Month: October 2008

Yesterday the Lords finished off what we had started in the Commons – the attack on the government’s proposal to lock people up for 42 days without charge or trial. They did it in style. The government could not get many of its supporters to the vote, and faced a rebellion from amongst those who did attend. They went down to a huge defeat.

Many of us went to the Commons at 8.30 pm to hear the emergency statement of the Home Secretary on this flagship measure. For once she showed wisdom, and decided to abandon the measure in the anti terorism bill.

Unfortunately she did not do it with grace. A sensible Minister would have said she had listened carefully to the voices and votes in both Lords and Commons, and decided on reflection to accept the advice of Parliament. Instead we were hectored and told we were wrong. We were told she had prepared another bill to do the same thing, but instead of seeking to put it through the Commons she would place it in the Library.

People think more highly of Ministers who sometimes admit they were wrong, or at least bow gracefully to the views of others when they are strong and have a good case.

Let us hope that the Stock market will decide to get behind these banks, and offer more of the equity, to relieve the taxpayer.
It is good news that Barclays can go it alone. The shareholders of Lloyds and HBOS still have to make their decisions. In the meantime the aim should be to raise as much capital as possible from the private sector, with all concerned taking decisions and making statements with that in mind.

This morning the endless leaks and speculative stories about the banks and their capital continue up to the deadline for the announcements. It is far from helpful, and not a good way to conduct such sensitive negotiations and reconstructions.

The good news is that one of our main banks, rumoured to need public money to strengthen its balance sheet, is now rumoured to be be able to raise what money it needs in the normal way from shareholders and the markets.

Let us hope more of our banks want to stay independent and take the obvious actions they need to take to do so.

You would have thought all the banks needing more capital would start by asking their existing shareholders for more, and seeking money from the markets. Not paying dividends for a year or two might in some cases be sufficient without having to ask for more capital, as the dividends have been large. Certainly, a bank short of capital should adjust its dividend policy to its new straightened circumstances before seeking taxpayer gold.

It would be helpful to hear from the Regulator. How much extra capital does the Regulator think banks need in current circumstances? Whilst I am all in favour of the Regulator acting behind the scenes without leaks and rumours in the cases of individual banks, I would favour a public statement about the overall ratios the banks have been achieving, and about any move by the Regulator at this stage to demand larger capital cushions against future losses.

Those who want widespread bank nationalisation cannot have not looked at the numbers involved. Just four of our banks have combined liabilities in excess of £ 5 trillion, compared with UK public spending of around £0.6 trillion, and UK total income and output of around £1.5 trillion. The nationalisation of Northern Rock was a very bad deal for the taxpayer, preventing that bank from making new mortgages for competition law reasons and forcing the taxpayer to pay for the run down of the institution.

Most of us have to accept we are going to lose from this financial crisis.

Here in the UK the financial losses are going to be large. All homeowners are going to lose a substantial part of the capital value of their home. Some homeowners will lose their home, as they give up the struggle to pay the mortgage. Anyone with shares held directly, or through an investment fund or through a pension fund has already lost a lot. People owning businesses will find it more difficult to make a good living in the year ahead, and the value of their business will fall.

To those bloggers who tell me this is a necessary and useful correction, I say there will be a lot of human misery on the back of this big reduction in wealth. It will lead directly – and quite quickly now – to more people losing their jobs, more businesses cancelling their expansion plans and to less money for charities and good works. It is a correction which has got out of control and will do too much damage.

The issue for the authorities is simply this. How big a crash do they want? The Central banks triggered all this, by first allowing an overexpansion of credit and debt, and then deciding they wanted to bring the borrowing party to an end. Now we need to know how much they want to cut total debt by? They have clearly decided on a crash slimming programme of borrowing- which may now be getting out of their control, so fierce are the deflationary forces they have unleashed. It would have been more sensible to start to correct the excess earlier and at a slower pace. Now we are doing it at break neck speed, markets need to get a feel for how much debt the authorities want to take out of the system, so that market participants can start to make some realistic calculations about how big and how profitable banks will be in the future.

I have seen one forecast that the US wll take around $1 trillion out of total private sector borrowing in this adjustment. Some of this will go through write off of debt that cannot be repaid, and some from repayments from solvent institutions and individuals. Maybe the UK authorities are trying to take around £200 billion out of UK private sector debt. If so it would be helpful to know, and banks could work out how best to do it on what time scale. If the authorites, seeing the damage too sharp a deflation causes, now want to see debt stabilised rather than reduced, then they need to slash interest rates and redouble their efforts to pump cash into the system. There is no point in slashing private sector debt, if to do so you simply transfer it to public sector debt and put the taxpayer on risk.

Meanwhile the UK is having one of its idiotic arguments about whether we need more or less regulation, as if this were the issue. I know of no serious commentator on money, credit and the economy who thinks the authorities should wash their hands of responsibility for controlling total money and credit in the system. The issue is not whether to do it, but how to do it. Clearly the method chosen in the last ten years, the so called independent Bank of England, did not work. Credit was not properly controlled on the way up, and is now imploding dangerously.Large amounts of new mortgage regulation did not regulate the main things that matter – how much credit is lent in total, and how much to each individual in relation to the home value and income.

We now need some guidance. I would suggest that now the problem is far too little credit is being extended. The nationalisation of one and a half mortgage banks has hit new lending badly, removing two important institutions from new lending altoegther and burdening taxpayers with big commitments. The uncertainty over banking capital has also frozen the private sector. Can’t the regulator make a reassuring statement, telling us in its view all the main banks have more than enough capital to get on with their jobs – or that they are about to raise more than enough? Can’t then the bankers use the government guarantees to start lending again?
The authorities tried to reduce debt too far too fast. They need to signal that is not now their intention. Concerted interest rate cuts on a big scale would help do that. It would also take some of the pressure off borrowers. To those that say this in unfair on savers, I say it is necessary for savers protection. As the Icelandic banks have shown, it does not help to offer savers a good rate of interest if the borrowers that pay the interest to the banks can’t afford it and the bank runs out of money to pay the savers.

Savers and borrowers are hitched together. Both are going to be worse off in this crunch. The issue is how can we find a level of interest rates, banking cash and capital which allows the system to functon sensibly again.

Last night I travelled to Hatfield to speak at a dinner. The roads were eerily emptier on a Friday night – a sign of things to come. I am grateful to the audience – and to all of you bloggers – for your thoughts on the crisis. I would like to comment on some of the most common responses.

“Too much deregulation caused this mess” – showing the eternal power of Labour spin. The extreme version blames Margaret Thatcher for this “crisis of capitalism”!
The great difficulties in banking have occured in the most regulated of industries. Regulation of banks and other financial institutions has expanded greatly in recent years. This is a failure of regulation as well as a failure of banking. It is not that we had too little regulation – we had the wrong type of regulation regulating the wrong things, allied to weak regulation of what matters, capital and liquidity.

“People like you called for deregulation, so you caused the problem”!
This is the fatuous BBC line. It ignores the fact that I issued warnings about the dangers of the Bank of England have too little power to regulate banks and other financial institutions. It also is a muddled proposal in its own terms, as an Opposition MP calling for something does not mean that something happens! I thought Labour was in government and calling the shots on how much regulation we needed.

“Banks should not be allowed to lend more than they get in deposits, so they would be stable.”
The run on the Rock which brought the Rock down shows that deposits are not a stable source of cash if confidence goes. There is a lot to be said for a model where a bank draws its money from a wide range of sources, to reduce risk.

“Banks should not borrow short and lend long”
Borrowing short and lending long is a normal banking approach to making money and helping the economy. Done in moderation it makes sense. The interest rate is usually higher for longer term loans than for short terms. Intelligent exploitation of this difference can earn a return for bank shareholders. Of course, taking it to extremes can jeopardise confidence. The problem in the summer of 2007 was the Central banks, especially the Bank of England, left markets so short of short term funds a crisis was likely.

“It’s not fair of you to call for lower interest rates – this means savers will be hit”
In this crisis we are all going to be hit. Savers can only enjoy high rates of interest if people and companies can afford to pay even higher rates of interest to borrow the money. If rates are too high too little money is borrowed, and too high a proportion of exisitng borrowings are not repaid. Savers and borrowers depend on each other. At the moment it is too difficult for borrowers, so the savings rates have to come down to prevent the system breaking down completely. I would have thought the experience in the Icelandic banks might start to show savers the dangers of wanting too high a rate of interest for current conditions.

“We should limit people to borrowing just 3 times their income again, as they used to do, when taking on a mortgage”
I agree banks and Regulators need to look again at how much they are prepared to lend against any individual property, and how big a multiple of income they will allow. Today, however, the problem is not limiting the amount banks will lend, but getting them to lend enough. This is a something for the future when banks do want to lend more. Many of us were warning against the extreme deals we saw being advertised in 2006-7 before the crunch.

“Nationalising the banks would sort all this out – why don’t they just do it?”
Transferring problems from the shareholders to the taxpayers sorts out nothing. The day after you still have the same underperforming loans and the same need for extra cash and capital. The banking sector is too big as a whole for the UK state to take on. Why should the UK taxpayer have to pick up the losses, when we did not enjoy the bumper years for banking profits and bonuses?

It was a blow to learn that government, Councils and charities have lost over £1 billion in the Icelandic bank collapse.
Some Councillors have asked me what should they do now? I suggest the following:

1. Co-operate fully with the Treasury and FSA, who are pursuing the Icelandic authorities to get as much of the money back as quickly as possible.
2. Set up an internal Council enquiry to discover who made the decision to put the money with the Icelandic banks, what advice they took at the time, and why the Chief Executive signed off on the deposit or the system to place the deposit.
3.Work through the Local Government Association to review Treasury guidelines and rules concerning the management of Council balances.
4. Put in place sensible new rules in your Council, in the light of 2 and 3 above.

The public will expect Central and local government to do everything in their power to get the return of the money. They will also expect very expensive Chief Executives, who are recruited to manage these type of things for Councillors and lay members of quangos, to take responsibility.

Some think Councils should now withdraw all their deposits from other banks just in case, as they are not protected by the Treasury in the way smaller depositors are protected, and place the money in short term government bonds. This would cut the return for Council taxpayers, and be damaging to the banking system as a whole. There needs to be a better way, agreed between central and local government urgently.

Please be assured – I am not proposing to stop taking your contributions, which make this website interesting and lively.

My point was a simple one – I do not want any of you to end up in legal difficulties by making allegations against a person or institution you cannot prove. I have been cutting these out but given the volume I will sometimes simply have to delete the whole post rather than edit it for you. So please, once you have written it, just go through and delete for me the bits where you accuse X of being a crook, Y of breaking the law, and Z of being a moron or worse. There are better ways of making your good points.

Some suggest I take on staff to handle this for me. I am happy to pay the server and technology bill myself, but I haven’t the money to pay for a helper. Nor can I start charging this to the taxpayer, as some think.

Some of you think I am editing in order to protect the Conservative party, or because it is a Conservative site. This is not the case. I give Conservatives the same protection from abuse as I give Labour Ministers in any editing I do – no more, no less.

How I wish I could just write today that things in financial markets are calm. I would like to have woken up to better times, to spend the day without having to test out my views yet again on the state of the banks and the world economy.

Instead, this morning comes news of a large sell off of shares in Australia, Japan and other Asian centres, following the collapse of US share prices yesterday. The world’s investors are gripped by fear of recession, and are rushing into cash to protect what remains of their savings.

Listening to stockbrokers this week, they have said that their clients have been ringing up in larger numbers to express worries about their bank deposits. They have apparently been calmer about their shares. It is curious. People have been worrying about the wrong thing.

Since the credit crunch first hit in the summer of 2007 no-one has lost a penny by holding a deposit in a UK bank. Any deposit taking institution that has got into difficulties has been helped or rescued one way or another. The guarantee level has also been raised to £50,000 for each customer with any particular banking group. Meanwhile people have lost large sums through holding shares. Some have held their own shares directly. Many more have held them through investment funds and above all through their pension funds.

Usually it is right to get less pessimistic about shares as markets fall. The normal criticism of the public(not always fair) by the professional investors is that the public tends to get carried away with enthusiasm for shares near the top, and gets carried away with pessimism near the bottom. This time, according to stockbrokers, more people have been looking for buying opportunities as the markets fall.

The problem this time is that the markets have not fallen a sensible amount and then started to rally. On the contrary. The markets fell more gently and slowly for the first year, and now seem to be in freefall. How can we explain this?

Let’s take the UK share market. A little while ago it had fallen by about a fifth. You might say that means shares are 20% cheaper. If you think they will still pay the same dividends and still make good profits, that is attractive.

Unfortunately the market is now realising that if we enter a nasty recession, far from being a fifth cheaper, some shares may be dearer. If profits fall a lot, and if some dividends have to be slashed, individual shares may not have fallen enough to offset these adverse changes. If confidence is restored quickly some shares might now look very cheap, but others are in companies which still face difficult trading conditions ahead whatever happens to banking confidence.

The UK economy has been especially dependent on the success of financial, business and professional services. This sector is being badly battered, so it weakens the whole market. Are the banks really short of capital? How much money will they have available to pay dividends? Will they need to seek more money from their shareholders? Recent events have caused uncertainties about some companies.

In the first half of the year the companies quoted in London that are involved in mining and commodities did well. Commodity prices were still soaring, so the shares in these companies reflected the improved prospects for profits and dividends that followed from this source. In the second half of the year commodity prices have mainly fallen dramatically, so the share prices of such companies have to adjust to the worse outlook.

Some companies are still responsible for pension funds. To the extent that these pension funds are invested in shares and property, the companies concerned now have to face up to bigger losses in these funds.

This week people using share markets around the world are asking themselves How bad will this downturn be? They are concluding that it is going to be worse than they at first thought. They suddenly think profits and dividends will be lower than their previous idea, so they see a need to sell some more of their shares. Recessions hit profits hard. When profits reduce, businesses have less cash to pay the bills. If they are also finding the bank manager unhelpful when they want an extra loan to tide them over, there is more likelihood of bankruptcies.

There are now two problems superimposed on each other. There is the banking crisis, and there is the coming recession. They reinforce each other in a downwards spiral. If the banking crisis gets worse, the banks will lend even less money to people and companies to buy things. Businesses will then sell fewer things, and will need more borrowing to tide them over. Banks will be unable or unwilling to lend all that is needed. Companies will lay workers off, cut bonuses, and overall real incomes will fall.

Not so long ago we were all told that the Paulson plan to buy up problematic packages of loans from the US banks would be our salvation. A huge $700 billion was voted through Congress and Senate to do this. The banking markets still remain frozen but the money is still to be spent. This week the UK government has come up with an even larger package – $850 billion to provide liquidity and new capital for the UK based banks.

The US decided to tackle the problem by trying to relieve banks of some of their difficult loans, and by establishing a market value for all the others to show the banks were capable of trading with each other. The UK decided to offer cash and guarantees to banks so they could be reassured that each bank in the system was solvent and liquid, so again they can trade with each other. Much has been written about which of these routes is best or right. As the collapse of confidence is now global let’s hope both work. Each has more chance of working because of the other.

What should the authorities do next? At the G7 Euroland could offer a scheme to complement the US and UK ones. To the extent that the collapse of confidence is now a global problem, it requires similar responses from all the main centres. They could respond to the growing fear of recession and cut interest rates again on a concerted basis. There is no need to keep interest rates high to fight inflation, when we are staring deflation in the face. They could agree in confidence to return home and call in all their senior bank chiefs privately to tell them it is now up to them to start trusting each other and dealing with each other to help save the system.

The UK scheme has three components. I have praised the two that entail lending more money to the banks and offering guarantees. This is the bulk of the money. I accept the government’s pledge that they will take proper security for the taxpayer, that the taxpayer will earn fees and interest for the service, and that the money will be repaid in full.

The smallest pot of money is the pot to provide new preference share capital. I hope the main banks will decide that they do not need to use this. Some will be able to say they have quite enough capital without raising new. Others may say they think it would be a good idea to raise extra capital to demonstrate how prudent they intend to be, but they can and will raise it from a combination of existing shareholders and new shareholders other than the UK government. It might help if the regulator reminded everyone that all the banks it supervises more than meet their capital requirements, and reminded us all how it set those capital requirements to take account of possible stresses in the system.

If any bank does want to access the government’s fund there are important issues of accountability to taxpayers which need to be resolved. Taxpayers would not take kindly to their money helping pay large bonuses to senior executives and directors or even to large dividends to existing shareholders. If a bank is in need of taxpayer share capital, it will have to lead a much more puritan existence than it has been used to if it is to pass democratic muster.There also need to be clear protections for the taxpayer interest.

(Anyone needing investment advice should seek it from someone who understands their circumstances and is qualified to offer it – nothing above is intended to offer advice)