Tuesday, July 29, 2014

FOFA. How Palmer was conned. The rotten underbelly of Australia's financial advice industry

Clive Palmer has been conned. In the most exquisite of ironies he has allowed the Coalition to water down financial advice rules without first seeking advice.

"I didn't become a billionaire by listening to advisers," he said after he closed the deal, dismissing concerns the regulations he had endorsed would condemn ordinary Australians to years more of seeing advisers partially on the take from the firms whose products they advised on.

He’d insisted on safeguards. Fees and payments would be out in the open. It would help.

Palmer has probably never sought advice from George Loewenstein. The Carnegie Mellon University professor does cutting-edge research in the netherworld where economics meets psychology.

His examination of this very topic is called “The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest.”

Loewenstein says if advisers admit they are getting kickbacks their clients often don’t know how to assess the information. The clients don’t know much about the field. That’s why they are seeking advice. Sometimes it makes them more trusting. If an adviser is going out of his or her way to be honest the client might “place more rather than less weight on the adviser’s advice”.

The adviser on the other hand might feel emboldened, “exaggerating their advice in order to counteract the diminished weight that they expect estimators to place on it”.

His experiments find advisers make more money when they disclose kickbacks and their clients make less (because they receive even more biased advice). They are also keener to help out advisers by buying the products that will give them kickbacks.

If you doubt that Australians are extraordinarily bad at appraising the worth of their financial advisers, consider the results of this Australian Securities and Investments Commission survey, detailed in the interim report of the Murray financial system inquiry delivered on the day that Palmer caved...

Eighty six per cent of the Australian customers surveyed said they had received “good quality advice”.  Eighty one per cent said they trusted the advice “a lot”. But when ASIC examined the advice if found only 3 per cent was good, 58 per cent was adequate and 39 per cent “poor”.

The advisers who renounced commissions were the most likely to provide good advice.

“Unsurprisingly, where advice fees were contingent on a product recommendation there were numerous examples where the advice appeared to be structured towards recommending or selling financial products,” ASIC reported.

The regulations Palmer has agreed to will allow banks to continue to reward advisers for shifting their products. The only constraints are that the advisers must work for the banks, they must style themselves as “general” rather than “personal” advisers, the payments can not be ongoing and they must not be made “solely” because of the volume of product they have shifted.

Payments or in-kind payments not linked to the sale of a particular product are fair game, among them payments for training, promotion, conferences in remote locations, the upgrade of computer systems and direct payments to staff who “execute” trades recommended by advisers.

They are generous loopholes. They would have been illegal had Palmer not caved.

The Murray report doesn’t think much of them. It has suggested banning the use of the term “adviser” in such circumstances, relabeling it “sales” or “advertising”.

The inquiry’s chair David Murray knows about what masquerades as financial advice in Australia. He used to run the Commonwealth Bank.

“Advisers” are allowed to practice in Australia with as little as six hours training, although it’s often more - sometimes six weeks. In Canada, Hong Kong, Singapore, the United Kingdom and the United States would-be advisers need to sit a national exam. Not here. I know of one economist with impeccable finance market credentials who wanted to work as a financial adviser to give something back He was turned away because he hadn’t worked in sales.

Unfathomably, there’s not even a public register of who does and who does not have an adviser's licence. (Palmer is on to this one. He demanded a register as a condition of agreeing to water down the rules.)  If there was a register potential clients could see how long an adviser had been practicing and whether they had ever been struck off.

So limited are the regulators powers that when advisers do get stuck off they simply pop up elsewhere. Murray says ASIC can prevent someone being an adviser but can’t prevent them from managing advice firms, something stuck off advisers often do.

In Britain the Financial Conduct Authority has “product intervention” powers. It can review products or product categories and take them off the market. In Australia ASIC can only warn.

And it can do next to nothing about advisers who sell insurance. Incredibly effective lobbying by insurance providers means that under both Labor’s old rules and the Coalition’s new ones advisers can continue to accept commissions from insurance companies. It’s why advisers often ask: “Would you like insurance with that?”. The commission is often as much as 110 per cent of the first year’s premium. It’s a powerful incentive for advisers to advise their clients to switch, regardless of the consequences.

David Murray is on to it, even if Clive Palmer is not. But there’s hope. The regulations Palmer waved through apply only until December 2015. In November 2014 David Murray presents his final report. Palmer’s no fool. He would probably be horrified at the state of the industry if he took wider soundings. He has 18 months in which to do it.

In The Age and Sydney Morning Herald


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Red tape? You ain't seen nothing yet. 40 job applications per month

Red tape? It’s only just begun. Forcing job seekers to apply for 40 jobs each per month will bombard employers with more than one million applications per day, every working day of every year.

Around 740,000 Australians are unemployed. Even at the peak of the mining boom the total wasn’t much short of 500,000. Forcing most to apply for more than one job per day (while also working for the dole if they are under 50) will see them sending out proforma emails at a pointless rate.

Bendigo has 700 unemployed residents. Making them apply repeatedly to the same pool of employers month after month will drain their ability to apply for jobs they might actually get and drive their would-be employers around the twist.

It won’t be that bad for large organisations with well-resourced human resources departments. They have staff they can assign to worthless work.

But small businesses will have no-one to pass the work to.

“They will be inundated,” says Peter Strong, president of the Council of Small Business of Australia. “It’s an embarrassment for everybody and it’s going to make people angry. The small business person might be having a lousy day and no customers are coming in, but she’ll be getting job seekers. In the hospitality industry most of the time you know straight away whether someone can pour a cup of coffee. You don’t want that person coming back month after month.”

As minister Eric Abetz outlined the new rules on Monday the Business Council of Australia launched a major report stressing the need for businesses to “improve their productivity and strip out costs”...

It’s as if he wasn’t listening. Business Council chief executive Jennifer Westacott says while many aspects of the new model are welcome she is “concerned about the practicality of asking people to apply for 40 jobs each month”.

She is concerned too about how little we are paying unemployed people. Currently just $255.25 per week Newstart will be denied to young people during their first six months out of work and then paid at the lower Youth Allowance rate of $207.20 per week until they reach 30.

Without the resources of the time to properly present themselves for jobs many will miss out.

Peter Strong is surprised. He says usually the government has good ideas about getting people into work and is prepared to talk. He says this is an aberration.

In The Age and Sydney Morning Herald






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Sunday, July 27, 2014

Abbott and infrastructure. Nation building, one elephant at a time

We're on the road to Utopia. Unfortunately.

The team from Frontline and The Hollowmen is at it again.

This time their angle is “nation building – one white elephant at a time.”

Entitled Utopia their new program is “a satire about the difficult process of taking grand, uncosted, inadequately planned and fundamentally flawed schemes - and passing them off as nation building”.

But it’s not the sort of thing you would see in real life is it? Certainly not repeatedly, deliberately, at the hands of the Coalition.

Here’s the ABC publicity blurb: “Set inside the offices of the Nation Building Authority, a newly-created government organisation responsible for overseeing major infrastructure projects, Utopia explores that moment when bureaucracy and grand dreams collide.  It’s a tribute to those political leaders who have somehow managed to take a long-term vision and use it for short-term gain.”

It couldn’t be happening right now, when we are forever being told the budget is tight...

Tony Abbott has his heart set on becoming Australia’s Infrastructure Prime Minister. Whatever the state of the budget he is determined to spend massive sums building the “Roads of the 21st Century,” NorthConnex, WestConnex and the East West Link and so on.

The one saving grace in the election campaign was his promise that all Commonwealth infrastructure spending worth more than $100 million would “subject to analysis by Infrastructure Australia to test cost-effectiveness”. It was reassuring, until he ditched it.

Two weeks ago Labor tried to force the Coalition to make good its promise moving in the Senate that the reward payments made to states that privatise assets and use the funds for new projects be subject to Infrastructure Australia cost benefit analysis.

It rejected the proposal of hand.

Cost benefit analysis by the Commonwealth on top of whatever the states did was “red tape with no additional benefit”. It would “stand in the way of the government building a stronger more prosperous economy,” minister Mathias Cormann told the Senate.

On climate change the Coalition’s detractors accuse it of being anti-science. On roads they could accuse it of being anti-numbers.

And of providing material for Utopia.

That’s how Infrastructure Australia itself sees it. It has titled its latest report on road spending: “Spend more, waste more”. On the cover is a roulette wheel...

“Australia has a true gambler’s addiction to roads, the money spent is not a rational investment,” it writes in the draft that was leaked to Fairfax Media. “Unlike almost every other agency imaginable."

“Highway funding for example is not predicated on any nationally accepted standard related to the current quality of that highway, to a safety rating or to traffic flow levels.”

“No one community has any ability of knowing whether ‘their’ highway upgrade is more deserving than that of another. Under these arrangements, political success in roads is likely to be reduced increasingly to simply outspending one’s political rivals - regardless of how inefficient or ineffective these spending patterns might be.

“This problem is probably insoluble in the absence of measuring roads against national standards.”

It’s an approach endorsed by the Coalition in opposition then eschewed in government. The $3.5 billion to be spent on highways leading to a yet-to-be-built second Sydney airport is the standout example of a project that wouldn’t pass muster if it had to be graded alongside other more immediately worthwhile contenders.

Conceding that its assessment is “challenging” Infrastructure Australia says Australian politicians routinely prioritise roads over rail.

“Australia is the 12th largest economy in the world, and one of the most dependent on freight efficiency given the wide dispersal of its economy across big distances. Most casual observers would presume that for a freight task of such magnitude a core intercontinental heavy rail freight sector would be the dominant freight mode – as is the case in Europe, Canada, the United States and Russia,” it says.

Yet “road agencies continue to plan and undertake regular expensive upgrades of the highways that are the direct competitors of major commercial rail projects. It would be hard to imagine a way in which commercial rail could be further disadvantaged.”

In the cities Infrastructure Australia says inflated estimates of road congestion are routinely used to direct money away from public transport and into roads.  It has asked the government for more realistic forecasts but hasn’t got them.

It says we need better. Utopia isn’t enough.

Utopia premieres Wednesday August 13 at 8.30pm on ABC TV.

In The Age and Sydney Morning Herald











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Wednesday, July 23, 2014

Productivity Commission. Childcare is worth getting right even without an economic payoff

Ask the minister responsible to explain Australia’s present system of support for childcare and she can’t.

“It's impossible to explain,” she told ABC radio on Tuesday. “The current payments are so complicated.”

Sussan Ley isn’t alone. Curtin University Professor Alan Duncan is an econometrician.

When he ran the National Centre for Social and Economic Modelling he asked his programmers to produce graphs of the circumstances in which childcare support peaked and troughed. At first they couldn’t. He says they eventually produced a three-dimensional graph with contours “something like nose cone on a spacecraft”.

The Productivity Commission wants to simplify the graph. Instead of two overlapping benefits its wants one; means tested and related to the number of hours in care rather than what’s charged. Its preferred option would cost an extra $800 million a year. It would help out families on up to $60,000 with 90 per cent of the deemed cost, families on up to $300,000 with 30 per cent.

What it doesn’t do is to pretend its suggestion will much help the economy...

Despite all the talk about how many more women would work if only they could afford childcare it says the likely outcome is tiny, an extra 47,000 workers. As a point of reference an extra 20,000 Australian women gained jobs in the past two months. The claimed one-off benefit of 47,000 is minute.

Remarkably the Commission says it is worth doing anyway. To pay for it it suggests plundering the Abbott government’s proposed paid parental leave scheme. It too promises tiny economic benefits.

But the suggested tradeoff misses the point. Each scheme is worth doing in its own right. Neither is justified on the basis of economics. Paid parental leave at full salary is intended to become a workplace entitlement along the lines of sick leave and bereavement leave. The extra cost would be funded by a levy on big employers. Affordable childcare is intended to ensure that low and middle income Australians get reasonable returns from work. Some things are worth doing even without an economic payoff. Affordable childcare and paid parental leave are two of them.

In The Age and Sydney Morning Herald


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Tuesday, July 22, 2014

MH17. Why planes and financial systems crash

What does the crash of Malaysia Airlines flight MH17 have to do with the global financial crisis?

One was destroyed by a surface-to-air-missile, the other came about because huge numbers of American housing loans became worthless at once. Enabling each was a bet that the unlikely wouldn’t happen.

It’s usually a good bet.

Qantas, Korean Air, and Taiwan's China Airlines weren't prepared to take it. They rerouted their flights to avoid the Ukraine months ago. Their caution cost them fuel, travelling time and profits.

Airlines such as Malaysia, Singapore and Lufthansa took a punt.

“What logic, what lack of sensitivity, and what lack of basic decency influenced Singapore Airlines and Malaysia Airlines and others to expose their passengers to these risks?” asked aviation journalist Ben Sandilands on his blog Plane Talking.

The logic was that the unlikely probably wouldn’t happen, or at least wouldn’t to them. Being slaughtered while flying well above a war zone is what experts call a low-probability, high-impact event.

Coldly risking something catastrophic in the knowledge that it almost certainly won’t happen (at least not to you) is a way to deliver superior financial returns, right up the point when it is not. And it’s rife in the finance industry.

Fund managers get paid for performance. Well ahead of the financial crisis in early 2008 two academics from Oxford and Pennsylvania universities demonstrated that it was possible for a fund manager to consistently deliver superior performance by betting the fund that an unlikely catastrophic event wouldn’t happen.

If, as was highly likely, the catastrophe never occurred the bet would pay off and they would be rewarded for their superior performance. If it eventually did occur they would have already received their bonuses and could leave the fund to collapse, moving on to a new job.

Because fund managers keep their methods secret professors Peyton Young and Dean Foster said it was “virtually impossible to set up an incentive structure that rewards skilled hedge fund managers without at the same time rewarding unskilled managers and outright con artists”.

As they put it, “anyone can cobble together a car that delivers apparently superior performance for a period of time and then breaks down completely”. Airlines can do it, privatised electricity suppliers can do it by not investing in maintenance as Victoria has discovered to its cost during brownouts, and state governments can do it by continuing to allow building in flood prone locations as Queensland did before its most recent devastating flood.

The entire world can do it by acting as if climate change won’t be too serious (although that’s probably better described as a medium to high probability high-impact event).

And the manufacturers of financial products can do it...

In the leadup to the global financial crisis they created products sprinkled with loans that could never be repaid if housing prices fell. But they bet that prices wouldn’t fall, not all at once. Compliant ratings agencies produced estimates of how unlikely such an event was. When it happened the products and the financial institutions that created them became worthless. The government rescued the important ones and much of the world slid into recession.

There’s no quick fix to stop it.

Part of the solution is better regulation, something the world’s financial authorities are on to after the global financial crisis. But regulation usually only closes a door after a crisis. Then a different unforeseeable event occurs creating another crisis creating another regulation.

As strange as it seems rewards for performance are probably a bad idea. They are what encouraged reckless practices in the United States. If Qantas schedulers were paid bonuses for speed they might have been keener to flirt with danger.

On the other hand real ownership could help. Paying employees in shares that couldn’t be cashed in for years would encourage them to be careful, as would requiring maintenance engineers to engrave their names of the fuselage of the planes they repair - a practice that is said to take place in Japan.

The best antidote is probably a rigorous cost benefit and risk analysis performed by someone whose pay cheque doesn’t depend on the next month’s profit.

The Coalition embraced such an idea in its September election policy. All Commonwealth infrastructure spending exceeding $100 million was to be “subject to analysis by Infrastructure Australia to test cost-effectiveness and financial viability”. Even state government projects only partially supported by the Commonwealth were to face Infrastructure Australia scrutiny.

No longer. On Thursday the government rejected a Senate resolution that would have given effect to its own policy. Labor moved that the reward payments made to states that privatise assets and then use the proceeds for new projects be subject to Infrastructure Australia cost benefit analysis. It would have covered the Metro Rail project and anything else funded by the sale of right to use the Port of Melbourne.

The Coalition said no.

Commonwealth cost benefit statements were “red tape with no additional benefit”. They risked delaying “the delivery of critical infrastructure”. They would “stand in the way of the government building a stronger more prosperous economy and investing in new infrastructure,” according to the finance minister Mathias Cormann.

But when lots of money or lives are at stake, delay is often a good idea. There’s a lot to be said for caution.

In The Age and Sydney Morning Herald


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Thursday, July 17, 2014

The carbon tax is gone. Will prices come down?

The good news is that without the carbon tax you won’t paying $100 for a Sunday roast.

But you never did.

Ahead of the carbon tax in 2009 the present minister for agriculture Barnaby Joyce said the carbon tax would be “the end of Australia’s sheep industry”.

“I don’t think your working mothers are going to be very happy when they are paying over $100 for a roast,” he added.

In parliament this week asked whether he had found a $100 leg of lamb Mr Joyce dodged the question. At Woolworths this week a leg of lamb was on special for $15.10. It normally sells for $20.38.

As it happened the Treasury modelled the price of lamb when it modelled the carbon tax. It said the price would rise by 0.4 per cent, suggesting the price might have climbed 20 cents.

It’s impossible to tell what did happen, because for food the expected movements were so small as to be difficult to notice.

In the first consumer price figures released three months after the carbon tax the Bureau of Statistics says the price of lamb fell, sliding 2.3 per cent. It has since fallen a further 10 per cent, making any movement of 0.4 per cent difficult to discern.

This isn’t to say that lamb isn’t slightly more expensive than it would of been had there not been a carbon tax. It is merely to say to say that the effect is impossible to measure.

The Australian Competition and Consumer Commission had some power to restrain price rises attributed to the introduction of the tax. It could take action against false, misleading or deceptive claims linking price increases to the tax.

It has no such power over most prices on the way down. It can merely monitor.

Will the price of a leg of lamb come down by 20 cents because of the removal of the carbon tax? So long as the retailer doesn’t make any claims about the carbon tax it can charge whatever it likes. Last minute amendments to Clive Palmer’s carbon tax amendments make sure of that...

Insisted on by Liberal Democrat senator David Leyonhjelm and Family First senator Bob Day, they restrict penalties to just to just 60 or major energy suppliers.

“They are big enough and ugly enough to look after themselves,” Senator Day told Fairfax Media.

But the treasury expected the electricity and gas component of the carbon tax impost to add just add just $4.80 per week to a typical household budget ($3.30 for electricity, $1.50 for gas).

Total costs would climb $9.90 per week. Although big, the electricity and gas component didn’t account for the bulk of the $9.90. What did account for it was a multitude of small price changes. The treasury counted around 80, many of 0.4 per cent.

If the bulk of the price burden was made of adjustments too small to notice on the way up it will be impossible to notice on the way down. Whether or not retailers pass on lower costs will be up to them, and most of their customers will be none the wiser.

Electricity prices should come down by about 10 per cent, gas prices will be about 9 per cent lower than they would have been, except that the price of gas is unlikely to come down at all. Last week the NSW Independent Pricing and Regulatory Tribunal approved gas price rises of between 14.6 and 18.1 per cent.  A new processing complex at Gladstone in Queensland will allow eastern Australian gas to be sold at world prices for the first time. Eventually our gas price could double.

The prime minister says the saving per household from axing the tax is likely to be $550 per year. It’s more likely to be $250 or less, mostly on electricity. And don’t expect cheaper petrol. Petrol and the fuel used to produce and move it was carbon tax exempt.

In The Age and Sydney Morning Herald


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Wednesday, July 16, 2014

Superannuation. The financial system inquiry is talking about a revolution

And there were those who said it would favour the banks

The financial system inquiry has proposed a revolution in Australia’s superannuation system that would vanquish high fees and force Australians to take more super as income rather than lump sums.

Unveiling what are officially called “options” rather than recommendations, inquiry chairman David Murray raised the prospect of a 40 per cent cut in fees across the entire sector.

Such a cut would deliver a saving to members of around $7 billion per year. It would boost the average retirement payout by $40,000.

“I’ll take some flack for suggesting this, but it’s too important not to,” Mr Murray told the National Press Club.

Australian fees are twice as high as those in countries with similar sized systems. Superannuation itself is much more heavily weighted to riskier assets such as equities.

The report suggests banning borrowing by super funds and slowing down the process by which members can switch funds which it says encourages providers to hold more short term assets than they should.

Its most radical suggestion is that Australia follow the lead of Chile and auction off the right to be the nation’s default super fund. The firm offering to charge the the lowest fee would become the default provider for all new accounts until the next auction. Chile used the system to cut default fund fees by 65 per cent...

The inquiry also wants some sort of restriction on the ability of Australians to take and spend super lump sums knowing they can fall back on the age pension. It’s most extreme option would mandate the setting aside of a portion of lump sums for so-called deferred annuities which would pay out only after the age of 85 should the retiree live that long.

It is caustic in its findings about superannuation tax concessions observing that most go to the top 20 per cent of earners, people “likely to have saved sufficiently for their retirement even in the absence of compulsory superannuation or tax concessions”. It is likely to recommend changes to the system of super tax concessions that could form part of the white paper on tax reform to be developed next year.

Mr Murray refused to be drawn on whether if super fees come down there would still be a need to lift Australia’s compulsory super contributions from 9.5 of salary to 12 per cent as is presently legislated, saying the inquiry would be happy to receive submissions on the topic before it prepares its final report to be released in November.

Set up by treasurer Joe Hockey to to update the 1997 Wallis inquiry in light of the global financial crisis, the Murray inquiry finds the financial system is at risk from the perception that Australia’s big four banks are too big to fail and would be rescued by the government.

It floated several options to deal with what it calls “moral hazard” one of which is ring-fencing crucial bank functions such as taking deposits and writing home loans from other activities.

Although a former chief executive of the Commonwealth Bank Mr Murray is harsh in his criticism of the banks’ systems for rewarding their financial planners.

“The thing we have been very clear on is our view that conflicted remuneration can weaken advice,” he told Fairfax Media.

“There's not much we can do at the moment. The government is in the middle of having this voted on in parliament. But there is an information asymmetry between an advisor and a client, one we will be addressing in our final report.”

The interim report suggests outlawing the term “general advice” and replacing it with “sales” or “product information” if the people providing it continue to receive payments from the providers of financial products.

A spokesman for Mr Hockey said the treasurer would not be commenting on the report. It was Mr Murray’s and it was up to him to outline it. Labor’s treasury spokesman Chris Bowen said he would give it due consideration.

In The Age and Sydney Morning Herald


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