Thursday, October 09, 2008

Local Councils Do It Again

Oranges are not the only hopeless local council

We don't know exactly how much our local councils have lost on their deposits with busted Icelandic banks - figures vary from "a few hundred million, up to £1bn plus". But what we do know is that this is only the latest in a long history of such disasters.

Everyone remembers BCCI, where 28 local councils lost taxpayers' money on deposits they had placed with the notoriously dodgy money launderers' bank. The City had long since realised BCCI shouldn't be trusted, least of all with money, but the councils had carried on in blissful ignorance right up to the moment the thing exploded.

Then Hammersmith and Fulham council lost a fortune by spivving around in the interest rate swaps market. Luckily for taxpayers the courts subsequently let them off on a technicality - the Council had supposedly acted beyond its powers in entering into the swaps contracts in the first place, so the contracts were declared void. But what that ruling actually said was that nobody should assume they can enter into proper grown-up contracts with local councils. They should always treat councils like children who cannot be expected to understand anything.

More recently, there has been mounting concern about council pension funds and their predilection for "ethical investment". Many councils have decided they don't want their pension funds to invest in vice industries - arms, tobacco, booze etc - so they pursue "ethical" investment policies. Their portfolios have gone green and fair. But history tells us that distorting the range of investments like that is taking a big risk with future returns. It's another accident waiting to happen, and Council Tax payers will have to pick up the pieces - (see below for the alternative high performance vice portfolio).

And there's also a worrying scheme being punted around at the moment for councils to enter the shark tank known as the oil futures market. No, really, there is. And it's being spearheaded by Kent County Council - the same KCC who are among those to go down with the Icelanders.

So why did these simple shopping councils have cash with dodgy Icelandic banks? Even though everyone who knew anything about it could see there was a serious problem brewing with Icelandic finance (it was even on C4 News last March for God's sake).

The councils say it was because the banks still had high credit ratings. But given everything that's happened in the last 12 months, why would anyone still trust the grotesquely conflicted rating agencies (eg see this blog)? Why wouldn't you say - as we did at Tyler Investments - industry-leading deposit rates offered by one of the most highly leveraged offshore hedge funds in the world (ie Iceland) at a time of huge financial distress might be a tad on the risky side?

Of course, this is not just a UK problem. All over the world, local council officials get sucked into risky financial deals that end in disaster.

One of the most spectacular was the 1990s busting of Orange County in California, where a council official got flattered and schmoozed by hungry derivatives salesmen into thinking he was a financial genius. Piling bet on bet, he ended up losing $2bn and bankrupting the council (see F.I.A.S.C.O.: Guns, Booze and Bloodlust - The Truth About High Finance by Frank Partnoy - it's the definitive account written by a Morgan Stanley insider who describes a world in which MS managers whip on their salesmen to "rip off the clients' faces" - excellent read which should be compulsory for all local council treasurers).

The big question is why local councils still do these things? Why haven't they learned?

Where council taxpayers' cash is involved, the guiding principle really should be safety first.

PS According to a recent paper by Sebastian Lobe and Stephan Roithmeier, when it comes to investment, vice trumps virtue hands down. They say: "publicly traded companies involved in alcohol, gambling, tobacco, sex and nuclear power industries are able to generate abnormal returns. Using a worldwide index of 755 unethical firms, we provide evidence that the risk-return characteristics of sin stocks are superior in comparison to regular stocks as well as socially responsible stocks." Here's the optimal portfolio of sin:

It's a shame sex doesn't get more of a look in.


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