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The Davalos Affair For Idiots

From: andrew cooke <andrew@...>

Date: Sat, 25 Apr 2015 18:55:44 -0300


  This is a loose translation of
  by Matias Godoy Mercado.

  I cannot guarantee the truth of what is written below for two reasons.
  First, my Spanish is imperfect.  I am particularly unsure of technical terms
  (eg "impuesto de primera categoria").  Second, I don't have the general
  knowledge of Chilean politics necessary to check the details given (I am
  translating partly to learn about these things myself).  So please use the
  original (linked above) as reference.

  See also
  * Another Tax Fraud
  * The SQM Affair For Idiots
  * The Penta Affair For Idiots

  I generally translate the names of government institutions and common
  Chilean details (like boletas), but leave untranslated names of companies
  and political parties.

  My comments are [in square brackets].  Comments (in parentheses) were
  present in the original.



In the following column I [ie Matias Godoy Mercado] hope to explain and
critically analyse the "NueraGate Affair".  I prefer to call it the "Davalos
Affair".  Others call it the "CAVAL Affair", from the name of the company
involved.  It's just a question of taste.  The last few days [written
2015-02-16] the press have been all over this case.  The government has had to
face this offensive, which has included the resignation of President
Bachelet's son, Sebastian Davalos.

In the first part I will try to explain, simply, the details of the case.
What happened?  To whom?  When?  And, most importantly, how?  Although perhaps
there is not a convincing answer to the final question.

In the second part I will critically analyse the seriousness of the case.  And
yes, it's serious.  Leave the politicking and the politics (which are not the
same) aside, this case is a serious threat to the economy of the country.
Some accuse me of exaggerating.  It's possible they are right, but strong
evidence and (I believe) common sense suggest that it has damaged an important
pillar of the economy: confidence.  I would like you to read in detail how I
think this case damages the country's economy, with the hope that future cases
are taken seriously, and avoided.  Please read on.

The Davalos Affair For Idiots

Really, there's not much to explain.  Sebastian Davalos is the oldest son of
President Michelle Bachelet.  A political scientist, he was given the post of
"Director Sociocultural de la Presidencia."  Normally this position is given
to the First Wife.  Sebastian Davalos is married to Natalia Compagnon, also a
political scientist.  Keep Natalia in mind as the column develops.

The story starts here.  Natalia is the owner of the company Exportadora y
Gestion Caval Limitada.  Sebastian Davalos works in that company as Head of
Projects.  This company, despite having few assets, managed to obtain a loan
from the Bank of Chile of 265,980 UF, or approximately $6,500m [USD 10m].  To
obtain this credit the company paid for the services of a long serving manager
of current accounts of for important people in Chile's history, including
Augusto Pinochet Ugarte.  With this money the company bought 44 hectares of
land in the Machali commune, VI Region.

The Deal

So far, so good.  A credit, buying land.  OK.  The key is that this week the
sale of this land will be closed.  Exportadora y Gestion Caval Limitada will
sell the 44 hectares en Machali to the developer Ruta 68.  This deal will
allow Caval Ltda to pay back the loan, which with interest, amounts to
$7,000m, giving a profit of $2,500m.  So Banco de Chile and Caval Ltda made
very good business.

Now, how?  How can a company with few assets get a loan for $6,500m?  The
Davalos factor.  In some way, this small company managed to get a meeting with
one of the owners of Banco de Chile, Androniko Luksic.  That meeting included,
of course, Sebastian Davalos.  After the meeting, with one of the owners of
the bank, they were told of the approval of a "bullet" loan.  A bullet loan is
one in which the debt is repaid in a single repayment at the end of the
period.  In this case, after 180 days.  Caval Ltda got what it needed for the
perfect deal.

Use of Privileged Information?

The criticism starts here.  Caval Ltda bought land for $6,500m and sold it for
$9,500m.  In less than 6 months the land increased in value by over $3,000m.
How?  It turns out that for several years people have been expecting a change
to the planning regulations for the VI region, which would reevaluate much of
the area, particularly in the Machali commune, which is considered the upscale
area of O'Higgins.  One thing is to expect.  Another is to know.

There are two economic concepts that I'd like to introduce at this point in
the column: certainty and the use of privileged information.  Individuals take
decisions under different levels of uncertainty.  If you throw a dice, there's
the certainty that you will throw a 1, 2, 3, 4, 5 or 6 with equal probability.
Let's suppose that one night Snoopy decides to go to the casino "Peanut's
Dreams."  Snoopy goes to a table where they're playing dice.  Snoopy will win
a lot of money if he places a bet on the number rolled.  The risk is high,
because any number has an equal chance of being chosen.  But let's suppose
that Snoopy knows that the dice is loaded, in favour of the number he will
chose.  It lowers the risk, right?  The problem now is that to throw the dice
he has to gamble, but he doesn't have the resources.  No worries - his friend
Charlie Brown, is son of the President of the Republic, and is friends with
the people at "Peanut's Dreams."  So now Snoopy has everything.  Thanks to his
friend Charlie Brown he can get the money to bet, and he knows that the dice
is loaded.  A done deal.

Snoopy is Natalia Compagnon and Charlie Brown is Sebastian Davalos (to be
completely clear).  In many countries, to bet when you know the winner with
certainty, is a crime.  In Chile the punishment is a fine.  In the US the law
is more severe - you can be jailed.  To bet on a winner with certainty is
called "use of privileged information."  The person who leaked the information
and the person who uses it for personal or third party gain can both be
prosecuted.  In this particular case it has not (yet) been proved that
privileged information was used.  But attention is focused on the
relationship between Natalia and the eldest son of the President of the
Republic, with all that implies about access to information.

Common sense says that no-one asks for a load of $6,500m to gamble.  More than
that, common sense says that a profit of $2,500m is not just luck.  Common
sense says that that there was access to privileged information, given the
high political position of Davalos.  Common sense says that Luksic would not
have approved such a large loan for a simple bet.

The Principle Of Equality

Why is the use of privileged information a crime?  There are people that
excuse it.  There are even people that say it shouldn't be a crime.  Important
considerations, but the evidence is clear: it is a crime.  But why?  It's
believed that the use of privileged information works against the equality of
market participants.  I agree.  There is an inequality.  There are people that
know more and benefit.  Those that don't know, don't benefit, or arrive too
late for the benefit.  It's not fair.  It leads to the idea of an injustice.
But more than the moral argument, there are economic arguments, too.  A
market where only some gain (generally a minority) and the rest lose
(generally a majority) - what is the point of investing?  Imagine a casino.  A
few win and everyone else loses.  The ones that win, win big.  Why would you
continue going?  Because you hoe to win one day, because you have the hope
that one day it will be you.  But what happens if it's always the same people
that win?  Would you still go?

You can apply this to the economy.  A market where only a few win, and many
lose, is not an attractive market.  This motivates social unrest against
institutions, against the bank, against the economic system in general.  This
discourages investment (particularly foreign investment) and reduces job
creation.  In the end it's not just that people lose because they don't win,
but also they don't have the money to return to the table.

Access To The Bank

When you ask for a loan the banks evaluate your risk and solvency.  Both
variables help assess you risk of default.  Generally, they look at your
assets, or the assets of a cosigner.  Many good business ideas - innovative,
profitable - fail to get financed because they have no assets.  So how did
Caval Ltda get a loan of $6,500m?  The certainty.  In this case the risk of
default dropped significantly with the presence of Sebastian Davalos.  Not in
terms of assets, but in in terms of the economic, financial and accounting
information that he provided in his meeting with Mr Luksic.  It's not chance
that, after that meeting, the credit was approved.

Unfortunately, not all Chileans have the same luck.  Companies with similar
assets to Caval Ltda, or more, can't find loans from the banks.  A "bullet"
loan to a PYME [small or medium business]?  Dream on.  This isn't a crime, but
it feeds the point mentioned earlier: inequality.

Economic Growth?

One final point.  Here there was a transfer of land.  Was there any creation
of jobs?  No.  Was there increased production?  No.  The only positive
economic effect of this operation is the spending on goods and services that
the Davalos Compagnon family can make with the profits, or the tax that
government can claim from deal [technical details I do not understand about
exactly what that tax is].  The rest is smoke.  No salaries were raised, no
production was increased.  This is called "false luxury."  It's not a
criticism, but something to bear in mind.  A simple transfer of money.
Because what the family Davalos gained was paid for by Ruta 68.  Maybe the
shareholders of Banco de Chile gained something.


This part is typically where I am most angry.  Here I will summarise and throw
darts.  In summary: possible use of privileged information, unfair access to
to the bank, and no economic growth.  A crime and three disincentives for the
economy.  Bad.

Talking of which, my postgraduate thesis was on this: "The Use Of Privileged
Information In The Chilean Stock Market."  I analysed more than 400 price
changes.  En a little less than 25% of the cases there was statistical
evidence of the use of privileged information.  What signs?  Unusually large
profits.  Like this, like the profits of the Davalos Compagnon family.  The
family of the son of President Bachelet, or the daughter in law, if you prefer
that link.  This means that the use of privileged information is common.  This
is surely because of the flexibility of the law.  The fines that have been
charged were not sufficiently exemplary, to the point that the son of the
current President is possibly involved in such things.  Incredible.

The economic harm is regrettable.  The sensation of unfairness, the growth of
inequality, the unequal access to the bank, the lack of any economic growth
from the action, are all consequences of this type of conduct.  Inequality is
a brake on economic growth.  Evidence shows this.  Countries that are more
transparent, that are more harsh in punishing these actions, encourage
confidence and the growth of their economies.  More jobs, higher production,
better education, etc.

To end.  A call to the authorities.  The Ministry of the Interior and Public
Security, Rodrigo Penailillo, indicated that the case was closed with the
resignation of Davalos.  A sign of immunity.  President Bachelet has
repeatedly talked about the fight against in equality, identifying as a focal
point the Chilean education system.  Yet the action of her own family, in this
case, doesn't only illustrate the inequality that exists in Chile, but also
obtains huge benefits from it.  The end of inequality begins at home.  If not,

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