Month: February 2009

You cannot solve a crisis brought on by borrowing too much, by borrowing even more. You have to work your way through the debts, repaying some, and increasing your income relative to the interest costs.

You cannot magic away a load of bad debts and poor investments by transferring them all from the private sector to the public sector. That just undermines the credit standing of the government, and leaves the taxpayer lumbered with loads of losses they do not deserve. Most of the so called recovery plans the UK and US governments are looking at are just different ways to land the poor investments on the taxpayer.

I am amused to hear President Obama saying he is going to announce a halving of the running government deficit over his first term. How can he do that, when his government is busily taking on more and more obligations from banks and insurance companies, and when he is just beginning a big expansion of public spending financed by borrowing?

Controlling debt and cutting deficits has to start today if he wants to do that, not at some unspecified date in the future. Curing the banks entails working through all the investments and debts and saving as many as possible through intelligent banking – not shoving them off to someone else to pay the losses.

Report to Shareholders in UK PLC by the Chief Executive

This year will be difficult for your country. Our turnover (output) will continue to fall, as it has been doing for the last half year.

I have decided to use this opportunity to expand the cost base substantially. I intend to increase the numbers on the payroll and to raise their pay. I intend to pay bonuses to all employees who helped us make such large losses in the banking subsidiaries. I do feel we need to build up their morale when they have had such a setback. I rule out the conventional approach of our competitors who seek to husband cash and cut their costs at times like this.

I have also decided we need to borrow more. We will have to increase our borrowings by around 10% of our turnover in both 2008-9 and 2009-10 anyway, given my commitments to increasing our costs.

I think we need to go much further. This is a good time to take on more debt. I have decided we need to at least treble the debt. I intend to do this through two major acquisition programmes.

In the first I have been buying up banks and bank shares. This sector of the economy has been performing very badly. I do not wish to exploit their bad luck, so I will pay above the market value for some of the shares we buy. We have already bought all of Northern Rock, and the assets of Bradford and Bingley. We have a majority share in RBS and a substantial minority in Lloyds. Our own accountants think this will treble the country’s debt. Outside auditors suggest this is an understatement.

Just in case these acquisition programmes do not expand the debt enough, I have decided to accelerate the borrowing programme further by buying the worst assets off the remaining banks. I could probably expand our borrowing and liabilities by as much as an additional £400 billion by doing this. It could also be done quite quickly.

Some shareholders question the wisdom of this, pointing out that many banks got into trouble by borrowing too much in the first place. They ask how can we borrow all this money? I have taken the precaution of seeing that our interest rate setting subsidiary, the Bank of England, has taken the price of borrowing down to 400 year lows in preparation for this. Just in case there are problems I am about to sanction printing the money we need for the takeovers, to ensure we can get all the cash we may need for this ambitious programme.

It took my predecessors in this job 500 years to reach borrowings of just half a trillion pounds (£500 billion). I am proud to tell you I expect to be well above £2trillion quite soon. Our own Central bank subsidiary is showing the way by now having a balance sheet 120 times its share capital. Meanwhile I will continue to lecture everyone else on the importance of prudence.

Both American and EU capitalism are heavily regulated. Both have concentrated on a lot of detailed regulation of financial services, and both have done it badly.

The EU dreams that there is a free wheeling US system and a cleverly regulated EU system. In times of trouble when US output wobbles, they come out and assert the answer is to move from American to EU capitalism. This is all absurd.

Over recent months despite all the rhetoric the US economy has fallen less than Germany or the UK. The EU, the UK and the US economies have all messed up their banking regulations, failing to demand enough capital in the good times, and then temporarily demanding too much cpaital in the bad times. Both the UK and the US have set interest rates that were too low in the good times and too high in the run up to the bad times.

How can anyone believe Mrs Merkel regulating the detail of hedge funds or Mr Brown running the investment banks would suddenly put the world to rights? The hedge funds and the investment banks that did overdo it could have been controlled properly if only the US, UK and EU regulators had behaved sensibly over the volume of credit and capital requirements in the heady days.

The fact that they did not is no argument for more regulation of a different kind. it is an argument to try and find a few regulators who know what they are doing, to set sensible limits to credit. If hedge funds and investment banks had been able to borrow less we would not be in the current mess.

Mr Hester, the CEO of RBS, figures prominently in today’s papers with a plan to sort out the mess at RBS.

Some of what is reported makes sense and is welcome. There appears to be a realisation that the investment bank is undertaking too much risky business, and using too much capital This needs to be slimmed down drastically, with bits closed and other bits sold off. There is the outline of a cost reduction plan, which will need to go further than currently indicated.

There is some wish to sell off some overseas subsidiaries and assets . The more the merrier, given the stretch the whole bank imposes on public finances. One version of the story has a substantial programme with some urgency – the course I would recommend. Another version has a lesser programme with less urgency.

There is some suggestion the bank might need to make a further provision or write off of £2000 million to cover the costs of restructuring, on top of the £28 billion of losses and write offs. Let’s hope someone who understands figures is giving and independent view of whether this is fair and reasonable or not in the circumstances, as very soon we will be talking real money here.

Readers of this site will know that I have always thought RBS is too big and risky for taxpayers to take on. Once the government committed, I argued strongly for organised disposals and wind up of risky businesses, to limit our risks and likely future costs and losses. I restated the view at some length in “It’s the banks, stupid” on 3rd February.

The government and UKFI should encourage Mr Hester to go further faster than the outline plan we have seen today. The government should also be very wary of buying out loads of dodgy debts from the banks. The UK state is already overcommitted, so why do they think we can take on more debt? World markets may only a limited appetite and limited patience when it comes to UK government borrowings.

Can spinning get any more trivial?
What matters is the content of any meeting between PM and President, and whether it is in our interest and the US interest to develop the relationship.
Do we agree with Obama’s warlike moves in Afghanistan?
Can we advise the President to a wiser course in the Middle East?
Can we protect mutual intelligence from EU incursions?
Let’s talk about the real issues, instead of trying to cock a snook at other world leaders for being slow into Washington.
It’s so juvenile – playground tests for who’s whose best friend.

In January both share prices and government bond prices fell. This meant that most pension funds in the UK lost money, some of them very large sums.

In the through the looking glass world of pension calculations, the deficits of the UK funds actually fell a little. The combined deficits of all the funds coming under the Pension Protection Fund reduced from £194.5 billion to £`190 billion. This is because as government stock prices fall, interest rates rise. This is taken as good news for pension funds, meaning they might to be able to buy more income in the future for any given amount of cash.

It still seems to me losing more money by holding bonds that go down is bad news for them. If they had held more cash they would be in a stronger position today, able to buy bonds or most other investments at cheaper prices. I fully agree with those who work out the sums that losing lots of money in equities was unqualified bad news for the funds. In 2008 overall they lost 14% from holding equities, and in January 2009 another 3.7%. February so far has brought no relief from the plunge.

Why does all this matter? You could say these sums are all notional, that one day markets will rise again, that most companies will meet their obligations to present and future pensioners over the long haul. If you took such a relaxed view, you would be missing the serious crisis now facing many companies with final salary pensions.

The UK government set in train three different policies which have combined to undermine final salary pensions.

The first was the Pensions tax on investment income, costed inaccurately at around £ 5billion a year(the government refused to let us have the true figures). This removal of substantial income from the funds both hit their earnings on the investments, and helped drive down the capital values of the shares so taxed. If shares yield a large class of investors less income, it usually means they are worth less as a result. The funds also had less investment income to reinvest, so cumulatively it became a big hit.

The second was the decision to set up a Pension Protection Fund with powers to levy an additional tax on successful pension funds, to pay for the funds that got into financial difficulties. The danger today is that more companies will go bankrupt, placing their pension funds in the hands of the Protection Fund. This could strain the resources of the Fund further, requiring ever bigger levies on the funds that are still being supported by their sponsor companies. Sponsor companies strapped for cash to run their businesses will not only have to tip more money into their own fund, but will have to find extra to pay for other people’s funds that have got into an even worse mess.

The third is the regulatory system developed by the government. The Regulator for understandable reasons demands repairing the damage done by falls in values of investments within a limited time period. It means that companies have to start filling in pensions black holes whilst they are still struggling to generate cash in their own businesses. There becomes an unintended additional pressure on the company itself, where the demands for larger contributions to support the pension fund could be one of the straws that breaks the camel’s back in companies running out of cash.

Keeping the company going is probably the best way to underwrite the pension fund. Taking too much off the company to buttress the pension fund may make short term sense for the fund, but may make the longer term position worse, placing yet another fund into the hands of the stretched Pension protection fund.

What should we conclude? We can conclude that there is no substitute for pension funds making or preserving their investment money, and no substitute for each pension fund being backed by a strong company. The present combination of regulation, taxation and poor economic circumstances will spell the death knell of quite a few pension schemes, as well as the companies that went with them.

It will confirm the corporate sector’s view that final salary schemes cannot be afforded and are too risky. They are going to be a phenomenon primarily of the public sector where people still think money grows on trees. In the meantime, if the government wishes to save some pension funds and ward off more corporate collapses, it needs to do some constructive thinking about the system of creeping death it has invented for so many pension funds. If it hadn’t bought so many bank shares it could afford to do more to help. The problem is the government itself is showing itself to be a worse investor than Pension trustees, capable of losing more money more quickly.

The government’s stealth taxes have slowly but surely taken more of our incomes. Tax Freedom has crept later, from May into June.

Now the UK government takes financial responsibility for a very large bank with a medium sized government attached, Tax Freedom Day will advance still later, beyond the half way point of the year.

You need to add annual borrowing to the annual tax take. It is now well over 50%. The borrowing takes money away from the rest of us as surely as does taxation, leaving the state free to spend more and more of our national income. Sooner or later, depending on the whims of the markets, extra borrowing will need to become extra taxation, as we seek to repay some of the debt and meet the soaring interest bills.

You cannot run a truly free society nor a successful economy at these levels of state intervention. The government needs to get rid of its overmighty banks, back to the private sector, before they gobble the available cash and jeopardise the governent’s credit worthiness too much.

Iceland and Ireland should be a warning to them. The UK is not in such an extreme position as these two small countries, but the UK state is cruelly over exposed to risk and financial commitments. The £1 billion of bonus payments the government has seemingly accepted at RBS is £ 1billion more of loss for the bank, £1 billion less the government can spend on something more worthwhile in the public sector. There is no magic money or special pot money for the banks. It is all ultimately a caim on the poor taxpayer, who is under the cosh of excess government.

The Labour government is getting several of the things it said it wanted, but discovering they are not what they were cracked up to be

They said they wanted homes to be more affordable. Now they have house prices in free fall, they are not so sure it was a good idea.

They said they wanted fewer lorries and cars on the road. Now a deep recession is bringing that about, they are in a panic about it.

They said they wanted to balance up north and south, to stop the south outpacing the north as it did in the credit boom years. Now the southern economy is being sandbagged by the credit crunch the government is worried by the impact.

They said they wanted us to generate less CO2. Now our industrial demand is collapsing, the CO2 output will contract. They are no longer so keen to bring it down, if that is what it takes to do so.

The Unions are right to be worried about the future of British car manufacturing capacity. They are not necessarily right to say we need to preserve the capacity and the model ranges we currently have. We need to export more vehicles.

Even at the height of the over borrowing in 2007 the world had too much car capacity. Many of the west’s factories were geared to selling expensive and complex vehicles to the successful and to the affluent in the west. Some manufacturers concentrated on selling second and third cars to the very rich. Volume manufacturers often specialised in company car products to middle managers or ever more sophisticated vehicles to discerning individuals who could get access to large car loans. These markets are badly damaged by the end of easy credit, and may not return to their former levels for a long time.

The car market is a good illustration of the imbalances that bedevil the world economy. In the east are millions of people who have never owned a car. Many of them work very hard for low wages. A sophisticated and expensive vehicle is way beyond their dreams and current capacity. They would like the chance to buy a simpler, cheaper more rugged vehicle suitable for their pockets and local conditions. The Indian industry is now experimenting with just such a product.

In the west are millions of workers with cars, who are now finding it difficult to take out the loans to buy more modern and better specified replacements. When people fear for their jobs they rein in spending on cars. When banks are stretched, cutting down the car loans is an easy option for them.

The industrial renaissance of post war Germany in part revolved around production of the Beetle. A simple relatively cheap car became a popular icon, because it was affordable and reliable. Asia needs several such products to lead the expansion of domestic demand for cars. Is the west’s industry going to come up with something, or is it going to ignore that opportunity, watching the switch of leadership from western to eastern car companies?

Come to think of it, some smaller more fuel efficient cheaper products could go down well in the West as well. Many retired people, unhappy with the attack on their savings, might be persuaded to buy a realistically priced run about from some of their savings before government policy destroys more of its value.

The industry has to rethink its strategy. The Western regulators also have to take on board that their many requirements have been adding cost and weight to Western vehicles, putting them out of reach of many people round the world who would like to buy a car.

UK government policy is to cut private sector living standards for many, by increasing taxes, increasing borrowing from private sector savers, and slashing interest rates on money saved. That means we will not be able to buy so many cars.