Category: Blog

I can forgive the President for his stumbles with the Oath of Office. He was nervous, they were not his words, and his staff had failed to place the words on his prompt screen. It is a detail they will doubtless get right the next time he has to reproduce a traditional statement.

I do not agree with the carping critics that the speech was a let down. The House of Commons decided to have a vote on the financial crisis at the opening of the President’s remarks. I decided to watch it in the Commons tea room so I missed very little, as that provided the nearest TV to the Chamber. Some MPs and the Tea Room staff assembled to see it. The staff from a wide range of backgrounds were visibly moved by the powerful rhetoric, and by the sight of the US coming together after the dreadful past of segregation and racial hatred. Only a few hard bitten MPs were more cynical.

I thought he spoke well. He did not need to dwell on the success of the movement for racial equality – he is its embodiment. He did weave in a wider US history to his approach. As a Conservative he said nothing I wanted to condemn, and some things I admired. I fully support his passionate defence of opportunity, and of freedom, set within the message that people have to do things for themselves to protect that freedom and to grasp those opportunities. As a Brit I had to take the memories of the US struggle against the clumsy British government to gain the Republic’s independence on the chin. It was entirely fair, even if I would like to have seen it balanced by some friendly remark towards us for our more recent support of the US and our shared heritage of freedom and democracy.

I felt let down not by the words nor by the event, but by the actions.

If he is serious about closing Guantanamo, why doesn’t he just announce a date or process for closure? Guantanamo became a symbol of a great democracy failing to live up to its own standards. We democrats condemn torture and believe in no detention without charge and trial. Why is he delaying even military justice for its inmates by seeking another 120 day delay in the trials about to edge forward? If he wishes to transfer them to civilian trials then just do so.

He promised that he would start the withdrawal from Iraq on Day One. This morning there is hesitation in the briefing about that. In a way George Bush pre-empted him, but it would still be good to see the President instructing the Generals to take the necessary steps as promised.

Whilst they were partying on Pennsylvania Avenue, Wall Street was having a terrible day. The transition team should have had something ready to tell the markets about how the Obama Presidency would handle the banking crisis and the recession that might be reassuring. Instead Wall Street sees more of the same – more massive state borrowing to prop up ailing banks, and more state borrowing to create some jobs through Federal programmes whilst many more jobs are lost in the private sector.

He told us it would be tough, and he rightly united his country to take the actions needed to change America. He has little time to spell out exactly what changes he wants, as the markets are already spooked. He implied that the USA has to change its approach to the economy, by becoming more energy self sufficient and living more within its means. We know that, so why not get on with it?

Today the pound has lost significant ground against the dollar and the yen. The government should see this as a verdict on its approach to the crisis, and take action to instil some confidence in its management of public borrowing.

Yesterday was a disastrous day for the UK. The government had to tell us that its first banking package, amounting to £487 billion of share buying, loans and guarantees, had not done the job. They are now planning another package which includes new loans, new guarantees, the possibility of quantitative easing and an insurance scheme for bad debts.

The timing of this announcement seems to have been related to the publication of the news of the huge losses at RBS. The government had not completed the negotiations with the banks, and had not filled in much of the detail of its proposals, implying it had been rushed by events. We do not know which bad loans or obligations of the banks will be eligible for the insurance scheme, we do not know how they will be valued, we do not know what the insurance premium will be and we do not know the total taxpayer commitment. What we can guess is that the commitment will be large if the policy is to have any beneficial impact, and that pricing the insurance will be very difficult. There is no static and measurable pool of bad and doubtful debts. In this recession the lake of underwater debt is growing at flood rates.

In these circumstances a rumour spread that UK sovereign debt is about to be downgraded by a rating agency, whilst sterling fell again against the dollar and yen. The share prices of RBS and Lloyds plunged, leaving the taxpayer sitting on large unrealised losses on the shares the government has so recently purchased in these two major banks.

People often ask me now, how bad can it get? They have in their voices the apprehension of people who still have their jobs but are worried that all the bad news will one day cross their threshold.. They are relieved that petrol is a bit cheaper and maybe are benefiting from lower mortgages costs, but concerned that things might get tougher for them in some unforeseen way.

The answer is they could get a lot worse. The government has to avoid moving from a very serious problem of weak and overborrowed banks, to an even worse problem of a weak and overborrowed state. We need to be able to keep confidence in our currency and in the government’s capacity to borrow and spend sensibly. Were the government to lose the confidence of the bond markets and were the continuous decline of sterling to become a rout of the currency we would be in for much higher interest rates, much higher unemployment, and a further cut in living standards for many.

The starting point for the government’s analysis should be my simple point that the major banks in the UK are too big for the state to assume all their liabilities, or all their bad debts. The Chancellor yesterday confirmed they were looking at insurance for all the overseas loans as well as the UK ones, and seemed unclear on all the derivative and other financial instrument activities that these banks undertake. Put together, this all amounts to too much risk for taxpayers.

The second perception they need is that the private sector is short of cash. Companies are short of orders and revenue, Many individuals are overborrowed and are having to pay off credit card debts and other loans. They need more money. They are not necessarily going to go out and borrow more, even if the banks suddenly are in a position to lend it. The government does need to work on the money supply to ease the squeeze.

The government does need some combination of the schemes it announced in outline yesterday. It also needs to put some limit on the amount the state will spend and borrow, to start to instil some confidence in its own finances again. It should be seeking to dig its way out of its expensive and so far disastrous share buying amongst the banks, and finding cheaper ways of seeing the banks through a painful period of adjustment. Short term loans against security, the provision of banking cash and maybe guarantees on inter bank and new lending are the least bad ways of doing this. The banks themselves have to cut costs, change their business models and reduce their risks. Subsidising them too much delays this necessary process. Buying their shares just puts the taxpayer in line to pay the losses, which as we saw yesterday are eye wateringly large. When I first said the three banks the government was buying shares in could lose the equivalent of the defence budget, many people looked surprised. That is what RBS has announced on its own just a few weeks after the government bought shares!

I wish President Obama well. His journey from Chicago to Washington is a great acheivement which has generated him huge good will.

I remember when I first praised his ability to shape a new language and style of politics and to build a coalition of support eyebrows were raised by Conservatives. This was long before he became the front runner for the democratic nomination.

His train journey in the wheel marks of Lincoln show he and his team have a great sense of theatre and history. he klnows a good picture and a good story when he sees one.

I went on then to say the interesting question was whether he could show great skill at more than spinning a vision and crafting words and pictures for the media. He inherits a mess. We need him to change things for the better. What he does will now be more important than what he says.

Today I am sure he will give a fine speech, articulating a vision many can buy into. Tomorrow we need actions – actions on Iraq, on Afghanistan, on the banking crisis, on the conduct of economic policy.

The change I would like includes a decision not to continue with Bush’s approach to both Iraq and Afghanistan in the way I fear he will. I also want him to change the nature of government intervention with the banks and the economy to give us more chance of pulling out of recession without overweighting the state with debt.

The dreadful results from RBS more than confirmed the analysts forecasts of huge losses that I have been running on this site for sometime. As feared, RBS has lost more than the £20 billion of capital the government put in just a few weeks ago. It opens up the question again Why on earth didn’t the government make some sensible enquiries when they were buying the shares, and insist on proper disclosure of the losses at that stage? It is not good enough for them to say they had to take the action quickly. Even if you accept that debatable proposition, they could have announced they were going to the aid of the bank, and settled the terms once they had made proper enquiries into the health of its accounts.

Today we learnt that the government is planning a big insurance scheme for bad debts owned by the banks.

We also learnt that the government does not know how many bad loans will be covered by this scheme, how much they will charge the banks for the insurance or how much money the taxpayer will have at risk. They have not even settled whether the scheme applies to overseas loans by overseas banks owned by UK banks, or to financial instruments banks own other than loans.

In response to a question I put to him the Chancellor spelt out his problem clearly. If the scheme does not apply to the foreign activities of the UK bank Groups it cannot tackle enough of the bad debts to resolve the problem. If it does apply to them, UK taxpayers will be doubly cross if and when we lose money, as we are subsidising foreign businesses and competitors. The issue of whether gurantees apply to the investment banking activiities of our large banks cannot be ducked either. RBS for example has almost twice as much at risk in derivatives as it does in loans to UK people and companies.

The plunge in UK bank share prices just confirms how much UK taxpayers have lost so far from the mistaken share buying policy.

I was the only MP to tell the Commons I thought the share purchases in banks were an expensive mistake and were unlikely to solve the Credit Crunch. I went on to explain how the banks could be kept going with less taxpayer money at less taxpayer risk. The government seemed unaware when it nationalised RBS of how big it was relative to tax revenue, and how little of the banks’ assets were loans to UK people and companies. The government is rightly concerned to see more lending within the UK. Buying more shares in RBS is one of the dearest and clumsiest ways of trying to achieve that.

The whole Conservative party spoke against and voted against the nationalisation of Northern Rock. One of our criticisms was that it meant a large UK mortgage bank would no longer be able to make new loans. There were other ways of keeping the Rock in business, short of taxpayers taking over all the shares. Today we learn that the government now recognises that it was a mistake to stop the Rock lending, so now we have a state owned bank back in the mortgage market. The good news is that will relieve a little of the difficulty facing people who want to buy a home. The bad news is taxpayers have to pay the bill for mistakes with that lending.

The terms of the underwriting and new capital for the banks are what matters. We will not know until we see the small print just how much taxpayer money will be at risk. It may take a little while to find out whether the government has been too generous with the banks , leading to huge taxpayer losses, or very tough, leading to less use of the scheme.

In the meantime we need to know why the government put £20 billion into RBS without due diligence, and without understanding the risks? Have they lost the lot already? Some City forecasts and press reports suggest losses in the second half of 2008 for RBS at around the £20 billion. This morning more authoritative briefing suggests RBS will announce losses of over £6 billion, or one third of the government capital. This will leave some asking if they have written them down enough.

Someone quipped recently that a large modern bank was a public utility attached to a casino. Now we have a government that wants to play the tables of the banking world with large sums of our money. Why don’t they instead concentrate on saving and isolating the UK utility part of these banks, instead of standing behind the whole thing? The derivatives book at RBS is twice the size of the UK loan book. Why do we as taxpayers have to support that? What are the government’s plans for it, as they tighten their hold on this organisation?

The government is now risking huge sums of money. Of course I hope they get the terms of the scheme right and that credit starts to flow again. Even if that were it happen, I will still worry about the high risk and very expensive route they are using to achieve this. They could achieve it for less money and at less risk, with sensible guarantees and loans for the banking businesses that matter directly to the UK economy, without buying shares.

I was pleased to hear George Osborne this morning asking for an independent audit of any dodgy loans the taxpayer is asked to guarantee. We need to avoid a too generous scheme which improves the banks, at the expense of wrecking the government’s finances. At the moment we have an overborrowed government seeking to bail out heavily overextended banks. We need to avoid financial collapse in both by showing careful judgement from here about the balance of risks and the pace of sorting out the past banking problems.

What should we do with RBS, now we are all enforced owners?

RBS is too big for the taxpayer to stand behind. The bank made a foolish acquisition of ABN Amro near the top of the market which stretched it too far. It is now being made to repair its capital ratios, against a backdrop of reporting large losses on its credit market positions and its loans. I don’t think the taxpayer should be made to pay for the past mistakes.

We need the government to get a grip on this leviathan, and to slim it down quickly before it does more damage to the taxpayer and the national accounts. Presumably the government’s justification for taking it over is to safeguard and increase the lending to UK individuals and companies. This is a small portion of what RBS does.

In the half year figures for 2008 we learn that only £282 billion of loans have been made to UK borrowers. The rest of the £721 billion loan book is overseas. The total UK loans are only 15% of the balance sheet, a manageable amount for the UK government. It is the remaining £1700 billion of risk that is over the top for UK taxpayers.

The sensible thing to do is to slim the bank down to the bit that the government is concerned about. It should seek to sell:

1. The Insurance company
2. The Manufacturing division
3. ABN Amro
4. Citizens bank in the US

Taxpayers are on risk for nearly £500 billion of derivatives. That’s playing with the whole tax revenue of the country for a year. Why? Why aren’t these speculations on currencies, interest rates and commodities closed down? The Bank says much of it is matched business, but there is always scope for it to go wrong. In the first half of last year the bank wrote £5 billion off its credit market assets. They need attention.

The costs of the bank are huge. In 2007 10 non executive directors averaged more than £100,000 a year each for a part time job. Why not have fewer at more realistic fees for a loss making company? The 6 executive directors were paid £15 million between them, or an average of £2.5 million each. Nice work if you can get it. In its current state I wouldn’t pay the executives more than one tenth of that, until they can make some profits again and slash the risks.

RBS showed just £6 billion of “impairment” or potential loss on its lending book of £721 billion at the last half year. This looks very low for the conditions. Presumably all the current fuss has come about because they now realise they need to put in much larger figures for possible losses on their loans and their financial instruments. This just makes it crazier that the government rushed in to buy shares in them when they did without demanding a proper analysis of the loans and financial instruments then, and sensible write downs for the conditions. It is possible the bank will have to declare that is has lost most of the government’s new capital in the second half of 2008.

There is no need to panic today. The falling share price does not undermine the bank. The depositors are not in a panic as they assume the government stands behind them and the bank has substantial liquid assets. What needs to happen is the production of some sensible figures on the current state of the loans, and some active management of the bank to cut our risks.

We need to see a string of disposals of the non banking interests and the overseas banks. We need some serious cost cutting starting with the top executives pay. We need some intelligent new UK lending to re start the business.

We seem to have seen off the Bad Bank idea. Instead, as the papers reveal, we will end up with an “insurance scheme”. it will be very difficult to get it right. Either the taxpayer is going to be made to pay huge losses in due course, or the banks will be weakened further by high premiums.

My thoughts on the risks for taxpayers are in the Mail on Sunday this morning.

Constructing a Bad Bank to solve the Credit Crunch problem is too difficult in the current volatile situation. It would be quite wrong to force independent banks into one if they are not in receipt of taxpayer share capital.The main banks headquartered in the UK are too big to be taken on by the taxpayer. The taxpayer should not be expected to carry the burden of their potential losses on lending all round the world.
Some people think it is a relatively simple matter. They argue that too many bad loans are holding back the banks from lending more money. So why not, they argue, shunt all the bad loans off into a Bad bank which the government can own and work its way through, allowing the banks to start again with cleaned up balance sheets and loan books?

There are all too many obstacles in the way.
The first problem is that bad loans do not have a bad loan label on them, allowing easy identification. Some bad loans will be obvious – they are debts owed to the bank by companies or individuals who have already gone bust. The other bad loans are to people and companies who may go bust in the future or who may have trouble meeting the interest and capital payments.
The second problem is that there is not a given stock of bad loans, which once dealt with sorts the problem out. In this kind of fast developing recession the number of bad loans expands as the economy lurches downwards. Companies that can meet their payments today may be unable to next month. Individuals who can meet their mortage payments at the moment, may lose their jobs next month and then be unable to pay the interest.
The third problem is that the main UK banks are also big global banks. How would the UK authorities offer to take bad debts related to the UK in a way which did not leak out into other countries banked by the UK banks? If they could just buy up UK bad loans, how could they stop the benefits of doing this leaching abroad, making the whole task so expensive for UK taxpayers?
The fourth problem is how to value the assets or bad loans. Everyone involved now seems to understand valuing them is very problematic. If you cannot value them accurately then either the government pays too little, leaving the banks in a very weak position, or pays too much for the loans,leading to huge losses for taxpayers.

Let us look at some examples of these problems.

Loan One: to a man who has a drink problem and is a gambler. He fails to make his regular interest payments. The bank has to call in the loan. The bank manages to sell the house for more than the mortgage, so gets all the money back. (Ultimate value of loan £1 in the £)
Loan Two: to a steady well paid civil servant who has always made his payments and apparently has a secure job. He then gets involved in an acrimonious divorce, loses his job through bad conduct, fails to make the payments. The bank reposseses and sells the house for 75% of the mortgage. (Ultimate value of loan 75p in the £)
Loan Three: Loan to a company which is trading successfully in autosales. Demand halves, profit margins disappear as customers demand keener prices. The company fails to meet repayment schedule. The bank puts the company into receivership, and discovers it only gets back 20 p in the £
Loan Four Loan to a financial company which has bought financial futures. The bank believes it has full security and is told the future position is to reduce risk in the underlying financial business. The futures go horribly wrong, losing the company more than its capital. (Final value of loan zero)
Loan Five:Loan to another company that has geared positions in futures contracts 5 times the size of its balance sheets. Bank makes the company close them down over six months. Company does so and makes a profit. (Value of loan £1 in £1)

It is not easy spotting in advance which loan falls into which value band. Loan Two looked like a high quality one and Loan 5 looked very risky. Of course bankers spend their lives trying to evaluate these things. They look at the cash flow of a businesses or the income of individuals to see how likely it is they can pay the interest. They look at the value of the home or the business to see how they could get their money back if the client stopped paying the interest. In normal times their rules of thumb and their mathematical models work. In these extreme conditions they do not. Unlikely people and businesses go bust. Asset values collapse so quickly that banks are left without proper cover for their loans. That is why it it so difficult to sort out the true values of these loans and to make proper provision for them.

I was very critical of the government blundering in to buy shares in banks where it was obvious a lot more needed to be written off their loan books. The government should have tried to come to better views of the value of the loans before putting money in. This process is now happening because the banks need to produce end year figures and are having to be more realistic about how many loans will go wrong and how much they might get back.

The government needs to make the banks do this exercise for the year end. It needs to tell the banks they have to cut their costs and get themselves back into profitability quickly, as they need retained profit to strengthen their balance sheets. The government should be ready to lend against security, and offer sensibly priced guarantees both on deposits and lending, but they should not buy more shares, and should not yet buy bad loans. The situation is still too unstable, and we have no idea how many more bad loans will emerge in the hostile trading conditions of the first half of 2009

We are living through two crises, for the price of three, thanks to the authorities.

The first crisis was the massive overextension of borrowing in the Credit bubble, which low interest rates and loose banking regulation, off balance sheet financing and a culture of buy now pay later fuelled in the early years of this century. Government led this movement, making extensive use of off balance sheet financing itself.

The second crisis is the gathering slump, brought about by the authorities calling a belated time on the credit bubble with high interest rates and tougher banking regulation. They decided to change the attitude of buying things on credit in the private sector.

One of the reasons we are making such slow progress in sorting out the recession is the authorities are still unclear which of these two problems they are fighting, and which is the priority for their attention. Part of their actions are designed to stop another Credit bubble, actions which make it more difficult to turn round the slump.

It might be helpful to recap the main actions being taken by the UK authorities and to categorise them into one or other of the crises they are trying to tackle.

Interest rates.
These were lifted to higher levels and kept there to curb the Credit Crunch. Rather late in the day these have now been lowered to tackle the recession they have helped create. It will take time for the beneficial impact of lower rates to work through. In the meantime the very low interest rates now make it more difficult to banks to attract and keep deposits, at a time when the Regulator wishes the banks to become more dependent on deposits as a source of funds.

Capital Ratios
These have recently been raised and more strictly enforced by the Regulator. This is a policy to prevent another Credit bubble, which will make the downturn worse.

Banking liquidity
The proposals to increase the amount banks hold in cash and bonds is designed to fight the Credit bubble and to improve confidence in the banks. It will not help them extend more loans.

Money market activity
This has changed substantially from the very tight money to fight Credit expansion which brought the slump on, to much looser money, to begin to combat recession.

Loan guarantees
The recent proposals may assist in expanding bank lending and therefore increasing bank deposits, an essential prerequisite for recovery.

New share capital for banks
Given the likely rate of loss in the current nationalised banks this is unlikely to lead to more lending. The danger is it will allow banks to take longer to cut their costs and improve their business models, something they need to do quickly.

VAT reduction
This was designed to boost demand and therefore economic activity. It is failing to do so, as it did not put any new money into people’s pockets. Income tax reductions would have been better. Not all of it would have been spent, but people do need to repair their own balance sheets before they can spend more.

Increased public spending
This is also designed to boost demand. It will do to a modest extent. Some of the spending schemes are going to take a long time to get up and running, as they are large capital projects with long planning and legal processes to go through before any contract is let.

This is a very mixed picture, showing the confusion by the authorities over what they are trying to do. In the meantime the rapid deterioration in the real economy is making the task of turnround more difficult. There are a number of ways the downturn is gaining its own momentum.

The banks remain weak. They may well have to write more off their corporate loan books and their property loan books, as asset values continue to slide and as trading businesses experience more difficulties. As the banks are strapped for cash to lend, they are likely to force more companies into bankruptcy, which in turn leads to bigger loan losses for the banks, further undermining their ability to lend to others.

Many companies are experiencing unusually large reductions in demand. This forces them to sack more people, as there is nothing for all the employees to do and insufficient money coming in from customers to pay the wages. The more people who are laid off, the less people will spend. Those sacked have less money to spend, and those still in jobs want to repay debt or save as they feel insecure.

Companies find potential customers cannot raise the money to buy the goods, or find there is no trade insurance and credit to lubricate transactions. They have to become more suspicious of their suppliers, and require prompter payment from customers to minimise the risk of loss. The tightening of trade credit adds to the financing woes of business.

So how does the government break the damaging cycle? It needs to make sure all its policies towards the banks are designed to encourage more normal lending levels. It needs to maximise the favourable impact on jobs and activity that its spending creates, it needs to control its overall borrowing, allowing for the cyclical increase in the borrowing requirement, so that it can continue to finance itself sensibly.

I will write more about the bad bank/good bank idea tomorrow. I would advise the government to be very cautious about such an approach. The last thing we want is to saddle the taxpayer with all the bad debts of the banks, letting them go back to making big profits and paying big bonuses freed of many potential losses from past business mistakes. You cannot solve the problem of bad debts by transferring them from banks to taxpayers.