality of broadcasting content.

Red Flags And Ross Asset Management

The report by High Court appointed receivers PWC regarding Ross Asset Management makes for sober reading. In the wake of several ponzi schemes being uncovered as the global financial crisis led to more withdrawals than contributions, we have to think carefully about the enormous red flags that presented themselves when it came to Ross Asset Management.

Brian Gaynor wrote in the Herald:

Investors deposited funds with RAM, assets were purchased and sold on their behalf and held by RAM. The investment performance of these funds was reported by RAM without any independent verification or audit. RAM clients had their own individual portfolio and, as a consequence, could have widely differing investment returns.

As he notes, this was exactly the same structure employed by Bernie Madoff. The cash flowed into a single account and back out again when withdrawals were requested. The PWC receivers have identified just $10.2 million out of a supposed $449.6 million in assets under management. The cash flow analysis in the PWC report makes for sobering reading.

When you think about due diligence on potential investments, the Ross Asset Management proposition sets off multiple sirens. The lack of independent verification of returns, the use of an accountant who shared the same address as the firm, the absence of an independent custodian and maintenance of client records in a single Access database are just the tip of the iceberg.

There was quite a disturbing interview on Radio New Zealand where the poor lady involved had all of her savings with David Ross. It is clear that Ross Asset Management was operating on the down low, relying on referrals and word of mouth.

With the high average account balance of around $500,000 many investors would have been wholesale investors / accredited investors. That means lower disclosure is required and filing prospectuses with the FMA isn’t necessary.

It’s clear that having $500,000 to invest is not sufficient evidence of an ability to manage your own wealth. An enormous amount of reading and careful thinking needs to be done before writing a cheque to anyone – let alone to an asset management firm that operated completely outside standard practice.

Since the collapse of MF Global it has been clear that you are an unsecured creditor to any investment firm you have an account with. Every single dollar of your wealth is at risk – your term deposit, your bonds, your shares, your derivatives trades – they all require ongoing monitoring and tough questions being asked of the people you’re dealing with.

When the most clued up fund managers in the world regularly clear different types of trades through different prime brokers to reduce the counter-party risk involved, that’s a clear signal to ordinary investors that breaking up where you put your money is the bare minimum of risk reduction you can do.

I am surprised that accountants performing the foreign investment fund tax calculations for investors in Ross Asset Management didn’t double check shareholdings via the registry. How could you file accurate tax returns reporting foreign capital gains and dividends without double checking the relevant share registries?

I will follow the development of this case with interest. Because Mr Ross was an “Authorised Financial Advisor”, it will be interesting to see whether more background investigation will be conducted to see if other AFAs are running investment funds of this magnitude on the side and outside the regulatory framework the FMA oversees.


Book Review: The Alchemy Of Finance by George Soros

I’ve read a lot of investment books that make some attempt at justifying a particular theory as to why markets perform the way they do and why some investors perform above and beyond what probability would lead us to believe in the long run. Legendary hedge fund manager George Soros is best known for making billions of dollars betting against the British Pound when it foolishly tried to stay in the EMS in the early 1990’s. But unlike some commentators who vilify the likes of Soros for “making money off the back’s of taxpayers”, I recognise the reality of what his type of speculation does. It provides a clear signal to policymakers that they are doing something stupid.

Without the speculators of this world, economic policy could be conducted in a vacuum without any critical feedback in the form of prices and interest rates. Measuring risk would be far more difficult and the world would stumble towards Soviet-style committees deciding on exchange rates and interest rates. We all know how that ended and we all know that New Zealand’s attempt to fix our exchange rate lead to a currency crisis so severe it ran down foreign exchange reserves to near zero, necessitating a float in 1984.

In The Alchemy of Finance, George Soros describes his theory of reflexivity. It was what he attempted to write his PhD on, but the theory was tested in the way he applied it to the financial markets. The central thrust of the theory is that market participants are biased. As opposed to making consistently rational investment decisions, market participants jump on trends in a self-reinforcing and self-fulfilling manner. As opposed to trending towards equilibrium, the financial markets perform in line with the biased expectations of the participants.

He argues that the more people who believe in the efficient markets hypothesis, the less stable financial markets will actually be. Some of his comments with respect to groupthink are very prescient when we think about what happened in the sub-prime mortgage boom.

He disagrees with the idea that markets trend towards equilibrium. He rails against the theory of perfect competition, arguing that imperfect knowledge is almost always the case. In fact, he argues that based on his observations in the financial markets that they tend towards excess as opposed to any form of reality-based valuation.

He uses the rise of conglomerates in the 1970’s to illustrate that executives started creating conglomerates simply because other companies were and because the price/earnings multiples for conglomerates were rising faster than other categories of stock. By jumping on the trend they could raise their share price and earn higher performance bonuses. (1970’s executive earnings were several standard deviations below the obscenities of today). Eventually the conglomerates over-extended and suffered major losses. Up until that point no one took a step back and thought about things. They merely jumped on the trend.

There is also a highly relevant discussion of the international lending boom in the late 1970’s and early 1980’s which culminated in bank failures and the need for a centrally planned response. Arguments of “too big to fail” were being made back then, so leopards don’t change their spots. Banks segued from international lending to bridge loans or junk bonds that fuelled the merger mania of the 1980’s. Until the 1986 Tax Reform Act they also piled into real estate.

Soros argues that regulators are always one step behind the private sector. He believes that loose accounting requirements around recognition of bad debts have simply enabled banks to keep on keeping on when many should have been liquidated a long time ago because they are actually insolvent.

Soros also includes an interesting prediction that Japan will take over the world. The things he talks about – high ownership of US debt, high savings rate, growth, powerful export sector and cultural differences – are very similar to arguments currently made about China. It is clear that while Japan is still an economic superpower, it is not the major force it once was.

From this we can infer that making long term predictions about who will “take over the world” economically is extremely difficult. The thing that stood out to me throughout this book was that many of the situations Soros writes about were happening in the 1970’s and 1980’s. Yet they are analogous to what’s happening right now.

He outlines two interesting things at the end of the book – an argument for a World Bank financed through an oil buffer supply system and for an international currency with an international central bank. He thinks the actions of the G5 meeting at the Plaza Hotel as being key to saving global trade, and seemed frustrated that the German government eventually moved away from close co-operation between central banks.

The book is definitely not a light read. But if you are interested in the opinion of one of the most accomplished speculators on how financial markets actually function as opposed to academic claptrap, The Alchemy of Finance is a good a place as any to begin.

Book Review : Too Good To Be True By Erin Arvedlund

“What do you mean he’s been arrested?” she screamed. “But that’s where all our money is!” – Ellen Jaffe, wife of Madoff agent Robert Jaffe.

The central theme of the Bernard Madoff affair is that you can only trust yourself with your money. You cannot rely on personal relationships, cultural ties, regulation, due diligence, the historical relationship of your family with the asset manager or any other reason. You simply must conduct ongoing due diligence of every asset class you are exposed to and the “professionals” that you deal with.

A track record of solid performance doesn’t mean that your investments are safe or even being managed properly. There is always a risk of fraud or misappropriation if the correct procedures aren’t being followed with your money. Arvedlund describes in detail how all of the investments in Mr Madoff’s fund went to one JP Morgan Chase checking account. Billions of dollars flowed in and out, with nothing ever being done about it.

In Too Good To Be True Erin Arvedlund presents a detailed story of how Bernard Madoff exploited cultural ties and the need to feel special in order to run a ponzi scheme that could have started as early as the 1987 stockmarket crash. A successful market maker on Wall Street and well known in regulatory circles, Madoff cynically leveraged his ties to regulators and several failed SEC investigations as “proof positive” that his “split-strike options strategy” was legitimate.

The fraud also played on Jewish ties – country clubs with predominantly Jewish members, Jewish social circles, Jewish foundations and university endowments. Working class Jews were also targeted through lower level agents and referrals from Madoff employees themselves. Holocaust survivors like Elie Wiesel lost money. Absolutely sociopathic abuse of cultural ties on the part of Madoff.

 “Recessions catch what the auditors miss” – John Kenneth Galbraith

In 2008 the global financial crisis begun. Because of Madoff’s reputation for quickly returning customer money, he was flooded with almost $7 billion in redemptions towards the end of 2008. He didn’t have enough cash on hand and couldn’t raise any more money from the feeder funds who raised money for him.

Through telling his sons and pleading guilty, he avoided a trial. He also avoided a lot of the arcane but interesting details being brought to light. Arvedlund expounds on the network of feeder funds and how they worked. In exchange for a management fee and performance fee, these funds trawled the charity ball circuit and wealthy social circles for new investors. They then wired their money to Bernard Madoff. The people who earned commissions from Madoff lived lavish lives of luxury and didn’t ask too many questions – they simply couldn’t go back to the way they lived before the Madoff kickbacks.

Investors received regular but not excessive returns. It is clear that some investors had “returns to order” produced where they could invent losses in their Madoff accounts to offset their tax bills. When people asked questions Madoff always had an answer at hand. When Madoff investors were confronted by other people in the financial industry about the impossibility of Madoff’s consistent returns they ignored the suggestion that they remove money from their Madoff investments. It simply was “too good to be true”.

There is a sort of schadenfreude about the Madoff affair. The trustee Irving Picard is analogous to Breeden in the Conrad Black case. He is making millions of dollars managing the recovery of assets for investors. Some investors stand to receive more back than they initially invested in Madoff because their other investments have performed dismally during the global financial crisis. Ignoring opportunity costs and taxes paid on fictitious returns, it is estimated that at least half of Madoff’s investors will lose no capital.

Bernard Madoff played on our need to feel special, like we are one of the elite. By making it hard to invest in his fund he created an air of exclusivity that made otherwise sophisticated investors act like teenagers not invited to a house party. The need to perform extreme levels of due diligence before investing in anything is another central theme running through the book.

We will never know the true story of the Bernard Madoff affair. We will never know with certainty that all of the assets have been recovered and investors made whole. But some extremely arrogant people had their wings clipped by the collapse of Madoff. This is a good thing in the long-run and why arguments about taxing inherited wealth don’t make sense.

If investors in Madoff had stuck to the rules and not thought that they were better than the great unwashed with their special investment relationship with “Bernie” they wouldn’t have needed to sell their apartments and Palm Beach winter homes. They could have kept their NetJets fractional shares and American Express bills in the six figures.

The investors I feel slightly sorry for are the usual dupes – the “mum and dad” types who invested on the recommendation of friends and family. They never win in the financial markets because they are like people going to the sales without being able to tell a horses rear from its ears. As I’ve written before, they shouldn’t try and invest at all because it always ends in tears.

Relying purely on regulators as a risk reduction strategy as a success rate approaching 0% as evidenced by:

  • finance companies and the Securities Commission
  • the NZX, auditors and the Feltex IPO
  • Bernard Madoff and the SEC
  • Ratings agencies and mortgage backed securities being rated AAA

The book doesn’t touch on the reality that any investment fund can experience a run at any point in time. If all the investors want to withdraw their money, the fund won’t necessarily have liquid assets to cover the redemptions. It’s like a run on a bank, only investment fund’s will quickly sell off their assets to meet redemption requests. This will depress the value of the investor’s accounts even further.

I have followed the Bernard Madoff story closely. So far, billions of dollars has been recovered and due to the “net winners and net losers” calculation, many investors will actually get all of their money back. For sure, this is without interest and with considerable stress. But I’d wager it’s a better return than they would have got investing in some other asset classes since 2008.

If you like reading about the human side of how these schemes work, I’d definitely recommend checking this book out. It’s yet another cautionary tale about taking everything you read or hear with a grain of salt and pursuing a skeptical line of inquiry into the reality of the situation.

Book Review: A Matter Of Principle By Conrad Black

A Matter Of Principle By Conrad Black

My interest in the Conrad Black case was sparked by an article that appeared last year in Vanity Fair. I quickly forgot it, but when the disgraceful interview conducted by Jeremy Paxman appeared on my YouTube recommended list I was keen to explore the Conrad Black case in more detail. Jeremy Paxman was completely uninformed and came across as a numpty.

According to the initial trial by media, Conrad Black was an entitled, pompous corporate thief in the vein of Kenneth Lay or Dennis Kozwolski. He had stolen hundreds of millions of dollars from shareholders and deserved a life sentence in US prison whilst forfeiting all of his worldly possession.

While you have to take the words of a convicted “criminal” with some caution, the case of Conrad Black and the availability of court judgments on the internet enable the reader to perform “due diligence” on the case he makes for his innocence.

At first skeptical, I am now convinced that he was the victim of a terrible persecution. It all started when a non-shareholder and former SEC chairman Richard Breeden filed a 13D form with the SEC.

It set in motion a series of events where people who had no business interfering in the private affairs of Hollinger were able to cause shareholder losses of more than US$2 billion dollars.

These hangers-on even paid themselves millions of dollars with Hollinger’s money after taking it hostage. Tens of millions of dollars was wasted on high priced lawyers who couldn’t do much more than demand payment in advance from Conrad Black and his fellow defendants.

The corporate governance crew were able to greenmail, bully and intimidate the other directors into allowing a full-blown investigation of Conrad Black and his business partner David Radler’s “wrongdoing”. They included a former Chairman of the SEC and numerous powerful lawyers who cared more about getting paid than getting to the bottom of whether or not fraud had been committed.

It turned out David Radler really was a crook. He took the coward’s way out with plea bargain, serving up Conrad Black on a platter. The actual turn of events, which can be independently verified with a few hours Google searching, was completely different from the Murdoch media narrative.

Conrad Black very clearly sets out how the plea bargain process works – in exchange for false testimony, you can bargain with the prosecutors to save your own skin. In terms of game theory it makes perfect sense. For non-sociopaths it is morally repugnant behaviour.

One of the reasons that Conrad Black was so misrepresented in the media was that he refused to plea bargain with the US Justice behemoth.
For his insolence, the FBI seized the proceeds of a New York apartment sale. They had no claim to it but stopped $10 million from going to his defence lawyers.

Although convicted on “honest services” grounds and for obstruction of justice, Conrad Black didn’t back down. His appeal to the Supreme Court led to the “honest services” clause being struck out and very stern comments on how the original judge should review his reasoning in the case.

The author of the “honest services” conviction was Richard Posner of the Chicago 7th Circuit Court of Appeal. Black rails against Posner’s megalomania and refers to his reputation on the bench for a lack of attention to detail.

The case against Conrad Black had shrunk from an enormous alleged fraud to a handful of technicalities. But despite the Supreme Court effectively overturning his convictions, Posner ignored them and issued another judgment that still incorporated the unconstitutional “honest services” nonsense.

In order to save face for the US Department of Justice, the SEC and the greenmail corporate governance activists his sentence in Federal prison was reduced to 42 months in 2010. He had to serve another 7 and a half months before he could be released.

His time in prison wasn’t completely in vain. In this book Conrad Black clearly explains how US justice is not justice at all. He rails against the plea bargaining system, civil asset forfeiture, intimidation of witnesses and the implausibly high success rate of US prosecutors.

He talks about how upskilling in prisons is non-existent, why there are major incentives for prison populations to keep on growing and with his signature style mounts a convincing argument that the entire US justice system now operates on the basis of “guilty until proven innocent”.

If Conrad Black was not a multi-millionaire with the willingness to fight and the financial capacity to do so, he was facing a life sentence for a vendetta by corporate governance greenmailers.

The cost of this injustice has been the destruction of a career, the destruction of more than $2 billion in shareholder wealth and the enormous cost incurred by the SEC, DoJ and FBI in hounding Conrad Black for almost a decade.

This book completely altered my thinking on the role that corporate governance plays in public companies. The ability for an outsider to essentially hold an entire company hostage and bill it for the privilege shocks me.

The real world evidence of regulatory capture, rent seeking, miscarriage of justice, abuse of due process, judicial over-reach and a whole plethora of other abuses makes A Matter Of Principle a solid read for anyone interested in how the US justice system can pummel even an entrenched member of the 1%.

Leaky Homes Fiasco and FAP

The multi-billion dollar assistance scheme for leaky home victims is called the Financial Assistance Package.

It is clear no one at MoBIE realises how funny this is.

Mr Rainey asked the Ministry of Business, Innovation and Employment for details of FAP payouts, and was shocked to discover that although 1232 victims had lodged expressions of interest by the end of September:

Only 186 homeowner agreements had been finalised by the claimants and the ministry.

35 claims were proceeding, of which 31 had received one or more contribution payments.

Only 12 had received their final payments.

The FAP scheme, started last year, is a joint Government and local council plan to help people avoid having to sue and to enable them to get their houses fixed.

Are the government having a laugh with respect to leaky home owners getting assistance? Or do they really want them to just have a FAP?

The leaky buildings fiasco is one of the worst indictments of regulatory failure in the developed world. The ongoing cost that ratepayers and taxpayers will have to bear while culpable builders and industry executives waltz off into the sunset is appalling.

It is not a good thing that billions of dollars has to be spent fixing what should have been built properly in the first place. Anyone thinking that the rebuilding process will “save the construction industry” should read up on “The Broken Window Fallacy”.

The leaky homes fiasco represents billions of dollars in lost potential investment in higher productivity. It’s a major drain on the construction sector and with some homeowners saddled with hundreds of thousands of dollars worth of rebuilding expenses, a major drain on private sector consumption and saving.

NB: For those of you unaware of the meaning of “FAP” it’s a NSFW image search.

Bring Back The Bookies

It’s never hard to find a government agency wanting to rain on someone’s parade. The news that office sweepstakes on the Melbourne Cup could attract a $1,000 fine from the Department of Internal Affairs almost made me spit out my coffee this morning.

However, the Department of Internal Affairs warns that office sweepstake prize money cannot exceed $500 and those who breach the rules could face the long arm of the law.

This means tickets for the 24-horse race can cost no more than $20.83, according to a spokesman.

Any money raised must be returned as prizes and no one is allowed to profit from organising the sweepstake.

Violating these regulations could incur a fine of up to $1000.


Has the Department of Internal Affairs ever considered that regulating gambling simply raises the cost of “problem gambling”?

Most Melbourne Cup office sweepstakes are an innocent little flutter. They have nothing in common with feeding $500 into a poker machine or spending all night playing blackjack without an edge.

The lower level of competition in the gaming industry means that occasional gamblers will look towards alternative options, including office sweepstakes. If it’s easier to organise an office sweepstake than go down to the TAB it means the odds at the TAB either aren’t good enough or aren’t advertised well enough for occasional gamblers.

By cracking down on naughty middle class office sweepstakes the Department of Internal Affairs is not only propping up the NZ Racing Board monopoly but raising the cost of gambling – more competition in gambling would lead to more competitive odds and thus lower the cost of gambling alongside lowering the cost of problem gambling.

It is also amusing that the Department of Internal Affairs has never considered the level of the fine. If the fine is only $1,000 that’s hardly an incentive against running an office sweepstake with prizes of greater than $500. If the expected profits to the promoter are greater than that, with a low probability that a random Internal Affairs inspector shows up, then it’s a rational crime under Gary Becker’s model.

I wish that New Zealand would bring back the bookies. The impersonal nature of online betting through the TAB is nowhere near as enjoyable as going to the races in Aussie and having a yarn with a quick witted bookie at Randwick or Rosehill Gardens. Who would bother with an office sweepstake when you can go to a race day event with a proper bookie?