Tantamount to financial terrorism

Neil Barnett

26 April 2008

Neil Barnett says hedge funds should be forced to reveal their trading secrets, to deter them from the kind of market manipulation that has recently hit Icelandic banks

You sport a huge beard and a towel on your head and in the name of Allah you try to bring down the computer infrastructure on which the world depends. You are, in contemporary argot, a ‘cyber-terrorist’. You wear a button-down shirt and chinos, and in the name of turning a profit you deliberately set out to wreck a pillar of the financial system, or a country’s economy. In this case you are, it appears, a ‘market manipulator’. Can you spot the difference? Aside from motive, little separates the two: one wants to create a global caliphate, the other to make billions, but neither employs violence and both are indifferent to the chaos they cause. Is it time for hedge-fund managers to be subjected to extreme rendition from their Mayfair offices? Alas probably not, but the case for some equally firm application of justice is compelling.

Take the Icelandic crisis earlier this month. The frozen island in the north Atlantic undoubtedly has a puzzling economy. Once almost entirely based on fish, it has been enjoying a boom that brought with it a high current-account deficit and high inflation; and Iceland must surely lead the world in Range Rovers per capita. Its three leading banks are famous for their aggressive expansion and relatively heavy reliance on market funding rather than retail deposits — something superficially reminiscent of the dreaded Northern Rock. The banks’ assets are a vast eight times Iceland’s GDP, yet they are in some respects conservative, apparently avoiding, for example, the dodgy debt instruments that have caused so much trouble elsewhere. The overall picture has the elliptical and sometimes gnomic quality of the lyrics of that most famous of modern Icelandic exports, Björk.

Such obscurity provides the perfect grounds for market manipulation in tandem with short selling. For the uninitiated, this phenomenon allows institutions to take negative positions on stocks or currency; the more they fall, the more you profit. The value of the technique usually lies in its use as a hedge against risk — a means of minimising losses or maximising profits whichever way the market goes. Shorting is in itself a legal and long-accepted market activity. Illegality only comes in when an institution or trader shorts a stock, let’s say, then spreads false rumours intended to drive that stock down. In this respect it is a dystopian, postmodern successor to old- fashioned stock ramping.

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Chris De Vere

May 2nd, 2008 10:37pm Report this comment

Neil Barnett describes the behaviour of Hedge funds in shorting Iceland's currency and banking stocks as "financial terrorism". In doing so, he is missing the real culprits.

Bank deposits were originally treated as deposits for safekeeping and to be one hundred percent available, just as if goods were being stored in a warehouse. In other words, the funds on deposit could not be lent out to others in a process of credit expansion. Laws going back to Greek and Roman times have upheld this.

However, laws in more recent times have broken this principle by obscuring the difference between deposits for safekeeping and loans, legalizing fractional reserve banking and credit expansion. The great beneficiaries of this have been the banks themselves which have been able to greatly increase their profitability and governments which have been amongst the first and biggest beneficiaries of that credit expansion. Indeed, fractional reserve banking can only exist as partnership between the banks and governments, the governments having a monopoly on the issue of currency and a central bank to bail the banks out as a lender of last resort.

The Hedge Funds are therefore only pointing out what is essentially true: that in a fractional reserve banking system, the banks are technically insolvent; and the ability to trade in this way was only made possible by the legalizing of fraudulent activity.

I draw one’s attention to Jesus Huerta de Soto’s book, “Money, Bank Credit and Economic Cycles”.

David Jones

May 17th, 2008 5:34pm Report this comment

Chris De Vere makes a very noble post, but misses the point entirely, that the reason people deposit their money with banks in modern times is not only for safe keeping but to ensure a rate of return.

A bank that is required to keep funds '100% available' cannot produce a rate of return much higher than that of the depositor that chooses to store his banknotes under the bed.

Indeed a depositor who has done his homework, would weigh up in advance the level of risk/return that is acceptable before he chooses the institution that he places his funds with.

It is a brave cause to campaign against the evils of fractional banking, but much like the man spending his life in the street wearing the 'end of the world is nigh' sandwich board, the rest of the world is going to carry on around you regardless.

As for the hedge funds, they have been betting against Iceland in one way or another for the past decade... and they are still waiting for the collapse.

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