Tackling the menace of rigged capitalism is a herculean task

There is new phenomenon around the world and it can be aptly termed “Rigged Capitalism”.

From the 2G scam in India to the housing and subsequent financial crisis in the United States to the current LIBOR scandal in the United Kingdom, the world witnessed the rigging of bid documents, financial statements and a key bench mark interest rate resulting in handsome payoffs to a few top executives.

In the 2G scam, although yet to be proven in a court of law, bid documents were rigged and dates were changed to benefit a few new comers in the industry. The companies then sold their licences to multinationals realising humongous profits.

The housing crisis in the United States that rocked the world financial system was perpetuated by many. Customers rigged income statements to get bigger mortgages. Rating agencies rigged bond ratings to make securities marketable and financial powerhouses of Wall Street rigged the securitisation process to include subprime mortgages and various other loans in order to sell bonds to gullible investors.

Government Sponsored Entities (GSE) – Fannie Mae and Freddie Mac, by rigging financial statements, were largely responsible for privatising gains and socialising losses.
And in the LIBOR scandal, rigging of bench mark interest rate by more than twenty banks benefitted traders who were betting big on derivatives and company executives whose payouts depended on the bottom line. 

Then there are the capital markets. They are the bedrock of capitalism where companies raise much needed capital to fund their expansion and innovation. But many investors think, justifiably so, that the stock markets are rigged in favour of few big hedge fund players and institutional investors.

For individual and small investors, the stock market has been a lost decade with their investments showing zero or negative return. Just before the initial public offering, Facebook revealed the true state of it financials only to a few large investors that gave them sufficient time to withdraw their bids.

Facebook has lost 50 per cent in value since its IPO. Securities and Exchange Board of India recently cracked the whip on 19 entities including individual investors for market manipulation and price rigging in four mid-cap stocks. And true to the saying “Bulls make money, Bears make money, Pigs get slaughtered”, many small and individual investors have been slaughtered by big players.

Other sectors too are prone to this phenomenon in our country. NDTV, a television channel, filed a lawsuit against Nielsen for having rigged viewership ratings. In the dysfunctional property markets across major cities, builders are suspected of collusion and price rigging. Competition Commission of India busted the cement manufacturers for cartelising and price fixing after Builders Association of India blew the whistle on them. Resume rigging is rampant in the Indian IT industry.

Sound asleep

The irony for investors, customers and people is that the regulators have either connived or have looked the other way rather than reign in big banks and large corporations for bad behaviour. In the 2G case, the telecom minister himself stands accused of changing the bidding process at the last minute.

During the housing and subsequent financial crisis, the Securities and Exchange Commission along with the United States Justice department was sound asleep while Wall Street made hay. In the LIBOR scandal, both the Treasury Secretary of the United States and the Governor of Bank of England were supposed to be in the know-how since 2007 but were derelict in enforcement.

Also, in an intertwined and globalised economy, rigging in one country affects large number of people, customers and markets around the globe. In the 2G scam, firms affected included telecom players from Norway, Russia, Middle East and South East Asia. The housing crisis that originated in the United States brought the world financial system to its knees while afflicting damages on economies in many individual countries. The LIBOR interest rate rigging affected customers worldwide whose loans approximately USD 800 trillion are priced based on the benchmark rate and were ripped off unscrupulously by banks.

Since the fall of Berlin Wall, capitalism along with globalisation has indeed created enormous wealth for people and has largely contributed to decline in poverty in many countries.

While free markets are still the best way to organise economic activity, proper functioning of it depends on rule of law and governing institutions.  Corporate greed, human frailty and unethical behaviour of few individuals along with massive regulatory failings have tarnished capitalism and given rise to the new phenomenon of ‘rigged capitalism.’ And watchdog institutions along with corporate governance were a monumental failure in the transgressions of big banks and corporations.

Tackling the menace of rigged capitalism will be an arduous task since solutions are far and few between. The obvious and the most important lesson for regulators is that self-regulation does not work. Aggressive prosecution along with severe fines will be far more successful in deterring such crimes in future.

Thus it is of paramount importance for the enforcement agencies to be vigilant in monitoring and stop the rigging and manipulation much before it inflicts damage on the rest of the world.

Corporate governance too needs to improve leaps and bounds to deter company executives from committing such crimes. The current compensation and incentive structure is deeply flawed and requires major overhauling.

Board of Directors cannot shrink their fiduciary duty and overlook management profiteering in the short run while severely jeopardising the long term viability of the company.  They also need to foster ethical practices by setting high standards from top management onwards. And it might just pay for customers and people to be observant and sceptical.