One mightily damaging backstory: 1MDB

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Hello and welcome to the Intelligence on Economist Radio. I'm your host, Jason Palmer. Every weekday we provide a fresh perspective on the events shaping your world. The pandemic hasn't really shaken the banking industry since the financial crisis. Regulators have shored it up well, but that has driven a rise in what are called shadow banks. We examine a grand shift to a less regulated end of the industry. And in the Chinese province of Yunnan, wild mushroom picking is big business. Local mushrooms might make it to South Korea, Japan, even Europe. We visit a market where business is brisk even though the pandemic has driven prices down. But first, yesterday, the former Prime Minister of Malaysia, Najib Razak, was sentenced to 12 years in jail after a court found him guilty in the first of several corruption trials.

Did you predict the result? Did I predict the result? I must be some sort of soothsayer if I can predict the result. But as always, you hope for the best, but you prepare for the worst.

He was convicted on seven counts of abuse of power, breach of trust and money laundering for his role in the 1mdb corruption scandal for which he denies all wrongdoing. The state owned One MDB Wealth Fund was set up in 2009 when he was prime minister to raise funds for the country's development and to help some.

Of its Poorest people.

But Malaysian and American Authorities say that $4.5 billion was plundered from the fund and spent on, among many other things, a yacht, a jet and an Oscar trophy that once belonged to Marlon Brando. The scandal goes beyond just the former Prime Minister. Last week, American bank Goldman Sachs reached a $3.9 billion settlement with the Malaysian government for its role in raising six and a half billion dollars for the scheme. Having been charged with misleading investors when it broke, the scandal upended Malaysian politics and it could and there are still more trials to come.

This is definitely not the end of the world because there's a process of appeal and we hope that we would be successful there.

One MTB has dominated Malaysian political life since the scandal first broke.

Miranda Johnson is the Economist's Southeast Asia Correspondent and is based in Singapore.

In 2018, the party which had ruled Malaysia for 61 years, lost power in part because of its involvement with one MDB and in particular the involvement of Najib Razak, who was the Prime Minister at the time.

And what is it exactly that he's accused of?

So Najib Razak was the chair of the one MDB State Investment Fund and he at the time, as well as being Prime Minister, was also Finance Minister and so had overview of a lot of government linked entities and companies and other business that went on in Malaysia when the 4.5 billion disappeared over a number of years. From one MDB, prosecutors charged that he should have known what was going on. He now faces more than 40 charges related to one MDB. He also faces five criminal trials in relation to those.

Mr. Najib has ended up as the focus of this, but it was a.

Far wider scandal, right?

Yes. I mean, we're talking a huge financial scandal. Some of the money from one MDB went towards buying paintings by Monet and Van Gogh. It went towards diamond jewelry, a superyacht. Some of it went to fund the Hollywood film the Wolf of Wall street, which as many will know, is about financial scamming, which seemed apt. So this really was a scam of quite epic proportions. Another alleged mastermind in the scheme is one Joe Low, who is wanted by the Malaysian authorities. Joe Low is an interesting character in of himself a family friend.

Friend.

Initially he was educated in England and then became quite famous on the party scene as he held lavish gatherings Paris Hilton attended sometimes. He seemingly became friends with Leonardo DiCaprio and was very much caught up in all of this. But nobody quite knows where he is. He denies all wrongdoing. Another figure in all of this is Reza Aziz, who is the stepson of Najib Razak who became a Hollywood producer and actually his production company, Red Granite Pictures, produced the Wolf of Wall Street. He was accused of laundering $248 million in money misappropriated from one MDB. But a deal was reached in May in which money laundering charges against him were dismissed and in return he will return assets worth more than 107 million to the Malaysian authorities.

And so what has Mr. Najib's defence been?

His main defence has been that he didn't know what was going on and that he was duped by rogue bankers and by Mr. Jho Low, something Mr. Jho Low denies. The judge in his most recent verdict poured water on that defense really by saying it's, you know, unlikely that he wouldn't have had any idea what was going on in his own bank accounts. And also questioned Mr. Najib's defense that a lot of the money he was seeing was actually a political donation from Saudi royalty. At one point the judge even asked, you know, if it were all a donation from King Abdullah who was the previous Saudi monarch who died in 2015, if it were all a donation, why didn't you write a thank you note to King Abdullah? So some disbelief from the judge.

So if a lot of people at the top of Malaysian politics have been drawn into this tale, then what knock.

On effects has it had in politics?

Well, the most obvious effect came in May 2018 when Mr. Najib and his party, the United Malay National Organization, which goes by umno, were booted from office after more than six decades in power. And that was a very unexpected result. The man who once was Mr. Najib's deputy prime Minister and who in fact was fired by Mr. Najib because he called out his bosses management of the one MDB scandal once it broke. That man, Muhiddin Yassin, is now actually the country's Prime Minister because in the fallout from the one MDB scandal he helped to co found an alternative party for umno and that was part of a coalition which won in May 2018 and booted out UMNO and its allies.

And for the Malaysian people, do you think yesterday's conviction will seem like the.

ROT has now been cleared out of Malaysian politics?

Or do you think that's still to be seen?

I think it's still to be seen. We're very much going to wait on what happens at the Court of Appeals with all of this and of course it is in everyone's minds anyway. Because of the recent deal between the Malaysian authorities and the bank Goldman Sachs, it reached a settlement for its part in underwriting three bond offerings, which raised $6.5 billion for one MDB. As of last week, the bank has agreed to hand over $3.9 billion. In return, it's paying $2.5 billion in cash and promises to give back at least 1.4 billion in assets linked to the bond money. So it's all still very much ongoing. As long as one MDB is in the public mind, it will make things a little trickier for UMNO going forward.

Miranda, thank you very much for joining us.

Thanks Jason.

For more analysis from our international network of correspondence, subscribe to the Economist. To find the best introductory offer wherever you are, just go to economist.com intelligenceoffer in the financial crisis of 2007-2009, America's Federal Reserve had to go to great lengths to prop up the banks that were considered too big to fail. But it only intervened a bit in stock and bond markets. Yet earlier this year, when the economy seized up again, the script had flipped. Banks went relative unscathed, but the Fed splashed out with more than $20 trillion for those capital markets. Behind that swap is a decade of major change. Banks have become safer, but they've been upstaged by innovative financial firms offering a range of services. These non banks or shadow banks, fuel corporate borrowing and have become America's biggest mortgage lenders.

So banks are easy to define. They hold consumer deposits, they're regulated by the Fed, and in times of crisis they can borrow money from the Fed directly.

Alice Fullwood is the Economist's U.S. finance correspondent and is based in New York.

Shadow banks are anything that might not be covered by that banking definition. So this includes century old pension fund and insurance companies as well as sort of very new fangled types of investment funds like exchange traded funds which allow retail investors to invest in bonds and also things like private equity and hedge funds.

And it's all those institutions then that you say are getting more powerful these days?

Precisely. So I guess if you look from the perspective of the traditional customers of banks, so these are small businesses, medium sized businesses, and also consumers. If you look at who they are borrowing for, banks have become increasingly less important and non banks more so. So if you look at corporate lending as a share of GDP, the amount borrowed from banks has stagnated at about 12% even as corporates have gone on a sort of debt binge over the past 10 years. Corporate debt added just in 2012. Banks lent about 2 percentage points of GDP and non banks lent 6 percentage points of GDP. So significantly more lending is coming from the non bank sector than the bank sector. At the same time, if you look at the sort of bread and butter consumer borrowing, which was Mostly mortgages, in 2007, 80% of mortgages were created by banks. But today more than half are originated by non banks and they ultimately will end up being held by investors. So for those two classic ways in which people borrow, banks have become increasingly less important and shadow banks more so.

And why is that, why that shift of importance of these shadow banks?

There are two reasons that people tend to posit for why shadow banks have grown increasingly important. And the first one is regulation that was enacted in the wake of the global financial crisis. This took the form of the Dodd Frank act which was passed by Congress in America, and also a lot of regulatory actions made by various international bodies of central banks and things. And these basically required banks to hold more capital and it also asked them to take less risk. So banks tend to do sort of less of the risky, jazzy credit provision in an economy as a result of this. But at the same time, the Fed in America was trying to stimulate lending by keeping interest rates low. So inevitably, if banking sector is restricted in its lending and you're trying to keep lending going, that lending is probably going to be done outside of the traditional banking system. And that is precisely what has happened. The second thing that people talk about is innovation, and this is in particular exemplified by the rise of many fintech companies post crisis. You know, most of these firms were only founded a decade ago, but they have since grown to be sort of relatively important players in America's financial system. For example, Stripe, which is the sort of big payments company, was most recently valued at sort of $36 billion. Quicken Loans is a big mortgage broker. It became the largest provider of mortgages in America in 2018, largely, seemingly because it just has a sort of much nicer website and more responsive call centers than the banks do. Fintech has sort of taken over more of the front end customer acquisition side of things and has also muscled into payments. And these things sort of make it easier for other non banks or other shadow banks to also function.

But if the primary reason that all of these shadow bank institutions have risen in recent years is because they are in some way not subject to all of the onerous regulations that traditional banks are subject to, doesn't that make them inherently more risky? Even if they are sort of, you know, plucky startups with Whizzy websites.

It's definitely true that shadow banks are taking on many of the risks inherent to the banking system. So the reason that banks are so heavily regulated is that they are susceptible to runs. And what regulators have tried to do with the shadow banking industry is carve out the slice of shadow banks that are doing things that might also make them susceptible to runs. The regulator that's been looking at this most closely is the Financial Stability Board. Worldwide, the FSB identified about $50 trillion worth of assets that were held by shadow institutions that might be doing things that made them susceptible to runs. And they thought that about three quarters of that was held in instruments that were susceptible to being run. And that's almost doubled since 2010. It's grown very quickly post crisis. So it definitely seems as though there are a lot of shadow banks taking the same risks that banks do, which possibly suggests that it is just a regulatory arbitrage that has given rise to these institutions.

And I guess where you see these risks really borne out is when there are times of crisis. And certainly this year must fit that description. I mean, how have these different halves of the banking industry looked as we've gone through the pandemic?

The financial panic brought on by COVID19 in March and April this year was unusual for many reasons, but it was quite interesting from the perspective of the financial system, because actually the banks looked entirely fine. Instead, all of the places that the Fed had to intervene, it was all exclusively in capital markets. So they had to buy up more Treasuries. The corporate bond market completely ceased functioning until the Fed said that it would buy corporate debt. It has lent directly to money market mutual funds. And through all of these sort of various liquidity and funding schemes that it set up to all of those sort of markets, it ultimately was underwriting about $23.5 trillion worth of securities. And that is an enormous intervention that far outstrips anything that they've ever done before in capital markets. And it does raise the question of whether the banks are sufficiently safe and the risk has migrated elsewhere.

So what are we to take from that? That the Fed did have to step in and to a degree prop up this, this relatively new, this enormous part of the banking industry, in your view, all told, is this big shift within the financial system to the good.

In one way, it might be better that at no point were the banks in trouble. You know, banks are still sort of very important institutions, and when one of them fails, it can sort of imperil the entire financial system and the entire economy. This idea that you've migrated some of the risk inherently associated with intermediating financial markets away from the banks and towards shadow banks might make the system as a whole less vulnerable. So it's not necessarily a bad thing that shadow banks have become more important. But there is this sort of problem that people have long worried about with banks, which is that if you think that regulators will step in and save the day during a crisis, then perhaps you might take more risk in good times, make more profits in good times, on the sort of assumption that you will be fine for through bad times. And there is this concern put forth by some regulators now that you've set this precedent that the Fed will step into markets in times of crisis and that possibly could lead to less prudent risk taking. It seems very likely that shadow banks will be looked at more skeptically by regulators going forwards.

Alice, thank you very much for joining us.

Thank you, Jason.

It's not just the consumer end of banking that's changing. The role of central banks is undergoing a seismic shift these days too. The latest episode of Money Talks, our sister podcast on business and finance, looks at how governments are pumping money into their economies. The renowned economist Claudia Sahm wonders whether a new age of macroeconomics is upon us. Listen to Money Talks from Economist Radio wherever fine podcasts are sold. In May, when the monsoon season starts, foragers in China's Yunnan Province begin their hunt for wild mushrooms. The damp forests host a staggering variety of species, many of which are extremely valuable. The annual harvest provides money for thousands of families in the region. But knowing what to pick can be a life or death skill. And the COVID 19 pandemic has made the trade less profitable. Stephanie Studer is China correspondent for the Economist and is based in Beijing. Last month, she joined a local grandmother on a picking expedition.

So my colleague and I arrived at the Nanhua mushroom market in Yunnan Province early in the morning on a weekday and it was already bustling. Lots of people there already trading their pickings from that morning. Most of them had been up since about 4am and so these grandmothers would come in. They have wicker baskets strapped to their backs and they are filled with mushrooms. Some of them just have plastic bags and they're coming in and pouring these mushrooms out onto piles on the floor. And there's all sorts of colours. You've got red mushrooms and yellow ones and then these sort of fantastical looking mushrooms that change colour when you touch them. They develop these green bruises, which is why they're known as green Pinch mushrooms, and they were particularly popular at this time of the season. And then we met Yang Hong Yin, one of the older ladies that had been already out on the hunt in the morning. And had a pretty good basket of mushrooms. So then we asked Yang Hongying if we could join her the following morning for her daily hunt.

And how was it?

Well, we had to be up at 5am so we were out on the mountains and starting at the crack of dawn to look for these precious mushrooms. Within a few minutes, we had already found a couple of mushrooms that she was going to sell. But what she and others are really looking for on the mountains at dawn are matsutake, which are beloved of Japanese foodies, as well as morels and chanterelle. And many of these mushrooms do in fact, end up on South Korean and Japanese dinner plates.

So it sounds like mushroom picking is.

A pretty big business, all told.

It is. If you gather all the grandmothers, families and children of Yunnan who go mushroom hunting every season, which runs from May to October, they gather 160,000 tons of wild mushrooms a year, and that generates income for Yunnan of about 10 billion yuan, which is over a billion dollars. Yunnan in the southwest is a fairly poor province still, and it relies on agriculture, and so this is a big part of its income.

But this year, the pandemic has put.

A dent in demand.

Well, the local hunters were telling me that they felt demand was very much down this year. You would usually chefs in China coming to the region to buy the fresh wild mushrooms off them, and they only last for about four days. And if they're not sold in that time, then they need to be dried or preserved in other ways, in sauces and relishes or frozen. So they felt that those people simply hadn't been coming.

And what about the basic safety issue? I mean, not every mushroom on the forest floor is edible.

They are not all edible. And in fact, on our hunt, there were some poisonous ones pointed out to us. For many years, there was a condition in the province known as Yunnan, unknown cause, Sudden death syndrome. And it used to strike remote villages in clusters, usually during the monsoon. And nobody could quite work out what was causing it. And then in 2012, the Kunming Institute of Botany said it had discovered a new species of mushroom, which was known informally as little white, which looked remarkably like a button mushroom. And they suspected that villagers had been gathering this mushroom with the rest of their hunt and eating it. Of course, in among this great diversity of mushrooms in Yunnan, there are the magic sort as well. In fact, the green pinch mushroom that's being sold now. If you don't cook it well enough, then some claim that they see little blue men dancing in front of their eyes. I didn't try it myself.

Thanks very much for your time, Stephanie.

Thank you, Jason.

That's all for this episode of the Intelligence. If you like us, give us a rating on Apple Podcasts and see you back here tomorrow.

Sam.