Category: Blog

Apparently governments are made of money. Today Germany has taken far reaching action, following more problems at Hypo Real Estate.

The pressure is on the UK by the media to announce a similar guarantee. That is what we were effectively offered when the run on Northern Rock became serious.

At some point governemnt and Regulators have to find a way to get the banks back into sensible shape without government underwriting or nationalising them. The banks together are too large for even the taxpayers and governments to take them on. The sooner they get on with the task of recapitalising themselves the better. All these gurantees and special lending facilities have to be time limited, and there needs to be some more pressure on banks from the authorities to raise capital. The banks also need to establish a new level of prices and values for types of debt and property so they can start to trade with each other. These mortgages and corporate loans mainly have some value. Most of these loans will be serviced and ultimately repaid. The system is behaving as if they would not.

People sometimes say they wish the politicians would get together and agree, instead of bickering and arguing. I wish the politicians and political parties would disagree more about the issues, so that actions and policies can be properly tested and choices evaluated. Consensus often breeds the worst errors.

As someone who bore the scars from opposing the consensus that the Uk should enter the ERM – and probably go on to join the Euro – it surprised me just how much damage the consensus mongers were prepared to do before they accepted their idea was wrong.

As someone who has been a farily lonely voice explaining that the Bank of England was not made independent in 1997, and who thought the MPC alongside this government was likely to make a mess of running our economy, I have been less suprised at how long this nonsense has continued and how much damage it has done.

Today I read a senior military voice telling us we cannot win the war in Afghanistan. As someone who is not an expert in these military matters and who has not visited Afghanistan I wonder if this is a warning we should heed? This is a war supported by Barack Obama, John MacCain, George Bush and Gordon Brown. It is a war where Barack Obama and the Democrats, who have moved from supporting the war in Iraq to questioning it, want to see Western forces increased. They favour a troop surge in Afghanistan whilst being sceptical about a troop surge in Iraq.

I have always wondered how you can fight a war on terror. The US has the world’s greatest ever military machine, with amazing technology. Not even the US yet has the technology to identify and destroy an enemy living within residential areas full of people you are trying to help, without killing too many of them as well. Better bombs and smarter delivery mechanisms can help the US win any conventional war easily, but it does not mean the US can win enough hearts and minds in fledgeling democracies to make them safe for a particular way of life.

I am not suggesting there are any easy answers. I understand it is not helpful to say I would not have started from here. I would appreciate some thoughts on whether on this occasion the amazing consensus is right, and we need to intensify our military efforts in Afghanistan and over the border into Pakistan, or whether we should heed the General and try something else.

The story so far is easy to understand. Governments, central banks and banks got it wrong for five years, and allowed the western world to get too heavily into debt. Governments and individuals borrowed and borrowed at the attractive rates on offer.

Central banks then decided the party had to end and took the drinks away. Now we face the prospect that too many people will not be able to pay the interest on their borrowings and will not be able to repay them on time. Banks have too little money to lend, so house, property and vehicle prices are plunging. This means the banks are even more exposed, as they will not have enough money from the sale of an asset if and when someone hands back the keys and admits they cannot afford the interest.

It is now fashionable to say we need to “de leverage”. The main reason is to cure the inflation excess debt created. I have news for them. The future problem is deflation, not inflation. De leveraging was a good idea a couple of years ago, but today too much deleveraging will just turn a recession into a slump.

There are two ways banks can get their balance sheets into better shape. The first is to withdraw borrowing facilities from existing borrowers, and make very little or no new loans available to people and businesses that want to borrow. This is now happening on a dramatic scale, and will mean more bruising news from the rest of the economy.

The other way to do it is for the banks to raise new capital. If the main banks went out and doubled their share capital, raising new money from old and new shareholders, they would then have much stronger balance sheets and would be happier with the amount of lending they have already made.Some banks are reluctant to do this because their share prices are low. Unfortunately they have no choice. Their share prices are low because investors are worried about their lack of capital, so it is a circular argument. They also have the problem that if assets keep falling in value they can lose the money they raise, forcing them to write off more of their own assets. Again, they have no choice. They have to seek to replace the money they have lost. The shareholders have to pay up to keep their bank going.

It is now becoming popular to say that only the taxpayer can provide the capital the banks need. This is a dangerous argument. The taxpayer should not provide capital for the medium and longer term to help the private shareholders of these banks. Nor should the taxpayer nationalise them, as there is no evidence that nationalised management would be better. There are limits to what taxpayers can afford. Nationalising major banks is beyond their purses and their appettie for risk.In this downturn the governments are going to need all their credit worthiness to borrow to pay the running costs and to help the individual causualties of recession.

There is no substitute for major bank capital raising now. The sooner the better. They must just swallow hard and acept the low prices of the shares they can sell. It’s time for them to visit the Middle East and Asia, where the investment money is.

A year late the European leaders recognise that they, just like the Americans, have a serious Credit Crunch on their hands. As they meet they should avoid saying more things that can make things worse. The US politicians have just shown how easy it is for them to make things worse, by attempting action that does not have popular support, and then telling us all how bad things are to get through an amended package. It did not help restore confidence in markets to have so much bickering and black briefing from the top.

What could the meeting of European leaders usefully do? There are five main areas they could concentrate on.

Interest rates. They could tell the ECB and Gordon Brown could tell the Bank of England to get their rates down to around the 2% level chosen by the US. Concerted action to lead markets to lower rates might help. If we persist with high rates more borrowers will default, banks will be weakened further and confidence will continue to ebb away.The Central Banks have failed badly, keeping rates dangerously low in 2003-6 and keeping them dangerously high 2007-8. Market rates will remain much higher than recommended rates, but should reduce somewhat in response to such a lead. If my critics say we have now reached the point where MPC and ECB rates are completely irrelevant then they should recommend winding up the MPC who have got it so wrong for so long and save the money!Mr Brown could put more people onto the MPC who see the world as Mr Blanchflower does, to give him some support for cutting rates.

Liquidity. We have moved from a system where Central banks are rare lenders of last resort to banks, to a system where Central banks are the main source of short term lending to banks. When Central banks in recent weeks have tried to withdraw liquidity, commercial banks have got into financial trouble. Central banks should be told to keep the system as liquid as possible during this very stressful time, as we cannot afford Central bank actions to undermine any more institutions.

Capital and solvency. Regulators behind closed doors should be telling banks they must raise more equity and long term loan capital, whatever the price and whatever the dilution to existing shareholders. We must get away in due course from reliance on Central bank short term lending. Large sums are needed to buttress bank balance sheets.

Accounting. The Leaders should examine how we can get sensible views of the value of banks assets, adjusting mark to market where there is no effective market to value loan packages.

Government spending. Goverments must rein in their own excessive borrowing as their contribution to moving on from the credit bubble. The EU could take a lead by cutting its spending substantially, as much of its spending is the marginal spending on top of the essentials paid for by member state governments.

Mr Brown should remember we run our own monetary affairs and need to take actions that are right for the UK. They should all remember this is not an official EU meeting, and cannot bind the other EU members.

Presumably the PM wants to bind Mandelson and the Blairites into his voyage into recession for some industries. Does Mandelson want to help, or is he out to assist the Blairite cause from his new ringside seat?

Let’s assume he wants to help, as he tells us. Brown has given him the dreadful job of holding the hand of business as we enter a nasty downturn. Will Number 10 support him and take most of the blame for the poor position of business, or will there be tensions over what caused it and what to do next?

It’s certainly going to make politics more interesting, but I doubt if it will bring forward the policies we need urgently to fight recession. Don’t expect Mandelson to urge lower interest rates or better fiscal discipline anytime soon. There is still no alternative policy being advocated around the Cabinet table to try save some jobs and preserve some businesses, at a time of grave danger to our economy.

In recent weeks the BBC have shown some interest in what I have been writing and saying on the Credit Crunch, and occasionally I have been allowed an interview to put a point of view.

They still delight in juvenile “Gotcha” journalism. They always know my views better than I know them myself, but of course their version of them is normally a caricature and sometimes simply wrong. If you tell them they have got it wrong, they then try to assert you have changed your view!They never seem to read any of the pieces I write, but rely on hearsay, the distorted views of critics, and the misrepresentations they have helped put into circulation.

Before Conference the aim was to portray me as a deregulator who thought banking shoudl not be under any kind of control. They clearly had not read the Report I co authored for the Conservative party seeking stronger Central bank control over solvency and liquidity, the very things that have been going wrong under a government which has greatly increased the amount of needless regulation to so little effect.

At Conference the attempt was to get me to say I would have voted down the package in the USA had I been a Congressman. Had I obliged I would doubtless have been presented as someone who could not see the need for action at a time of crisis.

It’s pathetic. If all the BBC want to do is to assert their caricatures the interviews will simply be wasted in allegation and rebuttal over facts the BBC refuse to accept because they cannot be bothered to read what their guests have written.

Mrs Palin experienced a rapid descent from media praise after her speech to the Republican Convention. Her stumbles when trying to deal with various interviewers asking her questions she clearly had not thought about before enabled the media to present her as a liability to the ticket. Last night she fiound some of the phrases and some of the attitudes that the Republican base liked when they heard her Convention speech. They want someone to go to Washington who is not a Washignton insider. That will mean she is not necessarily equipped to deal with a “Gotcha” media constantly striving to get themselves into the story by unpending a candidate with a trick quesiotn or a twisted phrase. Maybe there are more important skills in life than the eternal vigilance and patience it takles to handle the ever brasher media. I don’t think worse of Miliband because he was caught holding a banana – it’s his views on the EU I want to see exposed, not his eating habits.

We are now entering the second phase of the Credit Crunch, the time when the crisis has a direct impact on the rest of the economy. The first phase was a problem for the bankers and brokers. The second phase is a problem for all of us.

In the early days of the Crunch there was some pleasure by many in the US and the UK to see rich financiers losing their jobs, or finding their share options and bonuses wiped out. The years of plenty and easy money for bankers had produced plenty of jealousy and anger outside their privileged banking halls. The feeling that the bankers should be made to pay was still there when the Bush administration came up with its $700 billion package to buy distressed debt from the banks. People asked “Why should Wall Street be bailed out?”. Wouldn’t this nationalise the losses, after the bankers had pocketed the profits?

The political establishment who wants to “bail out” the banks argues correctly that crisis on Wall Street will also hit Main Street. They try to persuade their electors that they must spend all this money, otherwise the banks will be unable to lend sufficient to American borrowers to run their businesses, buy their homes and carry out their normal transactions. The public seeks guarantees that any bail out will not leach public money into shareholders dividends or bankers pay.

The revised version of the Bill to be voted on shortly attempts to deal with these very reasonable concerns. It offers the US taxpayer a stake in banks that sell their loans to the government. It provides for controls over executive pay. It implies a new level of state control over US banking we have not seen before, on the very reasonable argument that the taxpayer is having to pay so much so the taxpayer deserves a say and a stake in the future business of any participating bank. The danger is that the terms may become unattractive to banks, and knowledge that a bank has to participate in the scheme may not be as good for confidence as the Administration hopes. There are no easy answers.

The argument is sometimes presented in stark terms as a struggle between a benign establishment – both Democrat and Republican – who want to save the banking system and therefore the economy, and a group of backwoodsmen and women who are “playing politics” in a way which will endanger the system. It is a pity it is so presented. What we need is a debate about what kind of a package will have most chance of success, rather than a debate about whether there is any need for action.

There can be no doubt that the banking system is in trouble. Given the run of news on both sides of the Atlantic you would need to have avoided all media programmes and newspapers for a year not to understand that. There can be no doubt that weak banks unable to lend much will undermine the general economy. US and UK voters are beginning to accept that. The issue should be, what combination of actions by the banks, the rest of the private sector, the Central Banks and governments can get the banking markets working again sufficiently to avoid deep recession? That may include some spending of public money, but it may revolve rather more around the spending of private money to recapitalise the banks and around actions by the Regulators to move their rules into a shape which help fight deflation rather than inflation.

The sad truth is that even if you did want the taxpayer to take on the banking black hole and fill it with taxpayers money, it is too big to do that comfortably. Governments have been part of the problem. They have borrowed too much, and certainly in the UK have themselves used the modern off balance sheet techniques of finance which they are now criticising others for doing. Both the US and the UK governments have to accept there are limits to how much money they can borrow and commit to sorting out banks, otherwise the credit worthiness of government will become the issue. Governments must keep people believing in their financial management, so government guarantees when offered are things of value and mean something. Governments also need to understand that the capital needs of the banks are very large.

The banking crisis will only be resolved when banks believe each other major bank has adequate capital, and a sensibly structured balance sheet. Total debt will be reduced and has to be reduced. If it is done too quickly the consequences for the rest of the economy will be severe. Banking capital has to be increased. That means banks have to sell a lot more shares to raise new money, at low prices. That will adversely affect existing shareholders, but there is no alternative to taking such action. The sooner the banks get on with an other round of fund raising the better.

Expect over the weeks ahead to see banks trying to cut their loan portfolios to get their balance sheets into better shape. They will exert pressure on companies to reduce their overdrafts and repay their term loans, or face increases in rates and charges where these can be raised. They will lend people a lower proportion of a reduced house value if offering mortgages at all. They will be tougher over consumer loans. As a result there will be fewer houses and cars sold, fewer purchases of discretionary items in the shops, and lower prices for many items. Manufacturers will cut their output and lay off staff. Some retailers will sack people and be forced to reduce the scale of their operations. Restaurants, bars and hotels will face falling trade. At the very time when more people and businesses will want to borrow to tide them over a fall in income the banks will say they cannot borrow more. Government borrowing will surge as government will be left paying the extra benefits and collecting the lower tax revenue brought about by the slowdown.

Some of my critics on this website think I am underestimating the inflation problem. I know pensioners are understandably afraid of this winter’s fuel bills. Many people live in dread of the ever rising Council Tax bill. A trip to the supermarket is a shock to the prudent and those on lower incomes. Fear does stalk the land. People’s most recent experience is of rapidly rising prices. Savers are afraid that their savings income will fall, when it is already inadequate to meet the bills. All this is true, and reflects past mistakes which cannot now be corrected.

Today the authorities in the UK are making a different mistake. They are taking too many risks with deflation. Whilst the fall in some prices to come will be welcome, the rise in unemployment, collapse of asset prices and the difficulty in keeping businesses going will leave no household in the land untouched. To those who think the fires of recession are purgative I say remember many will be badly burned by them first if they are fanned by the authorities.

The Monetary Policy Committee might manage a 0.25% cut in their recommended rate at the next meeting or they may delay further.

Why does the MPC always want to get it wrong? They failed to put interest rates up enough in the days of easy credit. Their failure meant too much borrowing and a big increase in inflation. Now when it is obvious to anyone that the problem is too little credit and falling prices of most things, they stubbornly refuse to cut the rates enough or quickly enough. America slashed her rates to only 2%. She too had rising inflation at the time but realised that in future inflation will tumble.

Some people now say there is no point in cutting the recommended rate because market rates will stay much higher. At some point the Bank of England has to get back in charge of the markets. In the meantime, cutting the recommended rate will help all those borrowers whose actual interest rate is linked to the Bank of England rates.

If interest rates remain too high it just means many more bankruptcies and many more lost jobs.

Earlier this week the spin coming out of the EU was simple. The banking problem is a US one, and the US has to find a solution. The implication was there are no problems in Europe, other than some infection at the margins from their US operations.

Now we learn that there are problems which the French President thinks the leaders of European countries ought to discuss at a special crisis meeting. It’s a bit difficult to sustain the spin line that this is just a US matter if they are going to do that.

Meanwhile in the real world, a special credit guarantee of 35 billion Euros has been made available to Hypo Real estate, Bradford and Bingley is being dismembered and partly nationalised, Glitnir the Icelandic bank has been nationalised, Fortis has had an injection of money, Dexia has received special treatment and the Irish government has offered guarantees on all Irish bank deposits. For all that to happen in a week – and it’s still only Wednesday -you have to conclude the the EU has a banking problem as well as the US, and much of this problem revolves around excess European lending under the eagle eye of EU Regulators.