Category: Blog

What a fuss about nothing. If the Conservatives had taken money from a British company (legal) as a conduit for money from an overseas resident (illegal) that would have been an interesting story and a complex web to untangle. Fortunately we learn they showed judgement and took no such donation.

Readers of this site will know that I last estimated government borrowings and pension debts at £1.5 trillion at the time of Northern Rock. Today a new publication estimates it at £1.8 trillion, reflecting the increase in debts to pay for the banking rescues, the further build up in pension liabilities, and the general overrun on public spending and borrowing this year so far. Brooks Newmark has compiled his figures from official sources where possible, and brought together official government borrowing, public-private partnership borrowing, Private finance initiaitive borrowing, borrowing to fund bank capital and loan books and pension deficits.

The BBC wanted to score a couple of points against him this morning. The first was to remind him that the Conservatives did not include pension liability in the figures they used to publish for government debt when in government. That is correct. Mr Newmark responded that this government made companies put pension deficits on their balance sheets, and is lecturing us all on the need for transparency, so they should show the way in their own figures. The second was any incoming Conservative government would not want to change the figures in this way. I trust any incoming Conservative government would immediately order a proper audit of the figures, and publish the true position of the government accounts. Having an honest statement of the starting position is going to be essential to clearing up the mess.

Borrowings and other debts at 120% of National Income represents too large a risk for taxpayers. It is even worse than those figures imply, if the government goes ahead and makes RBS a subsidiary of the state. RBS has a £1.9 trillion balance sheet, larger than our National Income, so the taxpayer would be on risk for a lot if the bank were to start losing money under nationalised management. Northern Rock has been loss making since nationalisation.

A programme to cut the indebtedness of the state would begin by finding other ways to recapitalise the banks than buying shares with public money. It would move on to offering a different deal on public sector pensions for new entrants, which at least entails employee contributions which are then invested in a fund – like the MP and Local government schemes – instead of the pay as you go approach of the civil service. It might also entail only offering new entrants defined contribution schemes rather than final salary schemes to cut the risks. It would certainly include proper controls over administrative and advisory staff numbers, to fight the battle of the bureaucratic bulge.

The government has spent too much and borrowed too much before the recession begins. Now the red ink starts to flow seriously owing to the recession it is going to cause big problems ahead for state finances.

(WRITTEN FOR GUARDIAN COMMENT)

I am asked if we can spend our way out of a recession? I write against a silly political background, where the left are trying to annex Keynes again, as if he were a left wing figure whose views had been buried by Conservative monetarists and deregulators. The truth is very different.

Margaret Thatcher kept her copy of the 1944 White Paper on employment, which incorporated some of Keynes’s perceptions. She used it in one of her big party conference speeches. Conservative economists working since Keynes have usually drawn on his insights as well as the views of others. It was a Labour Prime Minister, James Callaghan, who officially incorporated monetarist thinking into UK government economic policy making, when he recognised that more public borrowing in an inflationary era would make matters worse.

Of course in one sense you can only overcome a recession by more spending. A recession is insufficient demand chasing too many goods and services , leading to job losses, falling prices and cuts in output. The issue is not whether we need more demand or not, but how you bring that about. Confidence is a precious flower, and can be easily damaged if governments take the wrong decisions.

The priority is to encourage more private sector demand, because it is private sector demand which is falling sharply. You do that by cutting interest rates substantially. I have been calling for cuts to head off recession for many months. The authorities are far too slow, persisting wrongly in thinking inflation is next year’s problem when recession is next year’s problem. Lower interest rates feed through immediately to borrowers whose rates are linked to MLR, and later will benefit others as money markets start to function better.

We need more confidence and cash in the system. That is why the Conservative leadership has backed the banking package in its entirety, to give it the best possible chance of succeeding. Until there is more confidence there will be insufficient private sector demand. The gap will be too large for an overborrowed public sector to be able to fill, even if the government took the risk of expanding public borrowing even more than they are already doing.

If the government presses ahead with borrowing £37 billion for bank capital its scope for further borrowing to undertake counter cyclical works will be even more limited. I think they should spend some time amending the package, to get as much of the new banking capital from private sources as possible. This would leave them with a little more flexibility.

As it is, we are facing a huge overrun on borrowing compared with budget. The downturn itself and other policy changes announced so far have probably boosted borrowing by £20 billion this year, on top of the £37 billion for the banks. This means a borrowing requirement forecast at £43 billion could exceed £100 billion. Government needs to keep confidence in its own powers to raise money. These figures are large. Given the delay in trying to get new larger capital projects off the shelf and into action, and given the high borrowing requirement, I do not see a lot of scope for the government on its own to spend us out of recession on this year’s budget. It has to find other ways of allowing the private sector to pick up.

The decision of the Dutch government to put more capital into ING is strange. A week ago when ING took on deposits from a failed Icelandic bank,and on October 17th in a press release, we were told that ING was in a strong financial position. Now we are told it will have extra taxpayers capital. The governments and Regulators have raised the bar over how much capital a bank should have, and are now having to pay up to meet their own higher hurdle to appease the markets. Meanwhile a French bank loses substantial sums in “unauthorised trades” so the three bosses of the bank resign. One wonders why the top people have to resign at a bank if employees broke the rules, but not at all the banks which got into financial difficulties by doing what the Directors asked or authorised.

It is good news that many in the political and media classes reckon we have now lived through the worst of the banking crisis and think it is now all on the mend. A return of confidence in banks is a necessary part of recovery for the rest of us. However, the authorities have to understand that you cannot have strong banks without a stronger economy. They need to do more to ease the recessionary forces, otherwise banks will face much larger losses right across their portfolio of loans. The issue now is whether we can stave off a corporate loan problem to run alongside the sub prime mortgage problem being experienced on both sides of the Atlantic.

It is also worrying that the main property specialists, who were very complacent going into the housing downturn, forecasting a very shallow decline in prices, are all now telling us to expect another year of substantial falls in UK house prices. If they are right this time round that means more grief on the mrotgage books for the banks, as well as many individual tragedies as the nation plunges more into negative equity.

Early on in Obama’s campaign for the nomination I drew attention to the excellent speeches and the new model of fund raising he was using. I praised both on this site and raised a few eyebrows. I said I thought they were going to be successful.

I went on to say I did not like Obama’s policies, to the extent that he then had any, and doubted they would measure up to the challenges ahead. People ignored that part of the comment. I now feel the same about McCain’s.

Now we have seen most of what both candidates are offering, the thing which comes across is how conventional in their thinking both these “Change” candidates are. They both want to commit more forces to the war in Afghanistan. They both have plans to increase spending and cut taxes at a time of high government budget deficit. They both agree with the Paulson/Bush plan for tackling the banking crisis. Neither have come up with anything new on how to fight recession. Neither have radical plans to slim central governemnt down and make it more responsive to electors.

It is strange that Colin Powell throws his weight behind Obama, offering us just slogans as reasons. He tells us we need change, and we need a new generation to take charge. It is time that he and other heavyweight backers started spelling out what change we need ,and how Obama is going to deliver it. It is obvious we need change, obvious the Bush policies of military intervention and economic management have run their course. The issue is how quickly can you change them, and how funadamentally, to put the West back on the road to freedom and prosperity.

I went to the shops today. In one leading retailer there was a queue at the returns counters where staff at three tills were busy refunding the money. Many tills in the leading stores were unmanned, and there was no queue at most of the other tills that were being used. There were not that many people out on the High Street, and those that were bnought a coffee and maybe ended up with just one bag of goods, or none. Lots of staff were standing around with nothing to do.

I bought some glasses because they were marked down by 60% from their usual price, putting them below the 50% off sale offers I have paid for in the past for similar merchandise. I had in my mind the question would there be further price cuts in the next sales? The deflationary psychology puts people off buying, as you think if you leave it it might get cheaper.

It is usually dangerous when the Establishment unites behind a single policy and says there is no alternative. The last time that happened in the UK we were lumbered with the Exchange Rate Mechanism which gave us a rapid inflation followed by a recession.

Recently in the USA the Republican and Democrat leadership united with both Presidential candidiates behind the Paulson plan. That plan turned out to be bad politics, failing its first vote in Congress, and bad economics, leading to subsequent modification by its own author.

It ws therefore a relief that this week David Cameron and George Osborne signalled that they do intend to be critical where criticism is warranted, and to offer an alternative. That is called democracy. Criticism of George Osborne is fashionable and unfair. It was George who thought up “Tax con not tax cut” to characterise the unsuccessful 10p tax band budget. It was George who rightly pointed out that the government did not mend the roof when the sun was shining, and George who is now using colourful language about a house burning down to draw attention to the problems.

The Opposition now needs to flesh out its alternative strategy to see us out of the current severe dfficulties. They can draw on the Economic Policy Report they commissioned. We called for a stronger Bank of England, making better decisions over banking capital, liquidity and interest rates.We warned against lurching from too easy an approach to credit and money to too tough an approach. We sought better control over public spending, an effciency drive throughout government, less useless regulation, and concentration by government on a limited number of things that government did have to regulate well – especially money and credit levels. We recommended a big increase in infrastructure spending, mainly privately financed.

Today I suggest a threefold aproach to the crisis.
The first is to amend the government’s way of handling its approach to the banking crisis.
I fully support the privison of liquidity and longer term loans to the banks. They must take full security for these advances to protect the taxpayer. The withdrawal of too much liquidity at times over the last fifteen months has intensified the crisis.
The government should not spend £37 billion it cannot afford on buying bank shares. It should refuse to finance the HBOS/LLoyds merger, leading to LLoyds going it alone in the private market for its capital needs. The Regulators should give HBOS and RBS time to increase their capital ratios, whilst the government makes it clear it stands behind both banks with loans and cash if needed. They could both improve their capital ratios by stopping dvidend payments, cutting very high pay and bonuses, reducing staff through natural wastage and other cost reducing measures, and reducing their loan books. It should be their choice which combination of these measures they adopt.
The government and Bank are right to experiment with other ways of lending and using guarantees to get the banking markets moving again.

The second is to get control of the public finances. Cancelling the £37 bllion will help. There are many other ways of starting to control public spending, whilst keeping every nurse, teacher, doctor and teacher and other important public service workers.

The third is to take action to stimulate the private sector, which is crashing downwards rapidly. That means cutting interest rates by 200 basis points or 2% immediatey, with the prospect of more to come if needed. It means working with the energy, water and transport industries to see which larger investment projects can be brought forward to provide some work for the construction industry. It means redoubling efforts to help people back into work who lose their jobs as the redundancies build up this winter.

I am glad the Prime Minister has reaffirmed his support for free enterprise and markets, whilst calling for proper regulation. This echoes our calls in the Economic Policy Review for better regulation of banks and the credit they extend by the Bank of England, when we warned of the dangers stemming from the loose monetary controls exercised in the early years of this century. We need the Bank of England to get its old powers back that this government removed. Then it might be better able to judge conditions in money markets, and avoid the excesses of easy money and tight money we have witnessed in recent years.

We also need to call today for proper control of government. The government should not have stepped in so clumsily with new capital for a couple of Scottish banking groups. If the government and Regulator wanted a bank or two to increase the capital required because it thought one or two banks were in a weak position, it could have done so through private discussion with the affected banks without letting their share prices suffer through leaks. If the Regulator wants to raise the minimum required capital for all banks it should make a statement about it, and give banks a period of time to adjust.They could do much more to remedy their own positions, without having to rush to the state as their new paymasters.

Any bank short of capital should as a high priority take action to keep more of the cash it is generating from its operations. Dividends should be cancelled. Bonuses to staff should be cancelled if the bank is running out of cash and capital. People on high salaries – say over £200,000 a year – should be asked to take a pay cut in a bank in need of state aid. If they prefer to move on that helps cut the costs. There should be a staff freeze on new recruitment, and discussions with staff about smarter working to see the bank through the troubled period. There are many ways of conserving cash and generating more profit in a large business. In the UK it is wrong to expect the taxpayer to finance a big merger between two banks. If the banks concerned can only do the merger with public money, they should be told they cannot do it. It is no business of the taxpayer to finance huge deals to reduce the amount of competition in the banking market. The total dividends paid by the three banks seeking public funds amounted to a massive £7 billion in 2007.

If the government presses on with its plans to nationalise RBS I can only see problems ahead. The pay levels, lending policies, attitudes to customers and much else will become legitimate matters of public debate. The rest of the public sector will be jealous of the special treatment highly paid bank workers receive.Taxpayers will be bemused at what is happening to their tax money.We will all be angry if the nationalised bank then proceeds to large write offs and losses. These banks are too big for the taxpayers to own and sleep easily at nights.

Any bank in need of help should receive loans and assistance in the normal way from the Central bank. The taxpayer should be protected by taking sufficient security for such lending.

Some analysts and commentators think there are two different problems, the banking crisis and the threat of recession. Now large sums of public money have been offered throughout the western world to increase bank capital they imply that the first crisis is on the mend, and maybe sometime we can start thinking about the second problem.

Unfortunately these two problems are all part of the same crisis. The banking crisis began when people in the USA were unable to pay their mortgages, and in the UK when a mortgage bank was unable to meet the demands of its depositors. The banking situation deteriorated this summer as forecasters came to see that it was not just US sub prime mortgages that could destabilise banks.

It is now important to make sure that the measures taken to restart the inter bank and money markets do not make handling the recession more difficult. If the economies of the west fall too far and stay down for too long, the banks will lose a lot more money on bad loans. It will not just be the UK and US mortgage books that cause problems, but the outstanding loans to companies will also be a source of weakness.

It is also important to ensure that public finance does not become overextended. In the days of the credit boom the UK government helped stoke the fires by its own activities. It borrowed huge sums under the Public Finance scheme and through Public Private partnerships, as well as through traditional borrowing. It added the loans of Network Rail to the taxpayer’s account. It is now about to add further huge sums through its bank nationalisation scheme.

The problem with a sharp slowdown or recession is that it damages the financial position of most people in the country and it greatly increases the strains on public budgets. Tax revenues fall. In this downturn Stamp Duty has been hit severely as the housing market dries up. Taxes on company profits, especially those on financial sector companies, will be greatly reduced in due course. Income tax on high incomes and bonuses will fall as a result of the job losses and lower profits. Spending on unemployment benefits, housing support and other government measures to handle the human misery that comes from a downturn will rise.

Gordon Brown used to call such spending the “costs of economic failure” which he rightly wished to reduce. Containing its increase should now be the prime concern of the government. Public finances are in a weak shape going into the downturn. We need to limit its depth and duration to keep government borrowing in some check.

My critics still complain about my support for lower interest rates. Savers understandably do not want their interest rate reduced, and tell me that we need to encourage savings because we have saved too little. Encouraging more savings by higher interest rates would have been an excellent policy three years ago to reduce the extremes of the boom, but is not the right measure now. Today we need to limit the downturn. That requires more spending. The danger now is there will be too little spending, cutting the money people pay to companies for goods and services. That leads to a bigger downturn, a more expensive burden on the state and more people out of work. In the end it also damages savers, because in the end in a big downturn interest rates have to be slashed to very low levels to try to get activity going again and to save some businesses. Savers cannot earn a high return with no risks. If savers want too high a rate of interest there will be more bank and savings institutions struggling, as the borrowers will be unable to cope. There are limits to how many risks the government can underwrite and how many financial institutions it can take over.

This crisis began because the banks lent too much to the private sector as well as the government borrowing too much. Between them they created a debt mountain. The Central bank and Regulator allowed this to happen, and even encouraged it by keeping interest rates low and drawing up easy going rules on the capital banks need. The Crunch began when the central banks decided to tighten conditions, with higher interest rates and less money available for the banks. Now the authorities seem to want to cut private sector lending sharply, by requiring more banking capital for a given volume of loans. Some of the strain will be taken by cutting bank lending to the private sector. If this has to be more than matched by more borrowing by the public sector to keep the banking system going and to pay the costs of recession, it is difficult to see what we have gained.

Two news items today –

The Audit Commission (public body dedicated to getting value for money for taxpayers) placed £10 million in a couple of Icelandic banks and tells us this accorded with its investment guidelines. Wouldn’t an apology and a mea culpa have been more in order?

We learn that they might close the Commons for up to three years to spend lots of money on modernising it! That would a fitting tribute on this government’s grave – “We closed Parliament so we could spend more of your money on modernising it”. They do say we might be able to meet somewhere else – that’s quite a concession! They have also sent out the Parliamentary holiday dates for next year. They amount to some 145 days.