Month: November 2008

This summer I ran a series of articles on this site about crumbling Britain. I challenged the government to bring forward the permits and the plans to allow private sector investment in electricity, gas, oil, water, and transport systems. Today we learn that a combination of government dithering and EU regulation will close down coal power stations just as we have to close nuclear stations reaching the end of their design life. It will leave us short of power, with a threat that the lights will literally go out in a few years time.

It would be a fitting finale to this government, long on rhetoric and short on action. If only they would listen and act, instead of listening and copying people’s rhetoric, we might get somewhere. Now is a good time to bring forward privately financed infrastructure projects, especially if the nationalised banks have any money to lend! I see no sign of it. There may be more announcements – like the much heralded Crossrail, announced before every general Election but not so far built. I see no sign of contracts ready to be issued to make sure we are not all buying candles in 2016.

The USA has been sent a fiscal wake up call – I.O.U.S.A. It chronicles the rapid escalation of the public debt and warns America of the dangers.

We need to make the research here on the huge stock of debt and other public liabilities more accessible for all, and to warn more strongly about the rapid build up of debt now the government is moving into its irresponsible phase. In Phase one of this government we were happily married to Prudence, in Phase two there were some loosely observed fiscal rules which provided some modest protection from excess debt , and in the latest Phase three there is only one rule – spend and borrow as much as possible. Even in Phase One we only stayed married thanks to a huge tax hit on the pension funds and the raid on the telephone companies. Throughout the whole eleven years there has been massive public sector recruitment of administrators and regulators and large bills for consultants, ad agencies and other advisers.

A stock of debt and pension liabilities of £1800 billion is now increasing with borrowing likely to be north of £120 billion this year alone.

Labour’s new lie to anyone who questions so much money being spent on bank shares is the say that they want the banks to go bust. This will doubtless become the new BBC standard line to take, but it is a further attempt to stop all rational debate about an important subject. There are so many other ways of adding capital and improving banking ratios than the taxpayer having to stand treat. John Mc Fall parroted this nonsense against me on Newsnight last night.

In the debate on the economy yesterday I asked Ministers two important questions. Firstly, when will they do some due diligence on all the assets and liabilites of the banks they are taking over? If Lloyds can renegotiate its HBOS deal, why can’t the taxpayer? Are they sure there will be no further losses on the loan books that have not already been provided for? Do they realise how much taxpayers might lose if they get it wrong? I was told they did not have time to do any proper analysis! They just want to spend £37 billion without asking what they are getting for it.

I asked now much private sector debt reduction they wanted?Their regulators have raised the amount of capital any bank needs for a given volume of loans. That implies they want banks to lend less. It is a simple calculation – I reckon its around £200 billion of debt reduction or substantial capital increases to offset. Did they bother to do the figures when they raised the stakes by regulatory action? Did they understand that banks could make the adjustment by lending less rather than by raising mroe money? Is that what they wanted? It appears it is, as their own wholly owned Northern Rock is in the mortgage reduction business, lending £14 billion less than last year.

Ministers simply could not answer that. It appeared it had never occurred to them that requiring a better capital ratio might result in less lending!

In the heat of the Presidential battle people concentrate on the differences. What struck me about the US Presidential race was how similar the main participants were on the big issues.

Mr Bush and Mr Obama both believe in spending and borrowing too much in the public sector.

They both believe in nationalising the main mortgage companies, and part nationalising the main banks.

They both believe in intensifying the war in Afghanistan as part of their wider war against terror.

They both probably will agree to find a way of offering subsidy or more capital to the US auto industry.

Both are currently happy – Mr Bush because he is about to lose the burdens of office that have come to haunt him, and Mr Obama because he has just won but does not yet feel the full burdens on his shoulders.

Mr Obama will feel rightly proud and excited by the thought of living in the White House. Mr Bush may now be looking forward to living in a home of his own without the constant comings and goings of staffers making demands upon his every waking minute.

I would expect them to get on well. It will be different when Mr Obama’s team starts brieifng against the former President, when they are seeking someone to blame for problems they encoutner.

We learn that the government is planning to borrow more money to cut taxes. Apparently it now wishes to limit the depth and length of the downturn.

Yet it was the authorities who brought about this downturn. The MPC late in the day called time on too much borrowing in the private sector by hoisting interest rates to make borrowing dearer. The Bank of England starved the money markets of funds to prevent banks lending more, forcing Northern Rock and a couple of other banks into trouble. In 2007 we had lectures from the Chancellor and the Governor that people had borrowed too much and banks had lent too much. They were told they wrong to have lent so much , and they had to sort it out as best they could without public subsidy or intervention. The authorities followed up the sharp slowdown by demanding each bank held more capital, and leaked the story in a way which damaged bank share prices and their capital raising ability.

Now the Authorities have what they said they wanted – a collapse of private sector lending and borrowing – they are in a panic. They turned banks from profitable lending machines into unprofitable damaged institutions. They now realise they have overdone applying the brakes, just as surely as they overdid encouraging the fast build up of credit through the accelerators of easy regulation of capital and low interest rates before. So now they decide to borrow more in the public sector, to offset the lack of borrowing in the private sector. If an economy borrows too little, too many people are out of work and too many businesses go under. If it borrows too much there will be inflation, and too many strains on the people, governments and companies that overborrow and on the banks that lend them the money.

The good news is they have realised that borrowing to cut taxes is more likely to yield the results they want more quickly than a programme of public works. Big public capital projects take time to get off the drawing board. When people are starved of income and paying too much of it to the government, quite a lot of the tax relief is more likely to find its way into spending. However, with individuals and small businesses under the cosh of needing to repay loans, and worried about their own economic prospects, the government should expect some of the tax cuts to be saved. The government wanted the private sector to cut its borrowings rapidly, in a damaging way. Some of any tax cut will go towards this , but will at least speed the process up and bring forward the day when more can be spent.

The bad news for the UK is the government is already borrowing too much. The taxpayer is now being asked to be the banker of first resort and the consumer of first resort. The strains on the UK public sector will be huge. This week-end in the press there were alarming figures about how much tax revenue the government is losing from the big fall in activity in the property market (Stamp duty and CGT), from the sharp fall in financial sector profits (Corporation tax), from the big decline in high income jobs in the City (Income Tax) and from the halving of the oil price (Duty, VAT, Corporation Tax). Now the government is going to add more cuts in revenue from tax cutting proposals.

Time after time this government sets up the next leg of the crisis by the way it tackles the last one. Easy money created an inflation problem. Tight money to control the inflation created a banking crisis. Bank nationalisation to solve the banking crisis is setting up a government borrowing and debt problem. Tax cuts on borrowed money to solve the deflation will add to the questions over state credit.

We need authorities who can manage things with reasonable stability. Stability requires sensible amounts of credit and borrowing in both public and private sectors. Lurching from too much to too little borrowing in the private sector was crazy. Compounding the error by now lurching to much borrowing in the public sector is not a good idea. The government’s approach is “Let’s halve interest rates and double the amount of debt we have to sell at those interest rates”. They still do not seem to understand money markets, and the price of money.

I went to a local shopping centre in an attractive town near my constituency yesterday. With just a few Saturdays to go before Christmas, the shops were practically empty. Sales assistants stood around talking to each other, and the tills were little used. One shop employee told me of the problems they were having with suppliers going bankrupt.It was a good reason for tax cuts, to put more money into people’s pockets so they might go and spend.

The cuts in interest rates will have some beneficial impact for those with tracker mortgages. Looking yesterday at the best buys in the money section of a leading paper, I saw that most of the mortgages on offer were for rates below 6%, whilst in the column of best savings rates most were above 6%. That dos not augur well for stronger and more profitable banks, and shows us just how damaged the banking sector remains. The truth behind the best buys is more sanguine. There are not many new mortgages on offer, and there are not many people who want to take one out.People are too worried about their job prospects and meeting all the other household bills.

Labour’s latest challenge to the Tories shows they still think attacking the Opposition is more important than governing well. They ask us if we would dare borrow to finance tax cuts, knowing that George Osborne has just made a good speech on the need to control borrowing. It is juvenile Labour nonsense, and the media are pathetic to go along with it as the story.

The answer is simple. Of course we need tax cuts to stimulate spending and help limit the downturn. Of course we also need more discipline on public borrowing, otherwise the strain on longer term interest rates and sterling will too great. The way you do both is to abandon Labour’s ruinously expensive bank nationalisation policy. Banks should be made to raise their own capital and get their own balance sheets into trim. Government should make cash,guarantees and if necessary short terms loans available to any bank in trouble, as of course no major bank should be allowed to go under.

The 1964 Labour government spent and borrowed too much, triggered a sterling crisis, had to devalue the currency in 1968 and then had to cut spending to get some confidence back. The 1974 Labour government spent and borrowed too much, and had to go to the IMF for a loan in 1976. The IMF made them cut spending. This Labour government when it came to power in 1997 seemed to have learned that lesson. It started by adopting cautious Conservative spending plans, and repaid some debt. Now it seems to have forgotten past disasters, and is throwing caution and Prudence to the wind.

Yes we need tax cuts. No this government cannot afford them. Yes we might afford them if they abandoned their crazy ideas of owning large Scottish banks. After all, the by election has now been won, so why not find another cheaper way to keep those banks going?

It’s great news that another group want second thoughts on this deal. Let’s hope they can come up with a persuasive enough proposal for more shareholders to vote for it.
It would be better if the government vetoed the merger on competition grounds. They should stand behind any bank as lender of last resort, but should not be buying shares and acting as midwives to mergers which cut competition, choice,and pressure for more efficient banks.

The G20 want to discuss how to bolt the stable doors – they should try looking for some horses first.

The putative agenda for the G20 is all about better regulation of the financial world to prevent a repeat bubble. I am all for that. The overblown regulatory industry of the last decade failed spectacularly to do one simple thing – keep lending and borrowing within prudent limits. Next time round we do not need more regulators, just regulators who use the powers they have to keep some overall size control on financial institutions balance sheets.

However, we are not in the luxurious position governments are spinning we are in. They want us to believe the banks have been saved by Gordon, Paulson and others, that money markets are gently returning to normal and all we need to worry about is some future credit binge. If only.

What we should be worrying about is recession. Last month 250,000 more Americans became unemployed. The car industry in Europe and the USA has fallen off a cliff, leading to financial distress amongst major companies, factory closures, and more job losses. Property related businesses in the USA, the UK, Spain and other distressed centres have seen a huge decline in the volume of business as well as a big fall in the value of any property assets they own. Steel makers now have to cut capacity. Retail staff hang around little used tills, worrying how much longer they will have jobs. This recession is finding its way into most nooks and crannies of the advanced economies. It will leave a trail of devastation in its wake – job losses, bankruptcies, broken dreams, damaged families, dislocated businesses.

Beneath the surface of their soundbites and their political games, the governments of the west are worrying about how to dig their economies out of the mire they have driven them into. There are now three main policy options being pursued, and two being considered.

1. Cutting interest rates. This is the best and in some ways the most important. It was high interest rates and tight money which triggered the collapse. Overborrowed countries, however, need to tread carefully.
2. Making more cash and short term borrowing available to banks, with guarantees to assist markets. If anything makes the money markets work again, this will. It is going to take time and unbelievable sums in cash to do so.
3. Buying shares in banks, to recapitalise them quickly. This is a foolish policy, as it puts the taxpayer on too much risk, and delays the cuts in costs and inefficiencies which the banks need to make to do better in the future. It limits the scope for interest rate cuts.
4. Bringing forward public spending on capital projects. This is being considered on both sides of the Atlantic. In practise it is slow to work, as projects take time to bring to contract stage. At the margin it is helpful, and shows “something is being done”, but cannot be done on the scale to power us out of the slump.
5. Tax cuts to give people more spending power, to encourage more demand. This too could be a useful contributor, and worked in the second quarter in the USA. It can only be done by countries with a sufficiently strong financial position to afford it.

What should be done?

I would do four out of the five policies above. Even the UK could afford some borrowing for short term tax cuts, if it stopped buying bank shares on the scale envisaged. I would also want the international meeting to address the wider issue of the big global imbalances.

China and the oil producers have too much in reserves and savings. The west has been overspending and borrowing too much. There needs to be short term transitional arrangements, and a longer term fix.

In the short term a combination of weaker western currencies and less demand at home should force more into export. The UK and the US have to start earning their higher living standards by selling more abroad and producing more at home. During the transition period the IMF needs to strengthen its reserves from the cash and reserve rich countries of the world, to relend to the strugglers. China needs to make more progress in freeing its currency, and in stimulating her internal demand to provide a market for the world to aim at. There need to be further relaxations of barriers to trade to encourage more export to the cash rich countries.

China and the Gulf states will probably carry on lending more money to the West, and buying shares in Western companies. We need their money to sustain our overborrowed lifestyle, and they have few other places to put their cash. We need to free capital and currency markets, and markets for goods and services, as much as possible to speed and facilitate the movements needed to right the imbalances. Now is exactly the wrong moment to impose new controls and to think protectionism is the answer. The answer for the West is not less world trade, but more world trade where we are selling rather than buying.

Western governments, instead of subsidising bankers bonuses, should be making heroes of the exporters. We need them now to right our accounts and help us wipe off the big deficits of the bubble years.

It is time to review the different approaches adopted to handle the banking crisis. Two months on from the deepening of the troubles and from the co-ordinated government responses, we still have largely frozen money markets and a credit seizure on our hands. Meanwhile the views of recession are worsening, with most forecasters rushing to catch up with reality and now estimating a longer and deeper downturn.

On both sides of the Atlantic governments rightly but belatedly concluded two things in September – that money markets and banks were starved of cash and liquidity by the authorities, and banks were short of capital at a time when they were revealing big losses on their assets.

The US and then the UK authorities set about solving this. Shortly afterwards the continental Europeans were also dragged in when several of their banks needed emergency capital injections. The US announced the $700 billion Paulson plan. The UK announced the $800 billion Brown plan, and the other Europeans also announced substantial increases in liquidity, loans and capital for their banks.

I supported the major injections of liquidity. The authorities in recent years lurched from too much money to too little with disastrous consequences. They are now creating huge amounts, realising very late that it is not currently inflationary and is much needed to try to kick start the banking system. Unfortunately, confidence is so low that much of it at the moment is a money go round. The authorities put it into the banks who lend it back to the governments. They need to keep on putting in as much as it takes, whilst always securing the taxpayers interest by lending relatively short against full security.

I did not support either the Paulson or the Brown plan for recapitalisation. I did not do so for two main reasons. The first is the banks are too big for the UK state, and even for the US state, to take them over and support them, without damaging the credit standing and the budgetary position of the two governments. The second is, the banks need to take some strong medicine of their own. They need to get fit rather than being put onto life support by the taxpayers.

The Paulson (Mark I and II) Plan reasoned that the banks had lent too much money to people and companies that would struggle to pay it back. This debt was overvalued in bank balance sheets, and could no longer be sold on to others to cut risks. If the government bought some of this debt from banks it would establish a value for it in the market and relieve some of the pressures on bank balance sheets.
There were three problems with this approach. Firstly, there was so much of this debt that the government could only buy up a fraction of it, leaving the banks damaged by the rest. Taxpayers might pay too much for what they bought, losing them money and creating an artificial market for a bit. The government might end up setting a price for the debt which would weaken bank balance sheets further as all the rest of the debt would have to written down to the new market level.

The Brown plan (and parts of Paulson Mark III) reasoned that the banks were short of capital to pay the losses and accept the write downs on their dodgy assets. It would be cheaper to put capital in than try to buy the dodgy debt. If governments put in enough new capital banks could establish a new lower value for the debts and pay the losses from the taxpayer cash. There were several snags with this approach. It undermined the share prices of the fingered banks, making it more difficult for them to raise additional capital from the markets. It assumed that there was a once and for all loss to be admitted and paid for, whereas the worrying dynamic of this crisis is the further deterioration of the loans as the recession deepens and more become unable to pay. The plan failed to see just what huge sums were needed by the banks relative to tax revenue. It failed to acknowledge that if the government ended up nationalising some of the banks it had to take responsibility for potential very large losses, as well as getting into nightmare territory on how many staff to employ, how many branches to keep open, and who to continue lending to.

What other options are open to governments? There are three obvious ones that warrant discussion.

1. Allow weak banks to go bust, and let the market pick up the pieces. Do this as quickly as possible to get the damage out of the way as soon as possible. There will be a recession anyway. This might deepen and shorten it. The market would then finance the new banks and the banks in the system that are viable. The experience with Lehmans has spooked both markets and authorities, leading most of us to rule out this approach.

2. Support weak banks that we need to continue by government acting as their bank manager. They should be offered sufficient liquidity, short term loans and guarantees so no major bank fails, with a view to their sorting out their balance sheets as quickly as possible under cover of the temporary state banking support. They should pay a fair interest rate and other charges to taxpayers for this assistance.

3. Use regulatory means and the role as bank manager of last resort to banks to force them to raise their own game more rapidly. Banks pay too many employees too much money. They need to slim and cut higher pay. They use too much property and carry other high overheads. These need to be reduced. They have been paying too much out in dividend and bonus. These need to be squeezed. Most banks could pay for their own losses and capital problems if they kept more and spent less of the huge revenues they generate.They should be made to get themselves in shape by astute regulation fo their capital ratios.

A combination of 2 and 3 is recommended. This would force adjustment without major casualties. It would reassure markets that there would not be a sudden collapse, whilst forcing banks to own up to the their losses and to work their way to a stronger financial position. The banks are too large to sort it out by public subsidy. Resorting to public capital takes some of the pressure off banks, delaying them waking up to the new realities and running themselves sensibly.

The authorities should study the experience of Japan. There after the credit explosion of the late 1980s the authorities kept many of the damaged Japanese banks going without forcing them to recognise their losses and to sort out their balance sheets quickly. As a result the Japanese economy suffered from more than a decade of insufficient bank credit and deflation. The West must make the banks sort themselves out more promptly, whilst taking care to avoid system collapse through needless bankruptcies of larger institutions.

Meanwhile the sharp deterioration of the Western economies is ominous for the banks as well as for the rest of society. It means more loan losses ahead on lending to companies and individuals. The governments do need to arrest the nosedive in the economies. Savers will be unhappy about plunging interest rates, but they will be even more miserable if the recession gets out of control and more banks go the way of the Icelandic institutions. In the end savers can only get good returns if borrowers can afford the interest.

The 10% drop in the US Stock market in the two days following the election of the new President is a warning sign for him and his advisers. They cannot delay until January. They are right today to meet to discuss the economy. They need to come up with a plan for how they are going to stabilise the situation. Quietly dumping or modifying the Paulson plan would be a good start. It is too dear and it’s not working well enough. I don’t think Mr Bush will complain if the new team try to control the steering wheel.

The BBC are up to their usual games, seeking to undermine a top Tory.
Conservative supporters should ask themselves why Labour, Mr Mandelson and the BBC are so keen to foment the Osborne story.
It’s because George has a good political mind and is important to Project Cameron. Life would be a lot easier for Labour if they did destabilise George.
So, Conservatives, don’t let it happen.