Month: April 2011

             Readers will know I am against the UK lending any money to Euro member states in trouble. We kept out of the Euro thanks to some of us arguing that case. Some of us  forecast the likely problems and do not see why the UK should pick up any of the bill for the failures of a badly executed currency scheme..

                The Coalition government  has rightly taken the UK out of any future bail outs of Euro states in the new regime after 2013. That leaves the issue of bail outs under the current system, where the UK was opted in during the transition post election in May 2010.

                    Mr Darling tells us he did accept the need for the UK to be part of the rescue parties. He also says he told Mr Osborne and Dr Cable, and they allowed him to make the decision. Mr Osborne implies  he did not feel he could override Mr Darling but agrees he did let him make the decision. The Coalition government  de facto underwrote the arrangement when they got into office and did not resile from Mr Darling’s consent. Some of us wanted them to notify our EU partners that we do not agree with  what they are doing or the way they are doing it, but we lost that argument.

                The case against the bail outs is this. Countries that have borrowed too much are not necessarily helped by lending them more. It is true the new loans come with policy conditions attached. They include requirements for the member state to increase taxes and cut spending in an effort to reduce future borrowing needs. Where the problem is mainly one of bank solvency and lossees, they include requirements to put more capital into the banks. It might however be better to sell assets and bring in new finance from outside, not on the state to state model.

                        Few think that Greece or Ireland can pay all the interest and repay all the debt they and their banks have incurred in recent years. Market rates for their debt imply that at some point they will have to delay repayment, cut the interest paid or cut the capital owing. Greece has already rescheduled its Spring 2010 loan.

                     The Uk has lent to Ireland at 5.8%. It may lend to Portugal at  a similar rate. Market rates for Ireland are around 9% and for Portugal around 8%. The loan to Ireland should appear as both an asset on the Uk balance sheet at a sensible value, and as a liability through the debt we have taken on in order to make the advance. If you valued the loan to Ireland at market rates it would have a value of around 75% of its face value today. This could rise if the market thinks Ireland is fixing its economic problems, or fall if things get worse.

                      What the Irish, Greek and Portuguese economies need is stronger economic growth. That would help raise asset values, which would make default on bank loans less likely. It would mean more incomes and better incomes from more jobs, whcih would also make default on loans less likely. It would mean more tax income to pay the interest on state debt.

                           Instead, locked into the Euro and not fully competitive at current Euro exchange rates, these economies will struggle to grow. The combination of spending cuts, higher taxes and a high exchange rate make it difficult to see how they can quickly resume a happy outcome.

Getting overseas interests to take on bank liabilities and refinance the banks would be a better answer than nationalisation and state to state loans on the EU and IMF model. There is a price for everything, and the private sector may have a better answer than the top down state model they are following.

                      As a critic of the regulators in 2006-7 I said the banks should be made to hold more capital. In those days they were too heavily geared. The banks were allowed to lend far too much money with far too little capital to pay the losses if some of the loans went wrong.

                       The Regulators said the world had developed a new paradigm. Long words often conceal sloppy thinking. The world of banking, they argued, had become so much better at managing risks. Because the banks were bigger and global in many cases, they could take on much more risk. Subsequently they discovered that more risks meant more problems. All the risks could go wrong together. Spreading risk did not necessarily equal reducing or managing  risk.

                    Now the Regulators argue the opposite. They believe that banks needs huge quantities of capital to back up loans, as they think many loans can go wrong. They add to the confusion by regarding loans to governments as risk free, at a time when they are about to learn the hard way that loans to government also carry substantial risks. The regulators have regulated the commercial banks into too much sovereign debt risk at the wrong time, whilst discouraging private sector risk at a time when we need more loans to power recovery.

               Making banks hold more capital does two things.  It lowers their profitability, and it means they lend less. That would have been a great thing to do in 2006-7 when things were getting out of hand. It is an odd thing to do when the banks need to rebuild their balance sheets and when good risks go unfinanced in the economy.

                Regulators now say they need to hold more capital to pay the losses that are all too likely on the loans. It is true that banks may still have to pay for large losses on loans made in the heady days of 2006-7.  The fear for the nationalised Irish banks is that they may lose many billions more on property values that have been badly hit by the crash.

                What we need from here is patient and better management of the bad generation of loans made prior to the Credit Crunch, allied to more loans for businesses and properties now, in the post crash enivronment. By definition values are now a lot lower and the risks on future loans therefore diminished.

                  Banks need to be profitable to get out of this mess. Economies need to grow to get out of this mess. If the alleged remedy for the ill is just more capital it will restrict or stifle growth. That in turn means less profits and fewer loans, which in turn makes it more difficult for the banks to be nursed back to health.

                The Regulators thought they had created a perpetual motion prosperity machine when they turned a blind eye to excessive lending and asset price inflation before the crash. Bankers loved the freedom the Regulators gave them to write more loans and book more bonuses. They need to be careful they now do not create a perpetual motion misery machine which keeps asset values low or falling, which prevents enough new loans and business, and makes it impossible for the banks and the economies to trade themselves out of the mire.

            The recent decision to increase banking capital in Ireland by E24 billion, taking it to a total of E70 billion and the effective nationalisation of the major banks, shows how expensive this policy and past mistakes can prove. These are huge sums for a small country. All this debt is a burden on Irish people for many years to come.

           Meanwhile it is important that the UK does not make any contribution to future Euro area bail outs. The policy is questionable as an approach anyway. It is quite wrong for the Uk to make loans to a system it rightly stayed out of. Lending money to countries which cannot grow owing to a high exchange rate, high taxes and spending cuts is not a great idea.

               The media and politicians concentrate on the coming squeeze on the public sector. It is struggling to live within an extra £485 billion overdraft to tide it over the next five years, and to live with an increase of just £93 billion a year by Year 5 for current spending.

              Meanwhile, the squeeze which everyone else feels is the squeeze on incomes from inflation, low wage increases, and higher taxes. According to the Office of Budget Responsibility, earnings will go up by 2.9% less than prices in 2010-11, 3.4% less than prices in 2011-12, and by 0.1% less than prices in 2012-13. In other words, the OBR forecasts a 7% reduction in average living standards as prices rise faster than incomes.

              Increasing tax takes do not help either.

              There needs to a balance between the squeeze on the public and the squeeze on the private sectors. The current strategy of large increases in tax revenue and continuing increases in public spending and borrowing are squeezing the private sector considerably.

                Based on doorstep conversations recently, and visits to speak to Conservative Associations, I encounter the following attitudes. Many Conservatives now see the Coaliti0n government as heavily Lib Dem influenced. They tell me they want changes in policy, to reflect the poor financial condition of the country and the preponderance of Conservative votes and MPs behind the government.

                They do not think it a good idea to increase taxes on hard work and enterprise. They want to see tax rates on income and capital gains that maximise revenues, rather than high rates which will deter effort and success and lower the tax collected. They prefer Tony Blair’s rates of tax on incomes and gains  to this government’s and think lower rates  would collect more revenue.

                 They do not think public spending should go up every year in this Parliament. They would like spending to be cut now and increased later when the crisis is behind us. In particular they think we should decline to lend money to Euro countries in trouble, we should cut out all overseas aid to nuclear weapons countries, saving that money, have another go at cutting the UK’s contributions to the EU, we should make stronger use of natural wastage rates to bring government overhead  spending down, we should return to the quango cull and abolish more, and should have a big repeal bill to cut regulation and regulatory costs.

                  They are apprehensive about the continuing Afghan and Libyan military interventions, and think it is time other UN countries did more and we did less. They would like the Ark Royal and the Harriers to be saved during the next few years of defence spending cuts. They are sceptical about large expensive projects like the HS2 railway and think this should be sacrificed to keep costs down.

               The Conservatives are fully on board to tackle the deficit. All agree it is too high and needs urgent attention. Many think this does have to be the  sole priority of the government, as success with this will determine what kind of economic recovery we have and how successful the government is at keeping interest rates and other costs down. That is why Conservatives want tax rates that stimuilate recovery and generate more revenues, and spending plans that are more realistic in the next year than the 2011-11 ones have proved.

                They would like powers back from the EU and are unhappy about the passage of further powers to Brussels under this government. Given the frequent Lib Dem criticisms of the tax, spending and health reform policies of the government they think they need to speak out more to provide some counter weight.