Month: September 2011

Last week John reviewed our new book Masters of Nothing, and he has invited us to reply to the comments left on the site.

 

We’ve found that you keep learning about a book you’ve written after you’ve written it, thanks to the comments of others, and the discussion it provokes, so we are grateful to everyone who put fingers to keyboard.

 

One of the reasons we wrote this book is because we wanted to provoke a discussion that was largely absent before 2008, a discussion about the way our financial markets behave, and the need for regulators to look to the big picture, instead of huge piles of box-ticking rules.

 

The discussion under John’s review is wide-ranging, informed and insightful. One of the key themes that emerged was the importance of competition within the financial system. Nearly all comments agreed that a more competitive banking industry would go a long way towards averting future systemic crises. There was also a broad consensus on the principal that market discipline must be restored – that banks should be allowed to fail without disrupting the wider economy.

 

We agree. More competition is crucial. But we would add an important qualification.

 

Groupthink, the herd mentality and our impulsive inclination to buy into ‘get-rich-quick’ stories, mean that large numbers of smaller financial institutions are just as capable of getting swept up in bubble manias as their global counterparts. People behave differently in groups than as individuals: that’s a fact of life.

 

The best defence against such complacency is not only downsizing or ring-fencing, but a culture of responsibility amongst the senior management of major financial institutions. This points to stronger boards, a regulator prepared to challenge irresponsible behaviour, and the ultimate sanction of prosecution for those executives who imperil our economy.

 

Several readers argued that in a free market the composition of a board, or the compensation package of a senior executive is the business of shareholders alone. Conversely shareholders and not taxpayers should absorb the consequences of banking failures.

 

Yet there’s a reason the state stepped in to save banks: when the whole financial system, and so whole economy  was put at risk. So the taxpayer is on the hook – whether we like it or not. 

 

All too often in recent history shareholders have not made it their business to assess the effectiveness of their executives, or the true nature of so-called ‘incentive’ packages. The structure of modern shareholding, which conveys a disproportionate influence on huge institutional funds, often means individual shareholders are ill-equipped to provide this kind of oversight. This is a market failure, which is why we call for the greater professionalisation of non-executive directors, who need both the time, the expertise and the incentives to hold the executive management to account.  

 

Several comments, which throw light on some of the most interesting issues, deserve a more specific response.

 

‘Major Loophole’ made an argument that we strongly identified with, suggesting that in the late 1990s the ‘old hands’ of local branches came to be dominated by ‘younger, less experienced ‘bean counter’ style managers,’ who ‘crucially, were given lending targets, the meeting of which, of course, led to qualifying for our old friend—the bonus.’

 

Such perverse incentives were a key aspect of the crash, but Major Loophole hints at a more fundamental problem with modern finance: a detachment from the society it serves. Too few decision-makers at the height of the boom questioned the wider consequences of what was effectively financial pollution.

 

Robert K wrote: ‘the idea that a rule-maker should control waves of waves of optimism and economic greed is silly.’

 

We agree. One of our central arguments is that you cannot legislate human nature out of existence.    The cycles of euphoria and panic – and the asset bubbles they generate are an inherent part of capitalism. What we suggest instead is that both policy and economic thought should be shaped in a way which takes account of human nature. We know, for example, that there can be no risk-aversion without fear, and we have to bear this in mind when we think about incentives. Similarly, we know that there is a relationship between testosterone and risk-taking, and this needs to be considered when we think about the role of women in finance.

 

Ralph Musgrave picked up on the role of the Bank of England’s new Financial Policy Committee:

 

‘The idea that the Bank of England should have the “the authority and the power to be able to tell a large bank that its strategy is too reckless…” is naïve. Various regulators had that power prior to the crunch, but they just got swept along with the irrational exuberance.’

 

This is a question we deal with at length in the book. It’s absolutely true that the regulators got caught up in what Alan Greenspan labelled ‘irrational exuberance’: the euphoria of the bubble. As we argue in our chapter on regulation, the FSA’s failure was a failure of institutional culture, in which box-ticking and the rulebook came to replace big-picture thinking and personal initiative. We need instead a regulatory institution capable of offering both a big-picture view of the UK financial system, and a culture of discretionary decision-making, so that the regulator is always one step ahead of those who game an abuse the rules. The Bank of England is well placed to provide these two things. But crucially, regulators themselves will inevitably fail, so the system needs to be structured so regulatory failure doesn’t bring the whole economy crashing down.

 

Finally ‘lifelogic’ asked ‘Who, on earth, has ever though that people behaved rationally?’

 

In a word: economists.

 

       PFI was coming in when I was a Cabinet Minister. I remember surprising officials by turning down seeking  a PFI proposal for a new hospital and saying we should do it from state borrowing as it would be cheaper.

        Andrew Lansley is right to highlight bad value contracts, and to try to do something to correct them. The private sector may have been better at keeping construction to budget and to timetable, which argued for suitable contracts to do just that. Adding in twenty or thirty years of responsibility for the building and including  borrowing the money meant higher prices overall in some cases. These are now proving dear for taxpayers, and inflexible at a time when we need to do more for less.

 

             In opposition Mr Cable told us “the road to Harare is not as long as we might hope”. Widely reported then  as a staunch opponent of printing money, owing to his colourful language about “Mugabe economics”, his argument was more hedged if you actually read what he said. He recognised that monetary easing was a judgement. You could have too much of it.

             Today in government Mr Cable has throw caution to the winds. He backs more money printing. He is urging the so called independent Monetary Policy Committee to print some more. Is he right to do so? What are the dangers?

              Remember the deal – this Coalition government was to offer us a tight fiscal policy in return for the Bank offering us looser monetary policy. The government  would control excess spending in the public sector, and allow the banks to fuel a private sector led recovery on the back of cheap money.

              I have no problem with the theory. I just have some doubts about whether that is what we are getting. Last month the UK government borrowed a record amount for an August – £15.9 billion  – up from £ 14 billion a year earlier. Tax revenues were up, so the increased deficit was the result of higher spending. That does not sound like a tight fiscal policy yet. If the media stopped saying there had been big and premature cuts in overall public spending it might be possible to have a  more informed debate about what is going wrong with the UK economy.

           Nor do I see the loose money policy for the private sector. Reports continue of small and medium sized companies finding access to new borrowing difficult. The very low interest rates only apply to the government. All the time we have some weak banks, and banks generally under strong regulatory requirements to increase their cash and capital, we will not have an adequate supply of new lending to fuel the private sector led recovery.

         I do not see how another round of creating money to buy up government debt would help much. The government interest rate is already low. It will not of itself unblock credit to SMEs or to the private sector generally. We need to fix the  state banks, and to improve the banking sector’s position  to do that.

         I do see some downside from more QE. The obvious danger is more inflation. I thought the Monetary Policy Committee were meant to keep inflation to 2% on the CPI. They seem to have abandoned all attempts to do that any time soon. Their loose talk about possibly having another bout of money printing has already triggered a slide in the pound against the dollar.

             Don’t they realise that it was the huge devaluation in part brought on by QE1 that produced the high inflation we are now suffering? Don’t they see the danger of yet more weakness in our currency bringing on yet more inflation? In an economy which imports as much as ours it is no good saying they have domestic inflation under control. Go into any shop and see how many things we now import from the emerging markets of the world, and see how vulnerable our living standards are to a weaker pound.

              Inflation is a kind of theft. High inflation is an unfair tax on the savers and strivers, and a windfall to the borrowers. I appreciate the main borrower is the government. That is all the more reason the MPC should for once stand up for the savers, and say “No” to anything which would undermine the pound and rob the prudent.  

             The government should also understand that high inflation this year is itself damaging recovery prospects. It is big price rises for enegry and other essential items that leaves people with too little money to buy the goods and services which would create faster growth. As inflation makes people poorer, so they can afford less tax, which leaves the government unable to afford all its spending. Money printing may not yet be a short road to Harare, but it is  far from helpful to a private sector led recovery.

               Recovery requires the government to fix the banks it owns, and make a bigger contribution to creating a strong and expanding banking sector serving the domestic UK market. Without that growth will continue to disappoint and QE will not get round that fundamental problem. Savers will worry about “Mugabe economics”, which is not good for confidence.

 

             In opposition Mr Cable told us “the road to Harare is not as long as we might hope”. Widely reported then  as a staunch opponent of printing money, owing to his colourful language about “Mugabe economics”, his argument was more hedged if you actually read what he said. He recognised that monetary easing was a judgement. You could have too much of it.

             Today in government Mr Cable has throw caution to the winds. He backs more money printing. He is urging the so called independent Monetary Policy Committee to print some more. Is he right to do so? What are the dangers?

              Remember the deal – this Coalition government was to offer us a tight fiscal policy in return for the Bank offering us looser monetary policy. The government  would control excess spending in the public sector, and allow the banks to fuel a private sector led recovery on the back of cheap money.

              I have no problem with the theory. I just have some doubts about whether that is what we are getting. Last month the UK government borrowed a record amount for an August – £15.9 billion  – up from £ 14 billion a year earlier. Tax revenues were up, so the increased deficit was the result of higher spending. That does not sound like a tight fiscal policy yet. If the media stopped saying there had been big and premature cuts in overall public spending it might be possible to have a  more informed debate about what is going wrong with the UK economy.

           Nor do I see the loose money policy for the private sector. Reports continue of small and medium sized companies finding access to new borrowing difficult. The very low interest rates only apply to the government. All the time we have some weak banks, and banks generally under strong regulatory requirements to increase their cash and capital, we will not have an adequate supply of new lending to fuel the private sector led recovery.

         I do not see how another round of creating money to buy up government debt would help much. The government interest rate is already low. It will not of itself unblock credit to SMEs or to the private sector generally. We need to fix the  state banks, and to improve the banking sector’s position  to do that.

         I do see some downside from more QE. The obvious danger is more inflation. I thought the Monetary Policy Committee were meant to keep inflation to 2% on the CPI. They seem to have abandoned all attempts to do that any time soon. Their loose talk about possibly having another bout of money printing has already triggered a slide in the pound against the dollar.

             Don’t they realise that it was the huge devaluation in part brought on by QE1 that produced the high inflation we are now suffering? Don’t they see the danger of yet more weakness in our currency bringing on yet more inflation? In an economy which imports as much as ours it is no good saying they have domestic inflation under control. Go into any shop and see how many things we now import from the emerging markets of the world, and see how vulnerable our living standards are to a weaker pound.

              Inflation is a kind of theft. High inflation is an unfair tax on the savers and strivers, and a windfall to the borrowers. I appreciate the main borrower is the government. That is all the more reason the MPC should for once stand up for the savers, and say “No” to anything which would undermine the pound and rob the prudent.  

             The government should also understand that high inflation this year is itself damaging recovery prospects. It is big price rises for enegry and other essential items that leaves people with too little money to buy the goods and services which would create faster growth. As inflation makes people poorer, so they can afford less tax, which leaves the government unable to afford all its spending. Money printing may not yet be a short road to Harare, but it is  far from helpful to a private sector led recovery.

               Recovery requires the government to fix the banks it owns, and make a bigger contribution to creating a strong and expanding banking sector serving the domestic UK market. Without that growth will continue to disappoint and QE will not get round that fundamental problem. Savers will worry about “Mugabe economics”, which is not good for confidence.

 

           I am pleased to report that this website was ranked Number One amongst MP websites in the  Total Politics rankings this month,  Number Four amongst  Conservative websites, and Number 20 overall. That is only possible with your interest and comments.

           This site is entirely written by me and by you, the contributors. I pay for the web service  myself, and so far have in fits of high mindedness declined advertising revenues.

               It is good to know that the wish to get beneath the spin, provide analysis and commentary, offer insights from official documents, statements, votes and executive actions, and to come to independent judgements of what might work best for our country can get this much interest and support. I know some of you would like the site to make more personal attacks  on individuals and companies, but I leave that to other sites and journals with better libel lawyers, or sites  beyond the threat of legal action for other reasons.

 

            Last night news broke that some Ministers think the government should kick start the economy with an extra £5 billion of capital spending. The BBC’s Economics Correspondent waded in giving it some credibility, revealing her lack of understanding  of the public spending figures and the economic situation.

             The UK economy is slowing down despite a massive £10 billion a month fiscal stimulus , all borrowed, planned for this year. It is slowing down despite the extra £10.6 billion of public spending the Chancellor put into this year’s spending plans in the March 2011 budget compared to the June 2010 budget. The UK economy is slowing down despite the boost given to capital spending in the March 2011 budget of £5 billion.  Yes, the BBC’s Economics Corespondent seemed unaware that the government has already tried the £5 billion capital boost, and the economy has slowed down markedly  despite it. (Red Book page  93  Public sector gross investment) She seemed unaware that the government upped the spending figures in March, with so little favourable effect.

               Instead of pretending that an extra £5 billion would sudddenly do the job, those wanting this change should ask why all the boosts to spending so far have not carried us to faster growth. They should ask why just £5 billion will make such a big difference, in a £1.5 trillion economy where £5 billion can be a small  error in the figures.

                The truth is this economy is not short of public spending. What the economy needs is a private sector led recovery. That requires different policies towards the banks, as this site has described in recent weeks. This economy is not going anywhere fast with broken banks under a regulatory cosh. It needs some new banks with new capital raised from private markets, to lend to decent prospects and to people who have income and want to buy homes, cars and other items.

                 The private sector needs more confidence, more orders, less tax and a sensible regulatory framework. It does not need higher interest rates, which will come if the government relaxes its pretty loose fiscal policy any more.  If all goes well the government plans to borrow a whopping £485 billion extra over five years. Given slower growth the government has already said it will borrow more than this to allow for the loss of revenue. How much more do these people want the government to borrow? Why would an extra £5 billion make such a difference? At what point do they think the UK would lose the confidence of the markets and face rocketing interest rates like Italy and Spain?

                   An extra £5 billion was tried in March 2011. It didn’t work. It’s time to try something else. It’s time to have some  more private capital raised for some better, more competitive banks.

                   The IMF’s recent study forecasts the Uk borrowing 0.7% of GDP more in 2011, and 1.3% of GDP more next year as a result of slower growth. That’s another £10 billion stimulus followed by almost £20 billion. Their figures show the UK borrowing more than Greece as a percentage of GDP  in 2011  and 2012 combined.

 

        I am glad Mr Huhne understands that high and rising energy prices are a serious problem. They make fuel poverty worse, and make it more difficult to attract and retain industry in the UK as our prices are higher than in competitor countries.

     The question Mr Huhne needs to answer is “Should he  put anti global warming policies ahead of tackling high fuel bills, given that such policies may just send the energy using industries elsewhere, to countries where the power is cheaper and more carbon dioxide  intensive?”  Having dearer energy than China and India does not save the planet. It  impedes a UK industrial recovery.

 

          Western governments mainly know just one refrain. They say they  need to spend more, so they need increased  revenues. When the economy is doing well they want to spend more, so the public sector participates in the success and modernises to keep up with the private sector. When times are bad for the economy they want to spend more, as a counter cyclical boost, to cushion the downturn, to help people in trouble.

           Most advanced country  governments have done this for many decades post war. They have long since come to the conclusion that their spending aspirations far exceed people’s wish to pay taxes. Though they often say they can do it by taxing the rich more, they know in practice they can only afford the increases in spending if they tax everyone more. Most western governments have in consequence resorted to the idea of borrowing more instead.

              The US, the UK, the latin countries of Europe,and Japan built up large debt mountains in the good times prior to the Credit Crunch. As the self inflicted Crunch hit, they decided to spend even more money on bailing out damaged banks instead of demanding an orderly administration of the worst cases, where  bondholders as well as shareholders would  lose money, and professional counterparties would have been taught an expensive lesson. They then added to this extra borrowing yet more borrowing to provide a fiscal stimulus at a time of recession.

            The result of assuming all these liabilities has been to push some of these countries into a debt crisis, and to leave several others dangerously placed, awaiting the market’s verdict and pleasure.

               Most commentators now say these governments have to curb their appetite for debt. There remains an argument over how quickly and to what extent. In the UK there is even an argument over what is happening, as very few commentators can be bothered to read the figures, or have a vested interest in misrepresenting them.

              So now we are at a crossroads. In Euroland the markets are saying they are not prepared to go on lending at the rates some of the states want. They are also saying they do not trust banks that are  full of dodgy government bonds. Euroland’s immediate response is to demand higher taxes. There are plans for a financial transactions tax. There are demands that Greece, Italy and the rest learn how to collect much more tax from their citizens. There are attempts to close down or tax offshore centres.

              They are also having a row about how much more to borrow. The high borrowers think it would be a great idea for them to be able to borrow Euros in Eurobond form, where Germany and France were standing behind their borrowings. Although Germany says “No” to this, it is happening by the back door. The European central Bank is lending  to weak banks in weak countries, and will presumably raise money to do so on their joint account. The Stabilisation funds also represent the use of the common borrowing account to subsidise loans to the weak countries.

                In the end, if they wish to carry on with their dangerous and damaging experiment, they may overcome German resistance to simply  printing it. The ECB could carry on buying up sovereign bonds in the weaker countries to keep their interest rates down, printing money to do so. The ECB would then have come of age. It would be just like the Fed and the Bank of England. It would have discovered that elysian field, that place where governments can print money to spend. There would be no tax bill, no tricky interest bill, no need to roll over debt.

               Any business faced with the probelms these countries face would get on with task of cutting spending. This never seems to occur to governments. Alternatively they say they are doing it, yet the figures for cash spending keep on going up. They manage to combine clumsy cuts to services, with no progress in reducing the outgoings.

             There is just one small snag. Countries that have tried relying on the printing presses have usually ended up with very rapid inflation, a lack of trust in the currency and government, and collapse of the system. It would be wise not to overdo the printing, or to rely on it as the easy way out.

 

 

          As we listen to a new round of banker bashing, with demands for bankers to go to prison, we need to ask who is to blame for the current serious sovereign debt crisis. Should they also be in line for prison?

           At the heart of today’s crisis is  Greek debt. There are dangers that the problems surrounding the Greeks could spread to Italy, Spain and Portugal.

            The crisis is brought on by one simple fact. These countries have borrowed too much.

             Is it the Greek government who are to blame, for borrowing more than they can afford?

             Is it the Greek people, for seeking to stop the Greek government cutting its spending so it can afford it?

            Is it the banks who have been prepared to lend money to Greece on poor figures?

          Is it the bank regulators who have actively encouraged the banks to lend more to sovereigns, as they regard sovereign loans as no risk loans that count as part of the bank’s liquidity?

           Is it the European Central Bank, that has encouraged sovereign borrowing by bond issues, and has bought up sovereign bonds itself to artificially inflate their market price?

          In the case of mortgages that go wrong because the poor borrower can no longer afford them, more people are inclined to blame the bank as lender than the borrower for the default. In the case of sophisticated countries with armies of clever people in their finance departments it is more difficult to blame the banks for the excessive borrowing of the sovereigns, and for their eventual reneging on the debt  if that is what they do.

           I suspect the enthusiasm for putting people in jail for their part in the Credit Crunch will wane as we move decisively into the sovereign debt phase. I do not expect to awake to calls from BBC programmes for leading politicians and government officials to go to jail for taking the system to the edge of bankruptcy by overspending and overborrowing in the state sector. Their morality is lop sided. Putting a banker in prison for a dud mortgage is one thing. Putting a left wing Minister in prison for overspending would be quite another. Arguably the latter has done more damage than the former.

             The Greeks today are protesting loudly against the demand for more public sector cuts as part of the package to lend them more money. As few think they can pay back what they have already borrowed, isn’t borrowing more a case of seeking money with no thought for the lenders?  How moral is a further Greek loan? 

               If a country defaults on its borrowings, how does that differ from theft?