Month: September 2010

I have only written once on the topic of the Labour leadership. At the time David M was the clear front runner. I suggested brother Ed would come from behind and overtake him. Apparently today that is now Labour’s majority view. You read it here first.

The Governor of the Bank of England today becomes a politician. We are told in advance of his audience hearing that he will offer to protect the public from the banks. That is not what I want to hear.

The Governor is the senior unelected official in economic policy. He and his institution are responsible for interest rates and the rate of inflation. He should read the cycle well, and report and defend his actions on monetary policy as required. He should also act in private as an honest and fearless adviser to the Chancellor, the senior elected official, who has overall responsibility for economic policy, and who has the power to change the Bank and its functions.

I want to hear today from the Governor answers to the following questions:

1. Why did the Bank so misread the cycle 2005-9? Why did it encourage or allow dramatic overheating, when the smell of scorching was powerful enough for outsiders to notice it? Why did the Bank then lurch to freeze the monetary and banking system, so we had many banks in trouble? Why couldn’t the bank feel the icy blast in 2007-8 which brought down Northern Rock and undermined others? Why did they ignore the strong advice some of us gave to ease money markets earlier to avoid the worst of the crash?

2. Why is inflation still at 4.7% (RPI) and 3.1% CPI when the target rate is 2% on the CPI? Why has it been persistently above target for so many months? Why have Bank of England forecasts of inflation been too optimistic?

3. How can we have confidence that the Bank is now reading the cycle better? Does the Governor think now is a good time to demand more cash, capital and caution from the banks? Could it be that the economy still needs a more generous approach to money and bank credit to help it out of the deep hole recent policy forced it into?

4. Why does the Governor think sovereign debt is a risk free asset class for banks to hold, and why do the authorities now demand that banks hold so much more sovereign debt? Could this store up trouble for the future, especially where banks buy sovereign debt in Euroland countries with poor balance sheets?

The Bank of England wrongly advised a previous Conservative government to go into the Exchange Rate Mechanism, which did damage to jobs, prosperity and enterprise. The Bank of England set wrong interest rates in the boom and in the early bust 2005-9, making the task of the last Labour government that much more difficult.

The new government trusts the Bank and is giving it large new powers. The Bank and the Bank alone now can lead and regulate the banks and the monetary system. We need a full statement from the Governor on how he and his colleagues will carry out these new responsibilities. We need to know they have learned from past errors. Grandstanding at the expense of the banks he is regulating is not a good idea.

We need to believe the Bank will this time listen to their criticis, instead of drawing on a narow group of economists who all agree they are right and end up with a slump and 5% inflation at the same time.

The public reports of strong arguments over welfare reform need some examination.

The welfare budget is different from most other government budgets for one good reason. Parts of it are “demand led” – if more people need unemployment or disability benefits they need to be paid. Other departmental budgets can be settled a year or more in advance, as you should know how many people you are going to employ and what you will pay them, and know roughly what your bill for bought in goods and services will be. So the arguments about the welfare budget are subject to the caveat that we could end up spending a lot less or a lot more , depending on demand.

In another sense it is also different. All sensible people want the welfare budget to fall sharply for the right reasons. We want more people to get jobs so they do not need unemployed benefits. We want fewer people to be in need of disability or long term sickness benefit. We would like pensioners to retire with savings and good second pensions.

So the argument about welfare reform is what magic combination of rules and spending would help get more people off welfare into work. What incentives would encourage more people to make provision for their future? Solving it requires low taxes on saving and working as well as fair but realistic benefit rules.

Both the Treasury and Work and Pensions have good points in their arguments. DWP says they need to spend to save. If, for example, they pay more by way of in work benefit to make it more worthwhile to work, we might find more people took jobs and saved the state some money overall. If they could adjust benefits so that it was always more worthwhile to work than to stay at home we might make better inroads into the 5 million plus of working age living on benefits entirely.

The Treasury replies by saying the problem with spend to save is the spend is certain and comes first. The saving may not materialise. They might prefer the Clinton approach – the way to make it more worthwhile to work is to do what Clinton did and withdraw benefits from people who can get a job so they have no choice but to take it.

In the UK we combine a progressive tax system with a progressive means tested benefit system. This results in people at the lower end of the income scale facing high combined rates of tax and benefit withdrawal. All the time we have means tested benefits there is a choice between two ways of handling the problem which are less than ideal. Either you have a few people facing very high combined tax and benefit withdrawal rates, or you have a lot of people facing quite high combined rates. If you withdraw means tested benefits quickly it means a high rate and fewer people.

This is ground for natural compromise. The Treasury can bring to the agreement proposals which toughen the regime for anyone who could get a job or is offered a job. DWP can bring proposals which make it more worthwhile for more people to work rather than staying on full benefit. The spend to save element of the package could be tightly monitored, week by week, to ensure savings do materialise. If they do not the formula shouild be amended or the system changed.

The news from Cuba, a socialist country, is bleak. A much smaller population than the UK’s has to shed 500,000 jobs in a hurry, because they have run out of money. Cuba is one of those places where state planning and a proportionately much larger public sector has kept the country poor. Now there is a day of reckoning.

If UK Trade Unionists are alarmed by forecast public sector job losses they should show their solidarity with Cuba, which has a real problem to complain about. Yesterday some UK Trade Union leaders condemned UK cuts that have not been decided, let alone announced. They studiously avoided debating how the modest cash rises each year in current public spending could be used to offer good public services, without cutting anything that matters. Partnership and productivity would be two good words to bring management and workforce around the public sector table.

Some public sector Union leaders want to use the “cuts” to trigger a massive Union campaign allied to strikes. When a public sector union goes on strike it is striking against itself and the public. Strikes usually make things worse all round. Strikes encourage people to find other ways of doing what ever the strikers used to do. Strikes usually result in more job losses, not fewer.

Whilst Union leaders and their active supporters are the main cause of strikes, some managements by their words and deeds give them help or cause. It is most important that the current government should not make it easy for the militants by using provocative or inaccurate language. Strikes this winter in public services are not a good idea for any of us.

The Unions say they will be running campaigns against 25% and 40% cuts. In a world where health spending will rise in real terms, and where I suspect education health spending will also be protected, there should be no cuts of 25% or 40% in anythign that matters. Overall, with spending rising by 15% in cash terms over 5 years, the question the government should be asking is a simnple one – can we use the extra 15% to maintain service levels and improve quality, or is all the 15% and more going to disappear in rising costs and inefficiencies?

A sensible management, armed with 15% more cash would seek to persuade the workforce that this settlement is fair, and can be accommodated without compulsory redundancies and with some pay improvements based perhaps on improved productivity. If the officials managing these services instead play political games and roll out long lists of provocative “cuts” which in the end will not be made, morale in the services will be damaged and the militants assisted.

It is a good test of senior officials to see if they have understood the mantra, “Do more for less”. The overall cash spending plans are generous in the circumstances. The endless rows about excessive or inappropriate cuts are far from helpful to anyone, causing some to worry about their jobs and others grasping the opportunity to go back to the old politics of the parade of the bleeding stumps. Surely the new politics of the Coalition can rise above this? Starting by setting out the true figures for increased current spending would help.

The agreement at Basel will require banks in due course to have safer levels of capital.

There were two main problems with the proposals. The first is requiring a sudden surge in new capital now might just delay or slow recovery, as the easiest way for banks to meet the requirements is to lend less. The Basel answer is to delay the introduction of the new demands by up to eight years.

The second is the new rules require banks to hold more government loans or sovereign debt, at a time when the quality of sovereign debt in some countries is being questioned for good reasons. Governments may like the idea of banks having to lend them money, but it only delays crisis and painful adjustment in countries that are borrowing too much. It does not solve their underlying problem.

Basel will also encourage the shift of some financial activities into non banks. Do not expect too much from Basel. It has not guranteed an end to crises! Meanwhile, watch out for another bout of Euro blues, as the numbers within the weaker countries of the Euro zone still look worrying.

Let me say something unpopular. The UK should drop the anti banker rhetoric. The sport of banker bashing may have come in handy for unpopular politicians facing their own crisis of probity, but time has moved on. Banking is a most important part of the UK economy. London and the Uk benefits from acting as host to some the world’s largest banks. They generate jobs and incomes which circulate in the UK. Banks may contain poor directors and managers who make bad mistakes. They may pay some of their people too much – rather like football and parts of the media. They may not serve us as well as we wish – like the parts of government. Nonetheless we are better off with them, warts and all, than if they left.

Some of the banks criticis take the view that they will always be around, so why not have another free hit. I would not be so sure. Change is mighty rapid in today’s world. Industry has been hollowed out to the East very quickly in recent years.There are many global centres working away to dislodge some of London’s biggest and finest. As the weight of world trade , world wealth and world activity gravitates more to the East there will be a natural pull for banks to set up their headquarters there as well. London and the UK are engaged in a fight to keep or grow what we have.

It is true that there were excesses in Investment banking in recent years. These were made possible by monetary authorities pursuing very easy money policies, and by Regulators who seemed relaxed about the excess until late in the day. The Vickers Review needs to examine how cash and capital controls could be used counter cyclically, to prevent excess when markets are doing well, and to help stave off disaster when markets are doing badly.Success in creating better regulation, sensitive to the market cycle, would be good for the future of London.

Above all the Review should see that we still have something to be proud of in the City. You do not see Germany bashing motor manufacturing, its core activity, nor France complaining about the problems the drinks industry can create. The UK has done enough self flagellation.

One of the reasons banks in the UK are so unpopular is poor perceptions of the service they collectively offer.

Small and medium sized enterprise can be frustrated by the apparent lack of interest in them. The branch bank Manager no longer seems to have the power to develop a relationship and make intelligent judgements about credit needs and risks. Regional centres pursue box ticking exercises evaluating credit risk based on numbers in business plans, which may make mistakes both ways. The banks are inclined to lend to the good business plan designer, which may not be the same thing as the successful entrepreneur.

Individuals can be frustrated at the short opening hours of branches, not designed to help those with busy jobs. Counter queues can be irritating. There is not the same personal relationship between branch manager and customer that used to prevail. Despite having access to large amounts of personal financial information, banks are often bad at deciding what additional service to offer a client, and bad at forseeing problems with solutions that might work. People get unhappy about fees and charges.

There should be economies of scale in banking, but there can also be diseconomies. If salary structres reflect the overall size of the bank, individual salaries might be high to run good value individual or small business banking service. If a bank’s business section can make mega fees out of the largest companies, working hard for small fees from small business may seem less worthwhile. Seeking to streamline small business services too much to cut costs can simply remove the necessary personal judgements and relationships which customers want.

There has been a lack of choice in UK retail banking for some time, made worse by allowing mega mergers in the last decade that has cut the number of potential competitors on the High Street. Barriers to entry are large, given the costs of setting up a branch network and accumulating the capital needed to back a sensible bank. The Review should examine the scope for allowing more competitors in the UK market. Most observers agree HBOS and Lloyds should not have merged,. Maybe this should be revisited. New competition guidance could make it clear that future mergers of larger UK High Street banks will not be welcomed. We need to revisit the rules and ease of setting up new banks in the UK, to ensure proper competitive challenge. There is room for improvement of current customer service.

There is also a problem over the availability of lending for small and medium sized enterprises. This is the result of the current regulatory vogue to demand more cash and capital at the wrong point of the cycle. The Regulators have lurched from demanding too little cash and capital during the boom, allowing banks to become too risky and unstable, to demanding too much cash and capital at the trough. This makes banks unwilling to lend money to smaller and riskier customers as they see it. More of their cash and capital is needed to lend to the government, as lending to government counts as a low risk activity, leaving them with a stronger balance sheet in the eyes of the Regulator. The sensible wish to increase cash and capital reserves has led to a dramatic strengthening of bank balance sheets in the last year. The Regulator should now delay demanding further improvements, until the economy has hown decent growth for a a year or more.

Sir John Vickers is a an accomplished senior academic, with Bank of England and Competition authority experience. He comes to the task of reporting on how the banks should be structured and regulated from a perfect background. I know he will approach it seriously with useful knowledge but no opening prejudices.

One of the first questions he needs to ask is Why did we have banking failures and problems in 2008-9? Some will be urging him to the veiw that it was the combination of “casino banking ” with clearing banking which caused the problems.

The evidence does not bear this out. The worst of the crisis was the collapse of Lehmans, a pure investment bank. In the UK the most distressed banks were three relatively small specialist mortgage banks, without Investment banking arms. Forcing Barclays and HSBC in London to divest their investment banking operations would not prevent a future Lehmans or Northern Rock.

It is difficult to avoid the conclusion when looking at Lehmans, Northern Rock, RBS, the Irish banks or the Icelandic banks that it was misjudgement by the banks of how much cash and cpaital they should keep to cover their risks, and bad judgement by Regulators who did not require them to be more cautious. Bankers and Regulators together presided over a massive expansion of leverage throughout the system. Both shared the view that the advent of new financial isntruments and larger banks alllowed more risk to be run . They threw out of the window the old ideas about prudent levels of capital and cash. The Central banks then withdrew liquidity from markets too rapdily and helped bring about the crisis.

My first conclusion is that splitting Investment and clearing banks is not the answer. Banks of all types and sizes got into difficulties, including small and specialist institutions. It is increasingly difficult to seperate investment bank activities from clearing bank activities. A business customer may need foreign exchange futures and commodity derivatives as well as a bank loan and current account. A retail customer may want investmnt management as well as a means of payment. Seeking to stop banks undertaking certain types fo financial business might just drive them offshore.

Yesterday I asked Mr Clegg to confirm that current public spending will rise 15% in cash terms this Parliament according to government budget plans. I asked him to confirm that this being so the puloic sector need not cut any important public service. It would be incompetence or perversity if it did make cuts in important public services, given the cash increase in spending.

Mr Clegg did not disagree with this view. The view, of course, was not picked up by the BBC. Clearly the increase in cash current spending by governemnt is an inconvenient truth amidst their narrative of deep and damaging cuts. Their journalists should weave this inconvenient truth into their analysis. I expect government Ministers to start explaining what they are doing on public spending a little more accurately, as the government itself has allowed the myth to grow that there will be deep and immediate cuts in current spending which are just not reflected in the budget figures.

The government challenge to those many well paid public sector managers should be a simple one. We can manage modest increases in cash spending – less growth than you are used to. Can you manage things so we do not need cuts in anything that matters? Private sector companies would avoid service cuts if they were sure of 15% more revenue over the next five years, with cash increases each year.