Friday, June 24, 2011

The Killing Fields of Sri Lanka

Since the Dominion of Ceylon became independent from the British Empire in 1948, it has struggled to achieve stability between its majority Sinhala speaking people and minority Tamil speaking people. Although the first decade of so of freedom was generally a good time for the country, after the election of Soloman Bandaranaike in 1956, the country took a major wrong turning. The policies of radical Socialism and Sinhala nationalism that Mr. Bandaranaike and -after his assassination in 1959- his widow Sirimavo, adopted began to undermine national unity. The generally higher level of education of the Tamils meant that they were more represented in the civil service and and many levels of society. However the determination of the radical Sinhala to create an officially Sinhala speaking, officially Buddhist state alienated the Hindu Tamils and since most could not speak Sinhala fluently, the Tamil population was largely removed from administration and positions of power.

Eventually the radical nationalism of the Sinhala was matched by an even more brutal Tamil national rebellion. In 1976 the so-called Liberation Tigers of Tamil Eelam was set up, and through its indiscriminate tactics, they quickly acquired a justified reputation for savagery. In the end, the Tamil Tigers attempted to break away from the renamed Sri Lanka. The result was a civil war that lasted 16 years.

That war was ended in 2009 with the complete subjugation of the Tamil speaking areas of the island. At the that time, it quickly became clear that tens of thousands of civilians, caught between the Tigers and the Sri Lankan army, had been killed.

As time has passed, it has become clear that the Sri Lankan army committed several massacres.

The national leadership of the country has refused to accept their guilt for these crimes- for crimes they undoubtedly were. Furthermore, since the victory in the war, the Sri Lankan state has failed to even attempt to make compromises with the Tamil speaking minority. If anything, Sinhala chauvinism has grown stronger since the complete defeat of their enemies.

Sri Lanka has essentially become an apartheid state.

As yet further evidence is revealed in the documentary aired recently on Channel Four, the international community is now considering their reaction to the mass murder of civilians that took place, and for which the current government in Columbo is ultimately responsible.

If nothing else, the World Community should insist that the Sri Lankan government ceases its oppression of the Tamil Community. If the LTTE were rightly reviled as the callous murderers that they were, that is no reason to ignore the plight of Tamils across Sri Lanka who are being held guilty of crimes which they are wholly innocent of.

Those that have the perception must make the allowances, and the bloody end to a brutal civil war involved crimes that can not be ignored. If General Gotovina of Croatia and Ratko Mladic of Serbia are facing trial, then those responsible for crimes no less bloody should be forced to face civilian justice too. If the Sri Lankan government will not respond to the justified outrage of the global community, and address this with investigations of their own, then the global community will have to do it for them.

The cells in the Hague are not yet full.

Tuesday, June 21, 2011

Euro futures

The European sovereign debt crisis has its roots in a variety of long term mistakes. The biggest of which is not the creation of the common currency, but the failure of states to maintain solid public finances. Whether the crisis is the result of a policy mistake- the Irish decision to offer an unlimited guarantee to its banking system- or long term corruption,-the fraudulent Greek public debt numbers- the impact amounts to the same. No matter what, all European states now have no option but to bring their runaway government budgets under control. That is as true for countries outside the Euro zone- such as the UK- as it is for the Euro member states.

However, the structural problem of Euro sovereign debt is now putting the entire mechanism of the Euro under intolerable strain. The European Central Bank, through its large scale purchases of the sovereign debt of the weaker Euro zone members, is placing its own balance sheet at risk, and even now, it is straining its own leverage ratios to a level- estimated at 23 times its capital base- that can not be considered prudent. Any default will force a significant recapitalization onto other Euro zone members

Yet in the last few days, it is becoming increasingly clear that the Greek government is under growing pressure, both domestically and from its Euro-zone partners, to consider the option of a default on debt and a withdrawal from the Euro. The fact is though, that there is no evidence that the the process can be done in an orderly way. The need to create new drachma notes and coins alone is a logistical problem that could take months to solve- and for the plan to work, this must be carried out in secret. Meanwhile the pressure on Athens grows more severe every day. A disorderly default is also a nightmare for the rest of the Eurozone too: not least, as I have written before, for Germany.

Yet, before the anti-EU brigade starts to crow, the next question is: what next?
The fundamental question, however, still remains: how to maintain a common currency without a common treasury? That may yet prove so intractable that the very idea of a common currency evaporates. On the other hand, there is growing talk of new and stronger mechanisms that can be applied across economies that are more alike, and which do not have major debt issues in the first place.

The fact is that the common currency drove interest rates substantially lower and gave far greater access to capital. The complete fall of the Euro would raise rates and reduce liquidity at a time when growth is already under attack from the dramatic retrenchment in government debt that the years of excess have racked up. The Euro has done an awful lot of the good that it promised.

The complete fall of the Euro could take Europe back to the 1930s. That is why the Greek crisis is rapidly becoming a pan-European crisis. In the face of the abyss, some of the politicians are beginning to panic.

Yet, there is also the conundrum of what would happen if Greek withdrawal were actually to take place in an orderly fashion, and that this helped to stabilize the Greek economy? In fact such a stabilization is likely to be many years away, no matter what happens: such is the scale of the crisis today, but let us make an assumption that Greece manages an orderly exit. In such circumstances, would not the pressure on other ill-fitting members lead to the complete breakdown of the currency bloc? I think the answer is that the peripheral states, such as Portugal and Spain may well follow suit, but for Italy and Ireland the message is far less clear. To a great degree the Irish are more likely to be able to complete the policy prescription. In Italy, despite the growing crisis of competitiveness, coupled with the death throes of the Berlusconi (should that be Burlesque-oni?) era, the country remains fundamentally much stronger than its club-Med peers.

The fact remains that a Euro is likely to survive.

That may be a Euro pared back to its core: Germany, Austria, BeNeLux, Finland, Estonia, Slovakia and Slovenia say: a Greater D-Mark; or with the continued participation of France, Italy and Ireland, it may remain something quite like the Euro we know today.

In the face of what is happening, some very cool heads indeed are now needed, yet the transfer of authority in the IMF with the exit of DSK and the ECB itself with the forthcoming exit of Jean-Claude Trichet makes the question of leadership in the crisis itself a tricky question ("who voted for Mario Draghi?" is a question already being posed by journalists).

However, even a default and Euro exit of Greece or indeed the gamut of the PIIGS states, would most likely still leave the Euro in existence: shorn of its more prickly weaker members, it may even face an new situation: the problem of too much strength.

Hold on to your hat, it is going to be a very bumpy ride in the next few weeks.

Monday, June 20, 2011

Assad 'as 'ad it

The speech from Bashar Al-Assad was long awaited. How would he address the crisis in his country?

In the end he has bottled it. By failing to recognize that the protesters have legitimate grievances and by making a speech insisting that the unrest in Syria is all the fault of shadowy foreign conspiracies, he may well have condemned himself to death.

If he will not enter into a dialogue with the majority in his country, then sooner or later he will be overthrown. A small part of me suspects that the clique that surrounds the Baathist regime in Damascus has got its own agenda that has little to do with the personal survival of Bashar al-Assad, after all the speech that they must have tacitly approved is astonishingly reckless.

The days when Bashar was a mild mannered optician at the Western Eye Hospital in London whose interest in politics seemed, at best, tangential are long gone. Indeed the death toll in Syria is already creeping up to the tens of thousands killed in in the time of his father Hafiz after a rebellion broke out in Hama in 1982. This time though, the rebellion is way beyond a single city and comes after the fall of three other regimes in the Arab world and the likely fall of a fourth and even fifth.

A spectacular mistake- I wonder if the Syrian President wishes that he and his British born wife, Asma, had stayed in Acton?

Greek Tragedy: German Crisis

In the face of the growing crisis in Athens, it would be as well to remember that this is as much a crisis of Germany as it is of Greece.

If Greece is to be rescued, the German taxpayer will be forced to find the money.

Yet if Greece is not rescued, it is the German banks that are first in line to take the losses, and again it will be the German taxpayer that will have to pick up the bill.

Meanwhile, if Greece is left to its fate, then Germany will have to carry the opprobrium for breaking down European solidarity: it will show once and for all that Germany will indeed put its perceived national interest above that of the wider European Union, which pretty much ends the idea of Germany signing up to ever closer union. In other words it would be a major change in German policy towards the EU- and if it were to be changed, there could be some widespread and unexpected changes in other countries policies towards Germany. There are some potential significant foreign policy risks for Berlin here.

Yet, it is for precisely this reason that the Germans may decide to take a step towards the transfer union that is potentially risky internal ground for the Merkel government. The German constitutional court has made it plain that there is a limit to the financial support that the German treasury can give, and, more to the point, there is a limit to the level of sovereignty that can be pooled. So a European Treasury would very probably be vetoed by the German constitutional court. This is why the ideas of permanent capital backing of government bonds in the Euro zone has been expressed in such nebulous terms: a "transfer union" might be politically unpopular in Germany, but it would probably be OK with the Court. So, in addition to calculations of foreign policy, the German Chancellor has also to make some fine judgments on domestic policy too.

Yet in one area Mrs. Merkel has already tripped up. By delaying discussions on the problems of private sector firms in the financial sector until after the government crisis has been addressed, she shows that she does not understand the interconnected nature of the crisis. The issue is not whether the problems of state liquidity and structural reform take precedence over those of the private sector: it is how to address the general crisis of over-leverage. It seems frankly outrageous that taxpayers are being penalized in order to payout a full return to the shareholders of the banks. Yet by separating the public and private sector restructuring, that is precisely what is set to happen, not just in Greece, but across the Euro zone.

The calls for a default and an exit from the Euro by Greece- mostly from die-hard anti-Euro commentators- miss the point. It is indeed already obvious that Greece must dramatically reduce its debt burden, but an exit from the Euro would not only lead to a crisis of confidence in Greece. In any event securing support for a New Drachma would be exceptionally difficult, and would still leave the Greek government owing a vast sum of Euros- it does not solve Greek problems, which can now only be addressed by a major restructuring anyway. What it could do is force other states out the Euro. Essentially that would been a major devaluation by several significant markets for German goods.

In other words the break-up of the Euro zone is also a significant crisis for Germany. Not only would the Germans get the blame, but they would now face much greater competition and a significant reduction in export earnings too. The German competitive advantage, arrived at with the pain of restructuring may now be over, as other countries face up to a period of spectacular instability and are forced to match or better the efficiency of Germany. Indeed whatever happens, the German competitive advantage must erode, or else the unbalanced Euro economy will enter a still greater crisis. Yet how to sell this to the German electorate?

So, as the Greek Prime Minister George Papandreou sweats through the passage of legislation and struggles to restructure his government in the face of a fierce blast of protest, it is not just in Athens that nerves are fraying.

In Berlin the lights are also burning late into the night. Germany too is facing its moment of truth.

Remarkable Lives

The death of Yelena Bonner at 88 is a reminder of the extraordinary courage that those who opposed the Soviet system needed to show in order to survive. Dr. Bonner- she was a paediatrician- formed part of a remarkable pairing with Andrei Sakharov, the father of the Soviet Hydrogen bomb, but above all the man who became the conscience of the Russian people.

Sakharov was in many ways the Mandela who never was. He become the voice of moral integrity in the Soviet society which had very little of any integrity. His harassment by the Soviet authorities became a cause celebre in the West, but it also underlined the moral crisis inside the Soviet system. Yelena Bonner became the vital lifeline between the closed city of Gorki (now, once again, Nizhni Novgorod) where Sakharov was exiled and the outside world. Inevitably she too was harassed and denied medical treatment for a heart condition and for a serious eye injury (she had been nearly blinded during the siege of Leningrad), and latterly it was the ill treatment of his wife that cause the most vehement protests from Sakharov himself. Alas, at just the point when Russia needed the strongest moral compass, the crisis of the dissolution of the USSR, Sakharov himself died, aged a relatively youthful 68. Had he lived to the great age of Mandela, perhaps Russia would have evolved in a far better way than the criminal society it latterly became. Sakharov had already become a member of the Parliament, indeed the leader of one of its largest fractions, the opposition Inter-Regional Deputies group. It is not beyond the bounds of possibility that he could have become President- the first genuinely non Communist President, which is a luxury that Post-Soviet Russia has yet to enjoy.

Yelena Bonner, despite the infirmity which forced her to live with her children in the US, remained committed to her homeland, and her passing reminds us of the need for moral integrity- especially in the weakened ethical world of Putin's Russia. Her era may have passed, but her message remains the same as it ever was.

Another death this week was of Sir Patrick Leigh-Fermor whose passing marks the end of an even older era, not merely that of an astonishing Second World War hero, but also of a certain kind of European civilization that was probably lost even before the rise of Hitler. At once glamorous and brave, nevertheless Leigh-Fermor did not escape the suspicion of dilettantism that more rightly belongs to his fellow writer and friend, Bruce Chatwin. Yet unlike Chatwin, Leigh-Fermor's intellectual foundations were more solid and as a result his learning carried a less pretentious air than his younger friend.

Thursday, June 16, 2011

Improving Estonian Politics

From a Liberal perspective it is hard to be anything other than enthusiastic about Estonia. The laws of the country are generally fair, and the process of government is generally open. The adoption of generally liberal economics has helped propel the country towards becoming one of the richest countries in the world. In many aspects, from health care to the adoption of new technology, the country is dramatically ahead of the the UK. Estonians are often genuinely self critical and therefore look to find ways of improving the way the country and society works. Quite often I have been genuinely stumped when asked what I would change: the fact is that in general things work quite well.

Yet, despite a well functioning democracy, there are two things that I would change.

The first is now quite topical: I would make the President of the Republic directly elected. Why so topical? Well, the first term of office of President Tomas-Henrik Ilves will expire in the autumn. Already, however, it seemed inevitable that he would be re-elected.The reason for this inevitability is more to do with a party-political stitch-up rather than the merits of the President (which are, I should make clear, substantial). The President is currently elected either by a two-thirds majority of the Parliament or if that is not achieved after three ballots, then by a majority in an electoral college consisting of members of the Parliament and representatives of local governments sitting together. Since the restoration of the Republic in 1991, all of the Presidential elections have gone to the electoral college. Both the first President, Lennart Meri and the incumbent, President Ilves have proven to be substantial figures on the world stage, and if the second president, President Ruutel, was perhaps less successful, he was nonetheless well qualified for the office.

Yet the decision as to qualification has been left to the politicians, and this has forces all three Presidents to make compromises with political parties that they have occasionally found uncomfortable. Now the entry of a new candidate, even if he poses little threat to President Ilves, does underline what the system needs to change. Indrek Tarand, MEP has a reputation as a maverick voice of conscience, and partly because of this, he topped the poll as an independent in the last European elections. As an MEP, he has cultivated independent positions completely at odds with the ethos of much of Estonian politics, which is dominated by machine pols. It was therefore something of a surprise when he announced that he would put his name forward for the Presidency as a candidate supported by the Centre Party, which embraces machine politics perhaps more completely than any other party in the Estonian political spectrum. Mr. Tarand's explanation: that there needed to be a contested election for the Presidency is indeed understandable, but it brings home the fact that despite Mr. Ilves's own, undoubted, independence, he too has been forced to make some compromises in order to secure his re-election.

Given the fact that three of the four political parties in the Parliament have already declared their support for President Ilves, even the entry of a potentially popular and effective alternative is unlikely to derail his re-election. Indeed it may not even be Mr. Tarand's intention to unseat President Ilves, who has proven to be both sagacious and effective. However, this surely should be the last time that the party political system is the mediator between the popular will and the office of head of state. President Meri proposed this change to the constitution on his last day in office, and to my mind it is now well overdue.

However direct Presidential elections are not the whole story of reform: in fact there is also a second change that I would make to the way that Estonian politics works. For it is not just in the matter of the choice of the Head of State that party politics needs reform. In both Parliamentary and local elections, parties present a list of candidates to the electorate. Often these include well known and popular names at the top. Yet often these names have no intention of taking the job, if they are elected. The result is that candidates lower down are the ones that actually get to serve- particularly in local government. To my mind this party control means that the voters do not know who they will get as their representatives. I believe that the list should be scrapped and that candidates should be elected by a single transferable vote. Given that the constituencies are already multi-member, this is in fact a relatively minor change: however it would eliminate the practice that a party puts its most popular figures at the top of the list, whose personal popularity then cascades down to the unknowns. Voters should know who will do the job, and it is up to the lesser known figures to introduce themselves to the electorate. The Social Democrats have already committed themselves to the idea that candidates should take their seats if they are elected, to my mind STV goes a bit further in forcing a candidate to engage with the voters.

Estonia, even without these changes, remains an interesting political environment- particularly from a liberal perspective, since both government and opposition are dominated by different Liberal blocs. The quality of debate remains high, and the majority of politicians do genuinely engage with the voters. Yet there are still things that may be advanced, and I hope that the political structure will not fossilize. President Ilves has used his position to spark debate and to challenge some of the political assumptions that he thinks impede the process. Should he- as seems likely- be returned to office I hope that he will continue to do this, but also to promote a wider political debate about the fundamentals of the constitution and the political idea of Estonia.

Friday, June 10, 2011

Tallinn Water Fight

In previous postings I have sounded warnings that Estonian privatization policy risks becoming incoherent. I have pointed out that few of the larger privatizations have gone without problems, and that far from being the poster child for economic reform, Estonia risks becoming known as an unreliable and even cantankerous privatization partner- which could have a significant financial impact in the future.

The failure of the Estonian Rail privatization now seems set to be compounded by the failure of the Tallinn Water company sell off. Some politicians have suggested that my views "as the view of one person" carry little weight, and it is true that my thoughts on the blog are entirely personal. However, they are views which, nonetheless, are informed by more than two decades of activity at reasonably senior levels at major firms in the City of London. Neither are my views given in the service of any sectional interest, but rather because I want to contribute positively to the country of which I am a resident and I fear that the success of Estonia as a whole may be imperiled by poor decision taking. I do not want to see the government of Estonia take decisions that I believe are not in the best interests of the country, or even in the longer term interests of the political parties that comprise the ruling coalition here- whatever the short term political temptations may be.

The history of the privatization of the Tallinn water company is, in many ways, a great success. The privatization of the water utility has resulted in large scale investment in new technology and dramatic increases in the quality both of drinking water and also sewerage. There is no doubt that from the point of view of investment, the consortium led by United Utilities has delivered a modern and efficient company that offers high quality water services.

The quid-pro-quo of this investment is that the shareholders are entitled to a return on the money that they invested. Because the provision of water and sewerage services is as close to a natural monopoly as you can get, under most privatizations these returns are closely regulated under the terms of various agreements, often including the sale-purchase agreement itself. So it is with Tallinna Vesi. However there is now a dispute, since the government of the Republic of Estonia is now vetoing price increases that even it implicitly accepts are clearly mandated by the terms of the original agreement.

In a letter to shareholders, The Estonian Ministry of the Economy, complains that the shareholders of Tallinna Vesi have been putting forward black propaganda against Estonia, in order to support price increases which it clearly believes are unjustifiable. However, in the same letter, it is pointed out that the selling party under the privatization agreement is the City of Tallinn, and the Government of the Republic can not be bound by the terms of an agreement that it was not a party to. The implication is clear: under the terms of the original agreement, the Republic accepts that prices should rise in the way that the company now wishes, however it disputes the right of the City of Tallinn to enter into such a long term binding contract.

By saying that the Republic will not be bound by terms agreed by the City of Tallinn, the Government effectively says that the City of Tallinn acted beyond its powers in the matter of the privatization, that is to say in legal terms that the City of Tallinn acted ultra vires. If that is so, then the privatization agreement that the United Utilities consortium entered into in good faith is clearly cancelled, and the shareholders are entitled to seek redress in the courts. Yet the government does not say this, they say only that the government will not be bound by pricing terms agreed under the original agreement. Yet they do not seriously suggest that investors acted in bad faith in this matter, so it is not the consortium that is at fault: even the Government is suggesting that the fault lies on the Estonian side, between the Republic and the City of Tallinn.

The problem is that the original agreement was approved by the Government of the time- the first item of due diligence would be the proof that the city of Tallinn had the powers to negotiate the terms of the sale. So it will be hard for this government to retrospectively argue that the City of Tallinn overstepped their powers. There will, I expect, now be protracted court proceedings that will hinge on whether of not the City acted ultra vires. If it did, then the agreement as a whole may indeed be cancelled, with messy ramifications. If it did not act ultra vires, then the next step will be to establish whether the regulatory regime recently put into place even has the powers to vary the terms of the original contract unilaterally- and here it will not just be a subject of Estonian law, but also European Union competition directives. The third question will be that even if the competition authority has those powers, did it act reasonably in this case? This litigation is therefore going to protracted and expensive, yet the government is offering a simple "take it or leave it" approach- no negotiation is on offer from the government side. Yet the Republic can not be sure of a legal victory, and in my view such a maximalist position carries significant risks.

The letter to shareholders is a clear indication that the government is on shaky legal ground. Even if the City of Tallinn only acted unlawfully in the matter of the post-privatization regime, those terms were a full component of the terms of privatization and their cancellation entitles Tallinna Vesi to seek legal remedy either from the City of the Government. If the Competition Authority has the power to vary the terms of the original agreement, why has it acted in such secrecy- failing, as the Company alleges, to even communicate with the Tallinna Vesi board? Meanwhile, the company insists that it has acted in good faith and has more than matched the investment expectations laid upon it since the Privatization took place. If the company has indeed acted in good faith, why- except for purely short term party political reasons- is Estonia seeking to vary the terms?

To my mind the government of Estonia risks getting itself into real trouble: any future privatization will now be considered in the light that the government may subsequently unilaterally alter the terms. This imposes a political risk which substantially increases the cost of investing in Estonia. From the point of view of Estonia, this reduces the price that investors are prepared to pay for Estonian assets. Secondly, acquiring a reputation of being investor unfriendly is something that, once established in investor perception, is very difficult to shake off.

It is in this light that allegations of corruption acquire a more sinister tone. Estonia is not a perfect state of laws- no country is. Yet, there has been a growing sense that a few bad apples have the potential to cause significant future problems. The price increases that the Tallinn Water company propose are unquestionably politically unpopular, but attempting by personal fiat to alter them opens to the door to changes by subsequent ministers that may be rooted more in personal gain than political popularity. It is critical that Estonia keeps her reputation for fair dealing and honesty.

There is now a breakdown in trust between the shareholders of Tallinna Vesi and the Government of Estonia. This may be remedied in the courts, but if the Government were to lose, despite the warnings they have received, then it may take a lot more than a ministerial resignation or two to repair the damage. Even a legal victory for the government, doubtless after years of litigation, would be a Pyrrhic victory- it would show the government failed to communicate to investors, and was unprepared to address legitimate grievances.
Having one privatization - Estonian Rail- fail, might be considered a misfortune. To have Tallinna Vesi fail too looks like a lot more than simple carelessness.

Thursday, June 02, 2011

The Unacceptable face of Capitalism

The point about free markets and an open and transparent economy is that they should reward success and penalize failure.

When competition becomes limited and access to markets or capital is denied, then individuals or corporations can behave in non-market ways. We are now seeing more and more examples of this happening: the corporate leader who presides over falling profits and faltering performance still managing to increase his compensation package, for example. This perverse result is justified on the grounds that "the competition for talent requires greater rewards for managers". The result is today's news that FTSE Chief executives have on average gained a 32% increase in their remuneration over the past year. Meanwhile the FTSE itself has only gained 7% and average workers pay has gained only 2%- or a fall of at least 2.5% in real terms. In other words the CEOs are gaining at the expense of both shareholders and of staff. This is not, in my view, the result of fair competition, but of the result of too many barriers to fair competition.

One of the major barriers to fair competition is the way that Asset Managers run their investment portfolios. When you buy an investment fund, say UK equities or an East Asia fund from an investment specialist like M&G or JP Morgan, in theory you are buying the management skill of the asset manager. In fact you are buying 90% exposure to a standard benchmark. Asset managers are compelled to keep very close to the proportions of the index that they invest in. The result is that most funds actually actively trade only 10% of their assets. The fact is that they cannot sell out most of their holdings, even if they wanted to, because this would introduce too wide a "tracking error"- that is the gap between the fund portfolio and the underlying index. This is deemed to be "unacceptably risky". Furthermore, asset managers will base their relative preference for one stock over any other to a great degree on the management of the company in question. In other words they will very rarely seek to oppose the management of a company, but rather- at worst- they would leave the stock "underweight" in their portfolio. Only a very few active fund managers will quiz a management in detail on its corporate strategy, still less its policy on management remuneration. Given that roughly 70% of the ownership of a typical FTSE stock will lie with these essentially passive funds, it essentially means that there is no brake on the greed of the management coming from the source that would have the most power, that is the owners of the company: the shareholders.

The City has thus developed a cozy cabal with the management of industrial companies. The asset managers do not pressure the management of the companies, unless under exceptional circumstances. Meanwhile the non-executive directors, who are supposed to oversee the company are drawn from an exceptionally narrow pool of individuals, most of which are directors of several firms and many of which have backgrounds in finance. Furthermore, many of the same financial conglomerates that run asset management businesses also run corporate finance businesses and stock broking businesses that pitch for mandates from the companies that their asset management businesses own. In theory there are procedures, the so-called "Chinese walls", that prevent a firm from mixing their different businesses in order to maximize the advantage to the financial firm. In reality, there is at the least an awareness that being an activist shareholder may have repercussions for other parts of the financial firm's business.

Meanwhile the greatest disconnect between performance and reward has of course been taking place in the banking sector itself. Managers of financial businesses have been paid millions for costing their shareholders money: indeed destroying so much corporate value that governments have been forced to nationalize the banks.

It might have been an ideal opportunity to force significant changes on the way the banking sector works, but in fact governments have tended to behave even more like absentee landlords of the banks than the private sector investors were. The result is that, despite continuing losses, the taxpayer continues to fund excessive pay amongst the bankers. It is not the politics of envy to describe banking pay as "excessive" when the performance remains loss making: it is a statement of simple fact. More to the point, by combining different banks into larger groups, the banking system is being made significantly less safe for the future. If HBOS or Bradford and Bingley were deemed "too big to fail", then what are we to make of the gigantic "Lloyds Banking Group"?

It is quite clear that the banking system in the UK needs far greater competition. It is equally clear that there is a well entrenched resistance to this across the City. It is not an accident that the Minister known to be most keen on forcing change in the City, Vince Cable, has been the target of several dirty tricks seeking to discredit him before he can take on these entrenched anti-market forces.

The fact is that the City, like the print unions or the Miners before them, has become the home of special pleading and entrenched self interest, that seeks to steal extra benefits from the rest of society by behaving in an anti-competitive way. The free market has been undermined by a corrupt system that refuses to address the huge conflicts of interest that its faces. The irony is that their actions are justified in free market language.

The investment funds may control the majority of capital in the UK, but they do not behave in a particularly capitalist way. Instead of maximizing value by actively pressuring and monitoring their investments, they have been content to see their value languish under often lacklustre management. Meanwhile entrepreneurs can not get access to these large pools of capital because the understanding of risk in the City is limited to mechanistic and failed risk models built around benchmarks and tracking error.

Slowly the industry is changing: at one extreme there are more straight index funds, that simply buy an index and does no more and thus charges only a small transaction fee. At the other extreme there are more active managers who trade 100% of their portfolio, not merely a 10% tracking error. However it is a sign of how low the market competition is, that there are still so many money managers that continue to charge active management fees while essentially following an index return (and more often than not even under performing the index). Active funds, particularly ones that invest in private deals or venture capital, still remain only a small part of the so-called "alternative investment" universe.

Nevertheless the process of even this evolution has been glacial. This represents a massive distortion in the whole structure of capitalism. The result has been a total disconnect between the winners, the leaders of corporations, and the losers, who are the remaining workforce and the shareholders, who under the capitalist system are supposed to be supreme. This is creating not only a divided society, but an unfairly divided society - one where the winners are not gaining wealth and position through merit, but because of a system that they are rigging in their own favour, and at the expense of others. The social chasm that is being created can eventually only lead to significant social conflict, and that is already beginning to happen across Europe, in Spain and Greece, for example. The bankers are bleeding the rest of society through their own mistakes, and although I admit there are a myriad of other contributory factors, increasingly the focus is going to be on the outrageous unfairness of the current system.

The irony is that the failures of Capitalism are the result of market failure based on a lack of transparency and open competition; rather than too much Capitalism, the problem is not enough Capitalism.

However, the time has clearly come to directly address this growing crisis. The retail and investment banking systems must be broken up, root and branch, leaving a larger number of much smaller institutions. Investment Funds must take greater responsibility for the corporates that they own and control. Much greater accountability and transparency must be brought into the boardroom with best practice setting clear limits to the salary differentials within a firm. The operations of investment banks, particularly those that use large savings/deposit bases to fund risk capital investment should be the subject of a Royal Commission.

The failures of the banking system demands that government as the voice of the whole of society, and in many cases as the new owner of the banks, they must act proactively to open up and change the increasingly closed and occasionally criminal activity of the Bankers.

Speaking as a 20 year veteran of the City myself, I think it is long overdue that the system was challenged to justify itself and to change.

It is time that success was rewarded and failure penalized, and not the other way round.