Category: Blog

I worried preamturely that the government’s wish to borrow so much would cause strains in the government debt market. Indeed, I underestimated their intelligence in this respect.

Forecasting a huge surge in government borrowing from the £43 billion for 2007-8 heralded in the Budget to around £120 billion, I discovered that the government now thinks the true figure is an eye watering £157 billion for this year, or more than 10% of National Income. (The government has of course got away with telling people half the story, with most journalists and commentators using the £78 billion figure they wanted them to believe). This could have been more than markets would willingly lend, creating new strains on our currency and long term interest rates.

Instead, the worry today is that despite the huge increase in government debt we will witness a further increase in the size of the government debt bubble. Government debt prices have been rising. How can this be?

The government has taken strong steps to ensure lots of buyers for their debt.
They are instructing the banks to buy lots of gilts (government debt) to “increase their liquidity”. Much of the money the government has put into the banks to “strengthen” them will be lent back to the government at a loss!

They preside over a pensions regulatory system which will force many more companies to increase their pension contributions, and will encourage Actuaries and other advisers to insist this new money is stashed in gilts.

Taking interest rates down to very low levels will undermine the returns of most savers in normal deposits. Some of them will be tempted into government debt through National Savings and related products.

Injecting huge quantities of money into the system through the Bank of England will also create large amounts of liquidity to let institutions buy government stocks. They are creating a huge money go round, where the Bank of England bloats its balance sheet, to create the cash to power the government debt bubble.

In the short term the government has designed a system which will allow it to borrow collosal sums at low rates of interest. At some point this will have to be unwound. Just as the property bubble burst and the commodity bubble burst, so one day the government debt bubble will burst. In the meantime, enjoy the show.

Yesterday I met people in the West Midlands, to take the temperature of manufacturing.

The sound of very little going on was eerie. My journey to and from by the M40 was all too easy. The inadequate roads were for once more than adequate for the reduced traffic. The Birmingham ringway gave me unusually free passage around the conurbation.There was a worrying quiet about the place.

The mood was of one of people waiting for the news to get worse in the new year. The crisis which hit sixteen months ago in the City of London, once a remote matter affecting people on high salaries in high finance, is now all too real. Orders have contracted, some lay offs and a lot of short time working have already been announced.

There is a worrying expectation that as the world’s factories close for extended Christmas and New Year breaks, to contract output in line with much lower demand, so there will be knock on effects throughout manufacturing. Today maunfacturing is global. Cuts in one country soon transmit to cuts elsewhere.

Even migthy China is now experiencing a savage downturn in parts of her manufacturing heartlands, as the much reduced demand for Chinese goods in the west hits a country which has been such a successful exporter that she has $2 trillion in the bank.

I wanted good news to tell them, something to raise spirits. All I could say was the US authorities, somewhat late, are now doing everything they can think of to try to turn their economy around. Let us hope something works soon. It is like watching someone in front of a huge board of electricity switches in a dark room trying every switch, but so far none turn the lights on. We just keep hoping the board is still connected to some power.

Metals, oil and food prices have tumbled on world markets. As predicted here, the story of early 2009 will be price falls, disinflation, deflation. The Central banks were so wrong to worry about inflation earlier this year, as they tightened the noose around the necks of easy credit. It’s making it so much more difficult to kick start the economies, as the damage to the banking sector is severe.

So why is US inflation well down, and UK inflation still too high? There are two simple reasons. The first is the pound is very weak whilst the dollar is strong. The UK has lost a lot of the benefit of falling raw materials and energy prices through the devaluation. Chinese imports are now also a lot dearer. The second is the cost of government. In the UK petrol and diesel taxes are so much higher than the US, with a large element that does not go down when the oil price falls. Items like Council tax always seem to go up (unless you live in Hammersmith and Fulham) whatever the economic circumstances. Many public sector fees and charges also exceed inflation on a regular basis, whilst the state monopoly post and the semi nationalised railway industry have recession defying price policies which sting the consumer.

UK inflation will come down next year. Looking at the range of government policies they are aiming to rekindle inflation again once they do manage to turn the economy round. The amount of money being printed, the low level of interest rates, and the reduction of competition in crucial areas like banking all point to a lot more inflation in due course, once they have worked out how to mend the banks enough to avoid a long and deep recession.

In this new world where the all powerful state can take on any financial obligation, I guess nationalising the Post Office pension fund deficit is small beer. After all, a one percent loss on the gross assets of RBS is three times the size of the pension fund obligation we read we are about to take on.

For those of us who still think governments too have t to control what they borrow, spend and guarantee, it is yet another large sum that taxpayers, sometime, are going to have to pay for. Pensions have become shrouded in jargon and regulatory complexity. Actuaries and experts exchange complex sums, attempting at any given date to come up with a figure for the “deficit”, the shortfall of money in the scheme to meet its future liabilities.

These deficit figures can be very volatile. They are the product of two very difficult forecasts. The expert needs to work out how much all the pensions are going to cost. That is a moving feast, as no-one knows for sure how long the pensioners will live, or how much their pensions will increase by in an inflationary world. Then the expert needs to decide how much the fund will make on its investments, an even more difficult matter to estimate.

Trustees responsible for the schemes are then faced with the issue of how they will fill in the deficit, if that is what their experts tell them they have at any given time. There are three ways of “correcting” a deficit, if all the assumptions in the deficit calculation are accepted and do not change over time. The trustees can improve the investment returns, above the Actuarlial assumptions in a way which persuades the Actuary. The Trustees can obtain more contributions from the company and the members. The Trustees can agree lower benefits with the members.

If the government is planning to take on the Post Office pension fund, it should first reach agreement with all involved on how it is going to tackle the deficit. Is the future semi privatised body going to increase employer contributions? Are members going to accept higher contributions or lower benefits? Can the investment strategy be improved? Or is the long suffering taxpayer simply going to pay whatever it takes to fill the present deficit, with no guarantee that there might not be another deficit in a few years time? If they go on getting the investment strategy wrong, or offer more generous benefits, will the taxpayer be expected to stump up?

Financial businesses are different from most other types of business. They entail sending your money to someone else to look after, on the promise they will give it back to you at a later dtae, preferably with some improvement in its value.

Because of this I have always favoured two types of regulation for financial businesses. The first applies to deposit takers. They should be required to meet overall standards of capital and cash reserves. The Economic Policy review I helped produce in 2007 demanded stronger requirements in these important areas, as we could see the banking sector was grossly over extended under the then current regulation, which could make it difficult for people to retrieve their deposits from some banks if many wanted to at the same time.

The second type of regulation should apply to all financial businesses. It should be a policing system designed to find the thieves amidst the large financial community, and take early action to prevent them trading or to wind them up rapidly where theft or fraud is occurring.

Instead, what we have witnessed is a a big growth in the regulation of the many honest businesses, in the strange belief that if you put in enough complicated rules to “prevent” some past way of carrying out a fraud, you will prevent fraud. This is never likely to work, because of course if someone is going to commit theft, breaking a few Regulators rules and lying to the Regulator is just a subsidiary part of the task in order to steal all the money.Fraudsters will break regulators’ rules as well as pocketing the cash.

I am not surprised that a large fraud may have taken place in the US. They like the UK have box ticking regulators who create ever more rules in substitute for being detectives seeking out the mercifully small number of bad apples in the financial barrel. The danger of the US system is the regulators concentrate on a wide range of honest businesses who fall foul of the increasingly complex rules owing to human error, disagreements about what the rules mean, and through misreading the complexity of all the process issues the regulator seeks to control. At the same time invetsment managers can be losing their clients billions legally, and a handful can be stealing billions of their clients money without the regulator being able to see it.

When I was the UK’s non banking financial Regulator, in the days when that role resided in the DTI, I drew up a list of things regulators should look for to try to detect crooked businssses. I told them to concentrate on that, as I was quite sure the public, like me, primarily wanted their regulators to find the Maxwells before they had taken too much money from clients or pension funds, and stop them.

Included in my list of warning signs worthy of investigation were: returns that are too good to be true;promised returns out of line with the asset returns they said they were buying; frequent changes of year end and auditor; complex company structures;lack of independent people on the Board and at the top of organisations;lack of independent custodian arrangements; market rumours.

I favoued using the invetsigatory powers, in private, when our suspicions were aroused. A public investigation, or worse still a press briefing before enough evidence had been amassed ran the risk of breaking a perfectly good business if it had good reaons for the warning sign.

In the hue and cry that will follow the Madoff case there will doubtless be the demand for yet more process regulation to “stop” someone else doing what it is alleged he did. Instead the cry should go up for a detection based approach to regulation, instead of yet more box ticking for the largely compliant and the wholly honest. People should rememnber that it is only the honest who do the box ticking honestly. Crooks can tick boxes too, and can make up the things to put in them. It’s just the same with money laundering. Money launderers doubtless have passports and gas bills. Making sure every financial business has all its clients passport and gas bill copies does not mean the end of money laundering.

According to the news media, RBS may have lost £400 million in the Madoff investment funds.

That’s not quite how I wanted the government to spend the tax money I and my constitutents send them.

The government thought the following would lead to more normal lending levels:

1. £37 billion of new equity for 3 banks
2. Nationalisation of 2 mortgage banks
3. £450 billion of short term loans and guarantees for banks
4. Much lower interest rates
5. A big increase in money market liquidity and substantial open market operations by the Bank of England

They thought all of this would bring LIBOR down close to the base rate, in turn leading to banks lending again to home buyers and businesses.

Now it is not working they have added:

1. The reflationary package, based on a VAT cut
2. Much higher levels of public borrowing
3. Lecturing the banks

So why isn’t it working?

1. The banks still have to write off substantial bad debts. HBOS last week revealed an additional £8 billion of write offs, three quarters of the new capital the government is supplying. If all or most of the new capital just matches losses it cannot be used to lend more.
2. The Regulator has chosen this bad moment to demand more capital and cash to sustain existing levels of lending. As a result new capital above the write offs does not necessarily allow any new lending.
3. Banks are lurching from being too confident to being very cautious about new lending. They are now reluctant to lend as they fear more losses.
4. Further big losses are emerging, as we learn today concerning a large US Investment fund. Such losses hit confidence and in some cases impose more direct losses on banks.
5. The Regulators are requiring banks to rely more on retail deposits and less on wholesale money. Retail deposits are dearer, making it more difficult for banks to make profits. Loss making banks are weak banks, unable to lend more.
6. The two nationalised mortgage banks are effectively winding down their mortgage books. This means far less mortgage money is available in the markets, leading to further falls in house prices. This in turn leads to more mortgage loan losses for the banks.
7. The sharp deterioration in business conditions in the UK, US and EU in the fourth quarter of 2008 will create more corporate loan losses. Bank executives are busy fire fighting problems in many of their customer companies.
8. The Regulator is going to require the banks to hold a lot more in gilts so they are more liquid. In other words the banks are going to be made to lend more to the government!

What can be done?

It is not easy breaking a vicious circle of less lending, more losses, less lending. The government should summon the Bank of England, the Regulators and the lending banks. It should say it wants to change the terms of its £450 billion package to make it more effective. The Regulator should be asked how it could be more counter cyclical to make it easier for banks to lend in difficult conditions. At the moment regulatory and monetary policy are pulling in opposite directions. That needs to change. The government needs to find a market answer to allow Northern Rock and Bradford & Bingley to lend again. It needs to find a way to limit taxpayer risk in RBS.

If they carry on in current mode we should expect more property price falls, more bankruptcies, more job losses and more bank loan losses. This is not a great backdrop for recovery. Whilst it is important the government stands behind the main UK banks to avoid another Lehman disaster, it must avoid feather bedding them. Taxpayers should not be subsidising six figure salary executives and their bonuses. The financial sector generally has been paying itself too much. The sooner costs and charges are cut, the sooner more normal business can resume.

The serious allegations about a large US investment fund show us how little a big Regulator achieves. The very least we should now expect is Regulator help to solve the current problems instead of making them worse. Putting in tougher controls to prevent the excess they allowed a few years ago just digs us deeper into our current hole.

We are told a big review of the Post Office awaits Lord Mandelson. The Unions are afraid it means faster rounds and more job cuts. Taxpayers are afraid it means more subsidies and underwriting the huge losses in the Pension Fund. What it reflects is the poor management of the company in recent years, cutting the quality of the service whilst increasing the prices and demanding more cash from the government.

What should be done? The first task should be to empower regional and local management, making them responsible for their own revenue generation as well as for costs, and putting them in charge of their property and other assets. It’s not much fun for local managers, constantly being told to cut costs and offered no control over assets and revenue to grow the business in more positive ways.

A couple of years ago I proposed a way of improving the service and releasing cash in my Wokingham area. The main Post Office in Wokingham town occupies a prime position. At the front is a handsome facade and shop space to handle the counters business. At the rear is cramped and inadequate sorting office space in assorted sheds and industrial style building, with a narrow access to the side across a busy town centre pavement and main street.

I suggested they sold off the sorting office and back land for what then would have been a lucrative office redevelopment, bought a suitable modern property on an industrial park with good vehicular access for sorting, and increased the number of counters by knocking the shop through into the store room within the main building to cater for increased demand. Local management thought this all made a lot of sense, but the idea got lost in the rambling central bureaucracy.

Instead, the central management decided on the closure of two branch offices in Wokingham, claiming people could go to the main Post Office in the Town Centre instead. We objected, but they did not wish to hear us. I said they needed to increase the number of counters at the main building first, as there were already long queues. Instead they blundered on with the closures, causing worse queues and worse service in the main office as well as making it more difficult for the elderly to get there at all without a car.

The Wokingham example is just a small one, indicative of problems across the network. the whole thing is one big missed business oportunity, a great franchise that has been grossly mismanaged in recent years. We cannot afford the losses, and cannot afford the Pension losses. Both fund and business need new directions. Whatever the rights and wrongs of the speedy postman debate, the bigger problem the Post office has is the quality and power of management. There is some good local management, and doubtless some bad. None of it has the power to do the job. That’s why the results are poor, there are many missed property opportunities, and many missed opportunities to fire up the staff. They could start by giving them all a share in the business. That would help electrify it.

Green is so much last year’s colour for western governments. Now they have stumbled into a policy which will cut carbon emissions sharply, their policy of falling living standards and recession, they are all rightly trying to run away from it. So are their voters, who might tell pollsters they want to live in a lower carbon world, but not if it means they have no car and have lost their job.

Let me make it clear. I see myself as a sensible green. I want to stop overbuilding, leaving some green gaps and lovely countryside between English settlements. I want to clean up the water and air through better technology and some regulation. I think the biggest domestic policy error of the Bush regime was the failure to work away at energy self sufficiency, to cut dependence on unreliable supplies from elsewhere, and see the UK government’s failure to find new, more fuel efficient home grown energy solutions as one of its more important mistakes.

What I dislike are the authoritarian greens, who see the cause of lower carbon as a means to try to stop personal transport, who wrongly think trains and buses do not cause some of the problem, and who refuse to look at the audit of where the carbon comes from. They do not accept that for some journeys the car is the lower carbon alternative to the nearly empty bus or the inconvenient train. They never tackle the carbon excesses of the public sector – all that air conditioning and over heating in bureaucratic offices, and all that travel on “fact finding” and “diplomatic” junkets, whilst condemning the commuter who dares to try to get to work through their congestion loaded streets by car. It seems to be freedom they want to stifle, rather than carbon.

The German government has faced a dilemma. Representing a car ridden economy, where the automotive industry is a very important part of their activity, the government has lobbied and argued for less onerous carbon regulation at the EU level. They have decided automotive jobs matter more than the latest fashion in carbon targets.

The US government faces a dilemma. President Obama is not yet in office, elected on a green ticket, before he is letting it be known that saving the gas guzzling car makers of Motown is important to him. Yes, he will dress up help with programmes to encourage them to make more fuel efficient cars, but in the meantime he accepts the reality that too many jobs are riding on making grossly inefficient vehicles to be a rigorous green. He is not about to say “thank goodness these makers of fuel wasting cars are about to go bust or slim down. That will help me to hit the new targets I want to impose”. Once again in the USA we see those two bank nationalising, war fighting, high spending and high borrowing advocates of big government, George Bush and Barak Obama, united in their approach.

In the UK we have come to expect contradictory responses, and differing language depending on the day of the week and the nature of the audience. One day we are told in the House that tougher carbon targets are the order of the day. The next we are told that propping up the auto industry and trying to get the banks to lend more money to the companies that make the cars and the individuals who might buy them is crucial to our future success. Meanwhile, in Labour inclining Manchester they vote by 4 to 1 against Labour’s mistaken green policy of trying to switch people from carbon emitting cars to carbon emitting public transport at a £1.6 billion cost of borrowed taxpayer money, and £5 a day for those who still want to use a car.

The Manchester defeat should be seen as the end of an era. Labour’s whole transport strategy was based on the premise that if they spent more on trams and trains, and taxed people more for using cars, they would achieve a “modal shift” . Only the rich would be able to drive their own personal transport, alongside the Ministers in their chauffeured limos. The rest of us would willingly take the shiny new trams or crowd onto the already full peak hour trains, saving the money on the Congestion charge to pay the extra taxes for the losses the public transport systems usually make.

This policy has recently suffered a defeat in London. Some Londoners voted Boris in to get rid of the anti car policies, and to scrap part of the Congestion zone. The consultation the new Mayor carried out was clear. The voters wanted the western zone scrapped, and he has said he will do so. Now it is defeated in Manchester.

The people are right. This very expensive switch will not make a huge difference to carbon output, but it will cost large sums of money and may make the journeys of many even more inconvenient. We need instead a positive policy of sensible investment in the railways to get more capacity out of them, and road improvements to cut congestion and improve the safety and flows at junctions. Motorists have had enough of taking all the blame for carbon output, when there are so many other sources of it from the inefficient domestic boiler to the old fashioned power station. The government needs to work away at improving the capacity and technical performance of much of the infrastructure, without inventing new taxes for people already groaning under the burden of wasteful government. 11 years have failed to deliver the modal shift, and the modal shift was not going to solve the carbon problem anyway.

The government is discovering that wishing for housing to be more affordable, as they did for several years, creates an uncomfortable world of negative equity, weak banks and mortgage famine. They by now should have worked out that their theory that you needed to build more houses to bring house prices down was completely wrong. We today have plunging prices at the same time as large cuts in new building.

So when will housing be affordable? There is no single good price level, as it all depends on what price level the mortgage banks will support. They, under strong regulatory influence both ways, have lurched from believing very high prices are affordable, to working with much lower prices. What is affordable when banks will lend 5 times salary is not affordable when they will only lend 3 times salary. What was affordable with a 100% mortgage may not be affordable with an 80% mortgage.

The boom was so overdone in London that even people on good incomes were priced out of the London housing market unless they already owned a property or had some other windfall to help them. Still today, after considerable falls in the market, a new MP on £63,000 a year would be hard pressed to find anything more than a studio flat he or she could afford north of the river near the office. A professional, middle manager or Doctor on around £100,000 would have little choice of anything other than a one bedroom flat in the central districts if they were starting out with a mortgage and not much else. Pity anyone on average wages, they do not have a chance in inner London.

I fear this all means the fall has further to go. The government has not yet found a way to help mend the banks. The mortgage market is still far from happy. Northern Rock is in effective run off, so Northern’s mortgages need refinancing elsewhere as they fall due. On current policies we have not found a base for the property market. That means more losses at the taxpayer financed banks, in line with the deteriorating loan experience revealed by HBOS in their figures yesterday. Taxpayers are currently losing more than £7 billion on the bank shares the government has bought for £37 billion at current prices.

This week I asked the Foreign Secretary why it appears that Northern Rock cannot offer competitive busniess rates in the market owing to EU competition rules, but this constraint does not seem to apply to RBS. He said he would write to me with an answer. I think we need to know, as it seems odd that the smaller bank is prevented from writing much new business, whilst the bigger bank is unaffected.