Month: January 2008

Three cheers for the Fed. One cheer for each 25 basis point cuts in interest rates announced as an emergency measure yesterday. It did the trick, limiting the savage market decline, and turning round the Asian markets which had been in freefall the previous day.

The US authorities have made it clear to the markets that they are going to stop a recession if it is in their power to do so. They have made aggressive moves in reducing interest rates. This will help a great deal. It means that many mortgage holders and companies in debt will now be able to afford their interest payments and repayments, improving the quality of the loan assets on the balance sheets of the banks and those held in securitised form. It means that all those financial companies that have borrowed so much to sustain the easy credit of earlier years will also have some relief on the amounts they have to pay in interest. The whole financial structure in the US is a little less unstable as a result of this development.

As I argued yesterday, two conditions need to be fulfilled for recovery to get underway. The first is lower interest rates. The second is the recapitalisation of the banks, so they have the stronger balance sheets they are going to need to lend people and companies more money again. This process can happen by the passage of time, as they trade profitably. It can be speeded up by cutting or cancelling dividend payments, or by raising new money from shareholders.

The gyrations of world markets in the last few days shows that the Indian, Chinese and Japanese markets are still very influenced by perceptions of the state of the US economy. All three are important exporters to the USA and are influenced to some extent by US conditions. The internal strength of the Indian and Chinese economies is becoming more obvious, but it is not thought sufficient to offset the full blown US recession which some market participants feared.

The Governor of the Bank of Englands remarks showed how far behind the plot the UK now is. The worse circumstances of the UK economy as a result of recent policy are now dragging it down relative to the US and the Asian giants. As the Governor pointed out, we have a bad inflation problem this winter. The governments own borrowing requirement was far too large before Northern Rock hit, only to be made far worse by the Northern Rock debacle. The big build up in UK public spending and borrowing, and the poor productivity of the enlarged public sector, all limit the UKs room for manoeuvre, at a time when the UK too needs lower interest rates to relive pressure on its financial system. The government is trying to control public spending at last by clumsy interventions on public sector pay, but still lacks a grip on large projects and staff numbers.

A recession can be averted in the US. The UK will experience a sharp slowdown, which will be made worse if the Chancellor presses on with plans to increase capital gains tax on entrepreneurs and with damaging plans to tax non doms too much.

Traffic Blackbook Review

Yesterdays vote and proceedings in the Commons show the grim reality that unless the Lib Dems honour their promise of a referendum there is no chance of us gaining one.

Yesterday was the Second Reading. The issue was simply ?? do you want this Bill and this Treaty at all? Conservatives and 19 Labour rebels voted against the Bill and Treaty in its entirely. Lib Dems and the rest of the Labour party voted for it, giving them a huge majority.

The Labour rebels put down a motion to deny the Bill a second reading because there was no referendum offered. This was not an amendment which could have led to a referendum ?? it was another way of saying Lets veto the whole bill. Their proposal was not called. Had Conservatives put our name to it as well, and had it been called, it would have ended up with the same outcome as we achieved by simply voting against Second Reading outright.

The opportunity to force a referendum comes later in Committee, when any MP can table a referendum amendment to the Bill, in the form that this Bill will only come into effect if there has been a referendum and if the public has voted Yes. The Conservatives will table such an amendment and vote for it, or support a Labour one if they table it first. We do not wish to see competing referendum amendments, and may prefer Labour to choose the words they want to maximise their support for it.

Either way we need the Lib Dems to vote en bloc for a referendum. Their slippery Leader finally this morning on the Today programme let slip he would vote against a referendum on the Treaty, tearing up their election promise. All those of us who want a referendum on this Treaty need to maximise pressure on these treacherous Lib Dems, as well as encouraging more Labour rebels, if we are to have any chance of stopping this juggernaut Treaty that the public does not want.

PS: The Conservatives have now tabled a suitable referendum amendment as New Clause 1.
<strong>Click <a href="http://www.johnredwoodsdiary.com/2008/01/22/john-redwood-speaks-in-eu-constitution-debate/">here </a>to read John Redwood’s contributions to the debate on the EU Treaty.</strong>

The collapse of Stock markets around the world should come as no surprise. As readers of this blog will know, the years of easy credit were decisively ended last August when the financial community woke up to the reality of the securitised loans crisis, aided by the Central Banks at last in tighten mode after years of sloppy credit.

A credit crunch means there is little new credit available at a time when too many people and companies are desperate to sell assets to raise the cash they need. Investors with cash suddenly decide they want to hold more cash. Investors who have been investing on borrowed money have to rein back their activities and pay down debt. Banks that were able to lend people money and then package the loan up as security to sell to someone else suddenly find there are no buyers for these packages. As a result asset prices crash.

A credit crunch ends when two conditions are met. The Authorities have to signal they want easier credit by lowering interest rates, so high borrowings become affordable again. Banks have to sort their balance sheets out so they have the capacity to lend more. It is this latter condition which may take some time to get right this time round, because so many banks have been involved in syndicated credits and in trying to put their loans off balance sheet in structured vehicles. The sooner the banks sort out what all these investments are worth, write them down, and raise the new capital they are going to need to be able to carry on their business, the better.

The weakness of banks is not solely a US phenomenon, and the so called sub prime crisis is not just a US or a property related difficulty. This is a crisis in the global banking system, where there are worries about the Bank of China as well as about the European and US commercial banks. They have to contract their balance sheets as they value their loans more realistically, and then many of them will need new capital ??whether by cutting dividend payments and keeping more of their profits, or raising new money directly by selling new shares to shareholders. Doubtless the worlds regulators, led no doubt by the UK authorities, will make it even more difficult to by tightening the rules on capital adequacy at exactly the wrong point of the cycle.

The worlds economies are in different conditions to meet this sudden lurch from easy money to tight money. The Italian and Spanish economies are going to be made to suffer for their membership of the Euro, with interest rates and money growth dictated from Frankfort leading to painful adjustments in their domestic economies. The US economy is so far mainly suffering in the real estate and banking sectors, with some signs of a good export led recovery emerging in other sectors from the lower dollar. The UK economy is badly placed, thanks to the very high public deficit and poor productivity performance of the much bloated public sector. The bungled approach to money markets and banking which uniquely gave London the only run on a bank does not help either. If the Chancellor follows this up by taxing the rich out of London then we will have a major residential property price collapse to add to the current woes. The Indian and Chinese economies may find exporting to the US and the West more difficult, but they have the cushion of rapidly growing domestic demand and China has the huge foreign exchange reserves its successful exporting has built up in recent years.

We have seen a sharp contraction in real estate in the US, in Spain, and in commercial property in the UK. We are now seeing a sharp fall in share prices, as investors adjust to the new reality that banks and property companies will find it difficult to maintain earnings, and as the growth rate of the worlds main economies slows.

There remains plenty to worry about. Some are still worrying about the price rises that are coming through this winter as a result of the years of easy money. Others are worried looking forward, fearing a recession in the US and elsewhere. I still think a full blown US recession unlikely, and do not see an inflation problem looking out a year, but recognise that these fears will remain real to many unless and until my two conditions are met for a recovery.

There will be growing pressure on the US, UK and European authorities to lower interest rates, and lower rates will help. There also needs to be a concerted drive to clean up banksbalance sheets and establish some kind of a market in all of these securitised loans that characterised the years of easy money. Once we can know what is left on banks balance sheets, markets can get on with the necessary task of recapitalising the banks so more normal credit conditions can be recreated.

PS: The Fed’s move today to cut interest rates by 75 basis points, taking them down in one go from 4.25% to 3.5% is a good start.

I am glad to have won the battle against Vince Cable to avoid nationalisation of Northern Rock. I am grateful to the Jeremy Vine programme and the Week In Westminster for giving airtime to the case against nationalisation. Their commonsense and fairness shows up the lamentable performance of the Today programme, the World at One and Pm who gave ample platforms to the pro nationalisation case but refused me the opportunity to explain why it was a bad idea, and to offer a more positive alternative.

In the arguments with editors I was told that my proposals were unlikely to be taken up, whereas nationalisation was the likely outcome. I explained that the government had to come up with something better than nationalisation because nationalisation would have wrecked the borrowing and spending figures. The BBCs flagship programmes as always remained wedded to an old fashioned state solution and to the Lib Dems, so their listeners were not made aware that there was a better way, and were in ignorance that the governments advisers were working on it.

I am pleased this morning that the government has decided to

1. Avoid nationalisation
2. Get some cash back more quickly by selling bonds to replace the loans
3. Seek a new private sector owner
4. Take an equity stake via warrants to give the taxpayer some profit if it recovers well.

What I want to see in addition is

1. Proper banking disciplines enforced to repay the borrowings. Northern Rock still needs an injection of tough banking controls to make it work.
2. A phased withdrawal of the guarantees ?? we dont just want the cash back, we also want to get the taxpayer off risk
3. A fair competition allowing in new bidders ?? as the basis for bidding is now very different from before Christmas. Otherwise there could be legal challenges.

The Lib Dems are playing games over the EU. They promised to vote for a referendum on the EU Constitutional Treaty in the last General Election, and like the Labour front bench are now walking away from their commitment. They say they now want an In-Out referendum instead, but cannot table one in the Commons as an amendment to the present Bill. Doubtless they realised this when they promised one! Never believe a Lib Dem promise. They are simply manoeuvring to get themselves out of the promise that should have mattered ?? a referendum on the Constitution – realising that as Eurofederalists in a Eurosceptic country they are in difficulties. All this wriggling will make it worse for them.

Euro Clegg should do the proper thing, and order his MPs to keep their word to the electors and vote for the Constitutional Treaty referendum as promised. The Lib Dems on this occasion matter, as it is very unlikely the Conservatives can win the vote for the referendum without support from all Lib Dem MPs. If he cannot bring himself to do this, then he should apologise to the British people and explain why he thinks the Constitutional treaty is a good thing. Voters can then get rid of these perfidious MPs at the next election.

Labour rebels today are moving a reasoned amendment to the Bill, asking to cancel it as there is no referendum. This is not the main vote on a referendum ?? that will come later during the Bills Parliamentary progress ?? when Conservatives will table a proposal to have the Bill enacting the Treaty with a ??Yes?? vote in a referendum as the essential trigger for the Bill to come into effect. We will of course be campaigning for a ??No?? vote should we get the referendum.

I would be happy to see the Bill killed at its first hurdle today, but as the Lib Dems will not be voting for the Labour rebel amendment there is no chance of that. What we need is for people to concentrate on persuading as many MPs as possible to vote for the referendum amendment which follows later. Anyone in the constituency of a Labour or Lib Dem MP should write to them demanding they keep their word. Conservatives will table the necessary amendment, argue the case and vote for it, but we need the votes of all the Lib Dems and some Labour rebels to finish the job.

The government needs to:

1. Get a grip on its lending to Northern Rock and set out how and when it will be getting money back from this bank.
2. Remove wasteful and unpopular public spending, like ID cards, regional government, extra contributions to the EU, too many spin doctors and consultancy contracts.
3. Start applying pressure to raise public sector productivity in those areas where we do need spending. Impose a staff freeze on the civil service.
4. Cancel the increase in CGT from 10% to 18%, and leave the new 18% rate in place of 40%.
5. Issue more index linked bonds to finance the remaining deficit, as inflation will come down after this winter’s fuel and food rises.
6.Create an employee ownership scheme for the Post Office and press ahead with its privatisation involving employees.
7. Open the water industry up to competition, to bring prices down and open up new supplies and new investment.
8. Get on with commissioning private sector investment in energy capacity by granting the necessary licenses and planning permission.
9. Introduce more private capital into railways, reuniting track and train in regional private companies.
10. Call a halt to the overregulation of financial services from Brussels, and put through deregulatory legislation which starts to lift the burdens on business.

This programme would at one and the same time

1.Lower prices by using competition to cut monopoly prices
2.Increase investment in infrastructure where we are short of capacity by harnessing private capital
3.Reduce public sepnding
4.Allow lower interest rates as a result of 1 and 3 above.

<p> The idea that Northern Rock loans will be packaged and sold to the private sector is not a solution to the crisis, especially as there will be a government guarantee on them. Instead, this represents a decision by the government to lengthen the period over which it is prepared to lend to Northern Rock.</p>
<p> It means that all interested bidders wanting to buy a share of the action in Northern should; be invited to rebid, as the terms on which they are bidding are now so much better than they were. It appears that a bidder now has the government as its bank manager, guaranteeing substantial lending, for a long time period. This is a much better proposition than the one they sought bids for before Christmas.</p>
<p> No-one writing up the story seems to grasp the importance of adopting the recommendations that readers of this blog know well, recommendations to the government and Bank of England to get a grip as Northerns most important bank managers.</p>
<p> Whether Northern is to be nationalised, sold to a private bidder or remain independent, the need is the same. It is high time the authorities toughened up the terms of their lending to Northern Rock, and set out a timetable for repayment that is demanding but realistic. It should be up to the management to decide if they can repay from trading profits and cash, or if they need to sell assets to meet the demands for money back by the taxpayers.</p>
<p> I find it almost unbelievable that Mr Darling and the Bank should make maybe £55 billion of loans and guarantees available to Northern Rock with no public statement of how long they can have the money for, how the asset cover has been secured, and when the money has to be repaid. All these things should be public because they have such a big impact on public spending, and so bidders can form a proper view of the value and the liquidity of the business. More worrying is the likelihood that there is no private agreement about how and when the loans will be repaid. What private sector banker would ever lend large sums to a distressed company without first asking and answering the questions How and When do I get my money back?</p>
<p> The governments decision to back the “solution” of selling bonds to the private sector to release cash to the government that it has lent to Northern would work well if there were no government guarantee, but the existence of the guarantee keeps the taxpayer on risk. At the very least if they wish to go this route they should look at time limiting the guarantee, or phasing it out.</p>
<p> This could prove to a dear way of avoiding the ruin of nationalisation. Maybe one day the Treasury will wake up and understand that they have a banking problem. The way out is by applying proper banking disciplines to this business, and making the shareholders and directors of Northern Rock confront the simple truth either they trade their way out of the borrowings, or they sell assets to repay the borrowings. Nationalisation, or lengthening the terms of the loans and guaranteeing them take the pressure off the management. A sensible bank manager with that much money at risk with a single client would want to hold their feet to the fire, not let them off in the way the latest proposal does.</p>

Things are bad enough without talking ourselves into recession.
Some banks and commentators have already called a recession in the USA, when the figures for the last quarter of 2007 show the US economy was still growing well. Here in the UK the retailers have added to the sense of gloom by concentrating on their sales figures on a ??like for like?? basis, leaving out all the sales in new shops.

The current position is both better than the pundits admit, and worse than the government will let on. The bad news is that the banking systems in both the USA and the UK are damaged by discovering that some of the lending they carried out in the heady days of low interest rates and easy money has been in their balance sheets at values that can no longer be sustained. We are living through a difficult time as banks adjust for the losses they have made, and rein in their lending as they are short of cash. In the UK commercial property values are falling fast, undermining the security for some of the loans. Residential property values are under attack from the UK government, who want housing to be more ??affordable??, but are being held up in part by the high Stamp duties and the imposition of Home Information Packs which is deterring people from selling their homes and buying a different one. There are too few homes coming onto the market at the moment to cause a crash in prices. The UK authorities have made the problem worse by their ham fisted approach to Northern Rock and by their failure to keep markets liquid enough during the last four months of 2007.

The good news is that many companies are still trading well. Profit margins are good in many cases, and on both sides of the Atlantic activity is higher overall today than it was when the Credit crunch first hit. Both the US and the UK have experienced a falling currency. As both economies need to divert much more activity into exports, or into import substitution, that will help. Both economies can export so much more to the rich parts of the world ?? China, India, Russia and the Middle East. Both economies now have to seek inward investment from these new giants that have built up huge cash surpluses at the same time as we have built up huge deficits by buying their oil and their manufactures. It is repayment time.

Few forecasters expect a downturn in the UK this year ?? just a sharp slowdown. Some commentators expect the US to get away with a slowdown rather than a recession. The US Fed is very keen to stop a slump, and is taking the right action by making cash available to banks and by cutting interest rates. Now the US President is also promising tax cuts, would boost activity as well. The US authorities recognised earlier than the UK that they had to shift from inflation fighting to recession fighting, and they have been bolder in their actions. They will probably succeed in avoiding recession.

The UKs position is weaker because the UK has increased public spending by too much, wasting too much of the money. At a time when other countries were reining in their public deficits and controlling their spending, the UK government went on a spending binge. This limits the UK governments scope to cut taxes and relieve the pressure on consumers. As consumption is the largest part of activity, this means we are going to experience a slowdown which consumers will feel badly. If the government really wanted to help us out of this change of fortune, it would get a better grip on its spending immediately, cancelling the needless parts like ID cards, computerisation schemes, regional government, and larger EU contributions as well as keeping wages down. Then it could follow the US example and cut taxes to help the hard pressed private sector.

Instead the UK is only going to tackle one of the twin deficits, the balance of payments one, through the mechanism of a cheap pound. Our best hope this year is that the strategy works and the private sector does shift a lot of activity into exports. That could be helped if the government would relent on its planned increases in small business tax and CGT. They need the goodwill of entrepreneurs to right the imbalances in this economy. Its a dangerous time for the government to be sandbagging the very people on whom they rely to recreate their much quoted ??economic stability??. Our economy at the moment is as stable as a row boat in a storm.

There is no need to talk ourselves into recession ?? we can get through with a period of slow growth. To do so, the government needs to curb its own appetite for waste and be realistic about how much it can squeeze out of us in tax.