How to sell horsemeat and sub-prime loans

Trusting businesses to do the right thing is naive. From banking to the meat industry, without strong regulation, it's inevitably the consumer who loses out

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It seems a far-fetched comparison, but the more closely the horse-meat scandal is examined, the more it brings to mind the origins of the banking crisis. In these two examples of globalisation gone mad, the resemblances are remarkable. To start with, there are the same hard-pressed customers.

In a recent poll of British consumers conducted by Kantar, more than 40 per cent of those questioned said that they would make no change to their shopping habits in light of the horse-meat scandal. They couldn’t afford to pay more. Horse meat, if that was what they were eating, was better than no meat.

Now recall the origins of the banking crisis. It began when prices in the US housing market suddenly turned down. This, in turn, undid the billions of dollars in mortgages granted to customers with poor credit ratings. This was called sub-prime lending and was also widely practised in the UK.

Just before the crash, Professor Harvey Rosen, of Princeton University, explained that what he called “innovations in the mortgage market” had let in the excluded: “the young, the discriminated-against, the people without a lot of money in the bank to use for a down payment”. So, like it or not, both the suppliers of horse meat fraudulently labelled as beef and the reckless suppliers of credit in the housing market were meeting a genuine need.

Nonetheless, what was going on had to be disguised. The meat that ended up in Tesco Everyday Value Spaghetti Bolognese, for instance, could no more be labelled 60 per cent horse meat than the originators of sub-prime loans could sell them on to investors around the world if they were described as the high-risk propositions they actually were. In both cases, the technique used by the suppliers of the dud products was the same – mix and match.

Fraud

Don’t try to sell horse meat as horse meat but mix it with beef and call it beef. Don’t attempt the hopeless task of selling bundles of sub-prime loans to international investors but mix them up with better quality securities so that the whole package gets a much better rating than would otherwise be the case. For many years, these methods were effective.

It may seem surprising that neither the hard-nosed buyers working for the big supermarket groups nor equally canny professional investors discovered the frauds that were being carried out under their noses. But perhaps they didn’t want to know. Wilful ignorance does happen.

Strong-armed regulation would be the remedy but instead, again in both cases, government rejected this approach. In the financial markets, Britain boasted of its “light-touch” regulation. In November 2006, two years before the crash, Gordon Brown, then Chancellor of the Exchequer, gave a speech to the CBI extolling what he called “stability through a predictable and light-touch regulatory environment”.

Now the extraordinary fact is that although “light-touch” financial regulation comprehensively failed, the Coalition Government has been regulating the food industry with a very light touch indeed. It proudly relies on what are called responsibility deals in which food companies, drinks producers and big supermarket chains make voluntary pledges to tackle issues such as alcohol abuse and obesity.

It’s a kindly approach. Who wouldn’t want to trust businesses to do the right thing, and to reduce regulation to a minimum? It’s like patting a tiger on the head and telling it to be good. Fortunately, a well-documented warning against taking this optimistic view of nature has just been published. The latest issue of the authoritative journal The Lancet documents the “strategies by industry to undermine effective public health policies and programmes”.

It reports that the main method is to bias research findings. Articles sponsored exclusively by food and drinks companies are four times to eight times more likely to have conclusions favourable to the financial interests of the sponsoring company than those articles that were not sponsored. Policy makers and health professionals are co-opted where possible, huge sums are spent on lobbying politicians and public officials to oppose public health regulation, and access to objective health information is blocked.

Broken links

The banking industry uses many of the same methods. Even larger amounts of money and effort are spent on lobbying. Policy makers are suborned. And before the crash, prudential regulation was evaded by the simple device of engaging in “shadow banking”, routing business through companies specially set up to borrow short and lend long (which is what banking is) without calling it by its proper name.

What we learn from these two examples of global business, the meat trade and banking, is that the individual units in the international supply chain have little idea of how they fit into the whole. Who knows where the labels are changed in the chain of relationships that links the horse dealer in Romania and the supermarket in London selling “pure beef” products? Could the British institution buying a package of mortgage securities before the banking crisis broke have had any idea that he or she had taken a bet on, say, the over-heated Florida residential market?

These cross-frontier relationships are vulnerable to fraud. A trader in Cyprus deals with a trader in Holland, business is placed with a factory in France that, in turn, subcontracts some of the work to Luxembourg. Who fully understands what is going on across the border? Instead, it is everyone for themselves and only strong regulation can keep consumers safe. Don’t pat the tiger on the head, it may pull your arm off.