Category: Blog

If proof were needed that many politicians and some political commentators live in a parallel universe, the response yesterday to Mr Brown’s speech was conclusive. Yes, Mrs Brown appears to be a very nice lady, and supports her husband. Now there’s a surprise!. Yes, Mr Brown can weave more of his personal story into a major speech, if his advisers and presentation team help him to do so. Yes, Mr Brown has always says he wants more fairness in society, and may well believe that. Yes, Mr Brown is serious and hard working.

None of this should have been in doubt. The issue with this government is not what they say, but what they do and what the results of their actions and inactions are.

Gordon may well have wanted to end “child poverty” and “fuel poverty”, but his flawed analysis, seeing these as different from poverty overall, and his failure to lift more than 5 million of working age out of benefit dependency are what matter. He chose to stop poverty by offering hand outs rather than hand ups and it has not worked.

Gordon may well have wanted to end “boom and bust” as he constantly told us, but he has ended up by presiding over an excessive credit bubble of a boom, and is now taking us into a bust, with mounting unemployment and falling asset values. One bank is already nationalised and another is seeking a rapid merger with a partner with a competition policy override. The falling house prices, lost jobs and bankrupt businesses will follow this winter.

Gordon may have been misguided enough to think he made the Bank of England independent by taking many of its crucial functions away, and may well have thought he had created a new low inflation stability. Time has proved this to be wrong, indicating yet another major misjudgement.

The sad truth is Gordon still does not get it. Far from being the man to lead us through the troubled financial waters, he is the man who does not understand why we are in the mess, let alone have policies to get us out. In his first three years as Chancellor, when he followed inherited Conservative spending plans, he did a good job as Chancellor (leaving aside the raid on the pension funds and the odd sale of gold). He repaid debt, the economy strengthened and we had low inflationary growth. In this century he turned to spend and borrow as his strategy:things started to go horribly awry.

Listening to him over this troubled summer, he still seems to think that spending more can buy him popularity. He seems ignorant of the extent of the government deficit, and the big increase in borrowing he is now presiding over. We saw the £2.7 bn package for the 10p tax band error, the North West transport package and the Aircraft carriers. Now at this conference we have free tickets for young people to go to the theatre and free computers with internet connections for 1.4 million households. These are all worthy ideas, but they show an underlying inability to understand a simple political truth – people will not vote for him to say thank you if they are losing their jobs, under pressures in their businesses and watching their house prices tumble. Knowing you can go to the theatre on the taxpayer does not make up for the inability to get a mortgage to buy your first home. It’s even worse to know that your ticket was bought with borrowed money you will have to help the nation repay in future.

He’s not even good at the politics. All of the carefully crafted spending packages that just happened to occur near the time of elections did not buy a single victory. Why can’t he get it? We need sound economic management, and that has to start by curbing the deficit, getting value for the money spent and controlling the borrowing of the state.

So today I add one more soundbite to the dustbin of history, to rot alongside “No more boom and bust” and “We made the Bank independent and created economic stability” – “Gordon Brown is the man with experience to see us through difficult financial times”.

Last night I heard David Cameron speak. He did see the need for fiscal responsibililty, for greater Bank of England powers to supervise money markets and the banking system and for progress in getting the Uk higher up the league table of competitiveness instead of slipping further down with the lost jobs and lower incomes that entails.

Mr Milliband’s incautious remarks in a lift are important political news, proving that the government fiddles whilst Rome, Wall Street and London burn.

There is one thing worse than Mr Brown in Number 10, and that would be Mr Miliband. He is completely sold out to the European project, and would hustle us into even more power give aways.

His enthusiasm for the Euro shows just how little economics he understands and how he would subordinate the UK’s economic interests to EU demands.

All those who heralded last week’s move to stop short selling of financial shares on both sides of the Atlantic wanted to believe that short sellers were responsible for the market fall, and thought a regulatory change could stop it.

Yesterday showed how wrong that was. Wall Street plunged another 3%. Markets can and do fall because holders of shares lose confidence in the financial world and want to get out. Markets can fall because holders of cash see no reason to invest it in shares. Those forces were always the main ones driving these Stock markets down this year, and they remain the main ones following the regulatory bans.

There is no quick or easy regulatory fix which will stablise the markets. The markets now are mainly driven by the actions of governments and Regulators, especially those of the USA. It was the decision to save Bear Stearns, Fannie and Freddie which limited declines. It was the decision to let Lehmans go that undermined confidence and started the big further falls. It was the decision to bail out banks with distressed debt which led to the huge rally – along with some short covering following the regulatory change – and it is worry over the bail out package that led to yesterday’s sell off.

The world’s financial markets are dependent on the US Treasury Secretary and on what Congress makes of his Bill. In that sense government is very important. What markets are waiitng to hear is how much money will be committed and on what terms. Until they know that it is difficult to establish sensible values for shares.

Jealousy and anger are powerful emotions. When mixed they make a Labour conference.

The Democrats have a point when they say they will not vote for a massive bailout if some of the money rewards shareholders of the banks in trouble, and if some pays large bonuses to the executives who got it wrong. Many in the UK have a point when they say some bankers bonuses are too large and not based on success.

So let’s consider some possible bonus payments. I would welcome your views on the following bonus awards.

Mr Canny, the Hedge Fund Manager, bought lots of oil shares as the oil price surged, made much bigger profits than most funds, and sold out near the top. He earned a large bonus based on the year’s performance to June 2008.

Mr Lucky, the Hedge Fund Manager, also made super profits in oil shares in the year to June 2008, and also pocketed a large bonus for the performance. He continued to hold them in the fund, losing a lot of the gains over the next few weeks. He keeps his bonus.

Mr Sharp, the Hedge Fund Manager, made huge profits out of selling financial shares short over the last year. He is now banned by law from doing this, so his fund has banked its profits and gone into cash. He was paid a large bonus for the performance.

Mr Nice, the Mortgage Manager, made a lot of mortgages available to first time buyers 2005-7, responding to government encouragement to make more long term mortgages available. Because he sold so many more mortgages, he was paid a large bonus in each of those two years. Today he sells very few mortgages. When he sold his mortgages to people his bank thought all but 1% of them would be to people who carried on paying the interest. They now think it might be 5% that go wrong. This will mean the bank loses on the mortgages he sold. Mr Nice’s bonus did not relate to how well the mortgages do in the longer term, but just how many he sold. Mr Nice himself was not responsible for assessing credit worthiness or risk.

Mr Chancer, the Investment Banker, packaged mortgages up into funds and sold them on through securitisation. He was paid large bonuses for all the fees he earned the bank by doing this. Unfortunately his bank decided to keep some of these securities on its own book. They are now worth perhaps only 25p for every pound they originally paid for them, meaning the bank has now made an overall loss on this business. Mr Chancer keeps his past bonuses.

The problem with several of these cases is one of timing. In the year of the sales achievement or the rises in the shares owned, the accounts tell everyone that something good has happened and that the employees should have a share in it. Subsequently, in several cases, losses are made that offset or wipe out the profits or revenues that were earned in the earlier year. Only two cases represent more permanent profit – the cases of Mr Canny and Mr Sharp. Both were doing things many people dislike. One was helping fuel a boom in oil and energy prices. The other was making profits out of helping push the price down of leading banks.

There are several ways a bank or other financial institution can deal with the timing problems of the other cases. They could offer the bonus in an escrow account, which only pays out sometime later if no problems emerge with the business written that involves the bank in loss. Alternatively, the bonus can be issued in the form of shares or rights to shares, and again there would need to be a holding period to see if all was well with the business.If the busienss did lose then the shares would go down in value.

The government has held out the possibility of regulating bonuses. The FSA are right to say they cannot undertake to review every individual’s bonus and decide whether it is fair and reasonable or not. It is too much work, could divert people to offshore centres, and would be subject to clever devices to get around the letter of the rules. Banks and financial institutions have to be responsible to their shareholders for this matter. Shareholders and some Directors have been remiss in allowing the bonus culture to become excessive in some cases.

We hear that the regulator may counter bonus schemes that it judges to be too generous by demanding more capital. That may be the least bad way to be involved, given the current political mood.

Would you regulate bonuses? If so, which ones? And how would you regulate them? The devil is in the detail.

Gordon Brown tells us he is the man able to pilot us through the financial crisis and the economic downturn. So what should he do?

1. Interest rates. The US slashed rates which ran at 5.25% through most of 2007, to only 2% today. In the UK Brown’s MPC (all his direct and indirect appointees) kept interest rates below 5% from 2nd August 2001 until 9 November 2006, in order to stoke up inflation, and have now held them above or at 5% ever since, to intensify the downturn. Will the PM sort out the MPC and try to make it counter cyclical instead of reinforcing the pain of the cycle?

2. The government deficit. Yesterday’s newspapers at last examine the huge drift in the deficit which readers of this blog will be acquainted with. Many now agree that this year could see an overshoot of at least £20 billion in borrowing. Some think next year will be far worse, and have gone further than me in forecasting up to £100 billion of deficit in 2008-9. Will Gordon Brown start to get a grip on the public finances, and reassure us convincingly that the deficit will not go up by these huge amounts?

3. Transparency. The PM urges the private sector to be more transparent. Will he at least adopt the same degree of transparency in compiling the government’s balance sheet as all large companies have to adopt by law? This would mean putting the pension liabilities and the off balance sheet borrowings onto the UK government balance sheet, revealing that we are around 3 times as much in debt as the official figures suggest. If he is right that confidence comes from transparency this will help!

4. Preventing another mortgage boom and bubble. Is he going to propose detailed regulation of individual mortgages, with the Regulator having a view on multiples of income and proportions of value? If so, how will he prevent banks and Building Societies issuing top up loans in addition, or sending the loan request offshore?

5. Tackling the bad debts in the system. Is he going to follow the US and offer to buy up poor performing loan packages to relieve the banks? If so, where will the money come from, and how will he price what he buys? If not, how will he respond to the US treasury Secretary’s request to other jurisdictions to follow his lead?

6. He tells us he has been presiding over markets which need to be cleaned. Will he specify in what way they are dirty and how he intends to clean them. Is he happy with current bonus payments in the banking sector? If not what can he do about it? Is he happy with Hedge Funds that follow short as well as long strategies, or is he going to ban them, forcing them all offshore? Is the ban on short selling financials just temporary, or does he wish to extend it?

7. Does he think recent large sums put into markets to improve liquidity have been well spent? Does he intend to offer more?

8. Will he give the powers back to the Bank of England that he stripped away in 1997, so they can do a better job of managing the money markets/? Does he agree the money markets have been mismanaged in recent years? Does he now regret how loose money policy was in 2004-6? Does he regret the change of inflation target he pushed through?

Some of you are bound to ask me again what I would do. I have set that out on many occasions as the crisis has unfolded. To summarise,today I would still cut interest rates, take action to curb wasteful and undesirable spending and to control public sector costs, give the powers back to the Bank of England, and ask them to keep markets more liquid. I would seek talks to ditch the current Basel II regulatory structure for banks, and seek to negotiate a regulatory framework that considered liquidity as well as capital adequacy, and which tried to be counter cyclical rather than pro cyclical. If we don’t do this we will just start another cycle in due course.

A few years ago when the Conservatives were stuck in the low 30s in the polls it became fashionable for the party hierarchy to try to copy everything Blair had said and done in the late 1990s when he was so popular. It did not work as a strategy, for people thought to themselves if even the Conservatives think Blair is right we might as well stick with him, or abstain from voting as there is no real choice. Subsequently it emerged that Blair had wasted his golden economic legacy and frittered his high standing with the public in the early years.

Now that Labour are wallowing in the mid 20s in the polls they are following a different strategy – hitting out against the Conservatives. It is an even more absurd strategy than the old Tory one. They create the Aunt Sally of a Conservative government, as if some parallel government existed in the UK, and then condemn it. Hence this weekend we are treated to the criticism that David Cameron has not done enough for single parents! How can David Cameron do anything for anyone, as he is Leader of the Opposition, unable to win a single vote in the Commons?

Labour figures on TV and radio programmes must also have been briefed to criticise the Conservatives for calling for an end to mortgage regulation. This according to the BBC and Labour Ministers is proof we are unfit for office. Clearly none of them who make this criticism have either read the Policy Report from which a single sentence has been extracted, nor have they any serious interest in trying to sort the unholy mess in the money and mortgage markets which they have created on their watch.

The Policy Report was a serious contribution to the debate about how to regulate and supervise markets. It warned that the removal of powers from the Bank of England would leave the Bank unable to handle a banking crisis, as time has proved to be true. It recommended giving the Bank the necessary powers to control markets in times of easy credit, and to make more liquidity available at times of stress, the very things this government has failed to do. It went on to say that this government’s extra mortgage regulations which they introduced were all cost and no benefit, as again time has proven. If their mortgage regulations had worked we would not now be facing too many people with negative equity struggling to pay the mortgage.

This was a balanced report. It said where we needed to strengthen control – in the money markets where huge mistakes were being made – and where we could cut out needless costs where regulation meant bureaucracy but no grip on the underlying risks and dangers. The events of the last year have more than vindicated the analysis of our Report. We warned that things had been too lax and were now too tight. We warned about sloppy public finance, and the lack of Central Bank power to handle credit creation and money issues.

Labour’s deliberate misrepresentations of this Report just make them look silly. Their technique of bashing the Tories may get them through a party conference, but it will not wash with the electorate. Voters expect them to grapple with this crisis and come up with some answers. This crisis was not caused by a single line in Conservative Report. It was caused by Brown’s bungled reforms of the Bank of England and by the way the world regulatory system was regulating the wrong things in the wrong way.

It is currently fashionable to argue that because there is a mess in the banking world there needs to be more regulation.

We need first of all to ask how this most regulated of industries got into the current difficulty? Why did all the regulaiton we already have fail to stop the crisis? Indeed, did the regulation itself in some ways allow the crisis or make it worse?

People want there to be easy answers. Let’s look at some of the suggestions:

1. Ban short selling. Most of the selling which has driven down share prices has come from owners of the shares selling. Banning short selling will not stop sharp falls in bank shares if people lose confidence in those banks.

2. Stop mortgage banks lending people more than say 90% of the value of a property. That looks like a good idea and would represent prudent banking. However, if Central banks decide to create very loose money with low interest rates again, as they did in the 2004-6 period, such a ban will not work. Offshore banks will be able to lend more than 90% and will steal some of the business. Onshore banks will obey the rules about mortgages, only lending up to 90%, but will encourage people to take out a personal loan at the same time so they can lend them more.

3. Raise the capital ratios for banks, to limit the amount they can lend. That would work, but is best done during the upswing. Doing it now will intensify the downturn. Today’s problem is banks do not want to lend very much at all, so making it dearer for them to lend makes that worse.

4. Offer a public sector bail out for difficult loans. This may be necessary to prevent worse damage to the system, but it sends out a dreadful message to banks who now know they are all “too big to fail”. Shouldn’t there be some financial penalty on the shareholders of banks who issued all those poor performing loans in the first place, if they need to take advantage of any subsidised public bail out?

5. Try to develop counter cyclical intelligent central banking. The errors of the last few years are errors of the whole banking system , led by the Central Banks. We need a new generation of Central bankers who raise interest rates earlier to choke off excess, and cut rates earlier, to prevent too steep a downturn.

Poeple should stop thinking there is a black box regulatory answer which will prevent another boom-bust cycle in the future. Indeed, it is more likely that action taken eventually to stimulate economies out of the present downturn will in its turn sow the seed of the next boom. Meanwhile, there is no way of appointing brillliant banking and mortgage regulators who will get the decisions right when the bankers and their clients are getting them wrong. There will always be mortgage excess if central banks allow money to become too easy, and there will always be a house price crash and mortgage default if central bankers make money too tight.

This morning we learn from government sources that the PM has taken the action necssary to see us through the crisis. Did I miss something?

I heard the US authorities announce large extra liquduity for markets, and heard them announce a buy up plan for unloved mortgages. The US Congress, which is allowed to meet, will be passing emergency legislation next week. The UK Parliament has been prevented from meeting throughout this summer’s crisis and remains uninformed of the government’s latest forecasts and thinking.I saw the US slash interest rates some time ago to only 2%. I have not heard a thing from the Uk authorities, other than to say they will waive the Competition rules to allow a merge of a couple of UK banks, and are banning short selling for a few weeks.

The truth is that the UK version of the Credit Crunch is a particularly bad one, and has been made worse by this government’s actions in recent years. Far from helping solve the crisis, the government has helped the banks create a UK crunch through bad central banking and bad regulation. The main regulatory mistakes have been:

1. Taking crucial powers away from the Bank of England to run and understand the money markets in the 1997 reforms.The Bank needs to be the daily regulator of the main banks and needs to manage the government debt.That was always a disaster waiting to happen.
2. Appointing people – and reappointing – to the Monetary Policy Committee who kept interest rates too low in 2003-6 and are keeping rates too high in 2008. We need an MPC with better judgement.
3. Setting a new target for inflation control prior to the 2005 election which encouraged the Bank of England to keep interest rates too low – that was obviously a dangerous mistake at the time.
4. Abandoning Prudence after 2000, building up huge deficits in the public sector during a boom, instead of taking some heat out of the binge by cutting the growth rate of spending and by reducing borrowing.
5. Accepting and negotiating Basel I and Basel II regulatory systems for the banks, which encouraged banks to put as much borrowing as possible off balance sheet, and encouraged securitisation, selling loans into less regulated funds. Far from controlling the banks, the global regulatory rules encouraged the type of excess which brought the system down.
6. Introducing expensive and elaborate mortgage regulation, giving the impression that it would make things safe, when it had no beneficial impact whatsoever. Never have mortages been so regulated in the UK as today and never have we had such a big mortgage mess.
7. Showing the priavte sector how to use off balance sheet borrowing on a huge scale, through the big PFI and PPP schemes to buy extra public facilities on the never never without putting them properly into the public accounts.
8. Failing to put enough money into the money markets in the sumnmer of 2007, allowing the run on the Rock to develop.
9. Nationalising Northern Rock – so the taxpayer has to pay all the losses,and so one of our once largest mortgage lenders can no longer lend any new money!
10.Making foolish statements at crucial times for confidence – ln the summer of 2007 telling everyone there would be no bail out which encouraged a run on the Rock, just before announcing the bail out, and more recently telling us the conditions are the worst for 60 years whilst failing to give us any hard information about what that means and what the government’s forecasts are.

That was quite a week in financial markets. The US Administration has been trying everything to get the money markets and the market in credits to work again. They decided that they could draw a distinction between financial institutions that were too crucial to allow to go into Administration – Fannie. Freddie and AIG – and those that should be put through bankruptcy or creditor protection to force them to restructure and revalue their assets – Lehman and maybe others to follow.

I guess it was worth trying. Unfortunately, the markets reacted very badly to the collapse of Lehman. Instead of market participants learning the lessons of past excess and coming to sensible judgements about risk, it invited two reactions. Firstly, everyone looked around to find out which large company might be the next to go down. Secondly, everyone decided to play it ultra safe, and only buy government backed securities, for fear of making a mistake.

It is another example of how important the work and words of the regulators are, and how they can have perverse consequences. The US had taken action to control short selling, but that didn’t stop big falls in shares of financial institutions. People who owned the shares decided to get out, seeing how a large and important institution like Lehmans could tumble in just a few days of reappraisal of their worth.

Now in the UK we have a ban for a few months on short selling shares in financial institutions. The general response of the press has been to say “shutting the stable door after the horse has bolted”. That is a false response. The experience elsewhere shows that banning short selling does not bolt the stable door. Doing it in one market still allows it in others, whilst the share movements in recent weeks where shares in some financial institutions have collapsed have been caused primarily by the owners of the shares wanting to get out. I speak as someone who never short sold a share all the time I was a professional investment manager, partly because your potential loss if you get it wrong is unlimited.

At the heart of the problems in the banking markets is fear of what the assets of each financial institution are truly worth. Normally markets are quite capable of putting a price on anything – that is all they do and they are usually quite good at it. Today market professionals who created large quantities of cleverly structured paper based on traditional mortgages or loans seem no longer able to come to a rational view of what it is worth. They no longer trust each other, and no longer want to hold all this paper they made a lot of money creating. As a result, instead of trading packages of mortgages or loans between themselves, one needing the money and the other prepared to take the risk to earn a better return, they will only buy bits of paper secured against the government revenues of a major country. Short term loans to government are now very highly prized, whilst loans to anyone else attract a low value.

It is curious that no new consensus emerges from the wreck of the mortgage securitisation movement about how to value all these loans in the new conditions. Packages of mortgages which were valued at 100 pence in the pound 14 months ago must be worth something today. It is true that people now think more of those taking out the mortgages will be unable to pay the interest, and true that in more cases when the home is repossessed to repay the mortgage there will be a shortfall because the house price has fallen. Even allowing for all that, most of these mortgage packages will still be worth considerable sums of money., especially the senior packages that were designed to avoid the worst of those two risks. The high risk packages may well be worthless, but people who bought them should have understood that could occur.

Meanwhile on both sides of the Atlantic the authorities have been involved as midwives to great new merged corporations that they think will withstand the difficult times better. We learn that Lloyds will merge with HBOS, and that famous Wall Street investment bank names are in talks to merge with deposit taking institutions to widen their capital base. The UK authorities who had been asleep at the wheel throughout 2007, allowing the run on the Rock to develop, are now awake to at least some of the dangers.

Yesterday the main Central banks of the world tried to jump start the markets with a huge injection of extra liquidity. $180 billion was made available. If all that remained was a liquidity problem it should have done the job. All it did was prevent the main share markets falling further. There was no sustained surge in shares prices. It was probably that disappointing response which decided the US authorities to try one more big move. They have now said they will take action to sort out the market in mortgage debt.

We await details of how this might work. For the sake of the US taxpayer, let us hope the people designing the scheme judge the right balance between toughness on those who made bad decisions to own all these packages of mortgages in the first place, and realistic valuation so it unblocks the market. In the longer term there should be money to be made for the taxpayer. The taxpayer can borrow short term money very cheaply, as the banks only want to lend to governments at the moment. There are many packages of mortgage loans and other loans on offer at what taxpayers will hope prove to be giveaway prices. A patient owner could hold them until the markets have come to their senses and are able to value them more realistically, or if necessary own them until all the loans in the portfolio have matured and most repaid. The US government clearly now sees itself as a credible buyer with the capability to get some extra value out of what it buys. This is an operation for professionals with very big pockets only.

I wish them well with it, as the good health of the world banking system currently depends on their actions. If they do it in order to make money for the taxpayer it might work. If they do it to offer subsidies to a banking industry which has got it hopelessly wrong it will stretch the taxpayer too far and create a new problem further down the track. Judging price and security will be most important. Pay too much for the loans and they will lose. Fail to offer enough for them, and it will not restart the markets. During this drama market players are ignoring the deteriorating numbers in government finance. That could become a story later , when the share prices of financial stocks no longer hog the headlines.

The PM’s belated intervention into the financial crisis is curious.

He tells us he intends to clean up markets. Who exactly was regulating and presiding over dirty markets over the last 11 years? In what way do they need cleaning? Why wasn’t it done before?

From past interventions we know the PM thinks there needs to be more transparency. He should start by cleaning up the government’s act in this respect. The government is currently refusing to give us sensible forecasts of its 2008-9 borrowing requirement, failing to update its revenue forecasts or its spending forecasts, and failing to give us a revised growth forecast.

The government seems to be condemning off balance sheet borrowing on a large scale, yet that is exactly what they have been doing. Does this mean an end to PFI/PPP off balance sheet borrowing? Does it mean we can look forward to seeing all the current off balance sheet finance consolidated any time soon? Do they now regret lumbering the taxpayer with the huge liabilities of Northern Rock, when acting as its bank manager would have more than halved the amount at risk? Will they respond to my estimate of £1500 billion of total liabilities for the public sector, including the unfunded pension liabilities?

The PM went on to say “we don’t want these problems recurring in the future” and told us he would be discussing what to do with other Regulators and governments around the world. What we need to know is how he is going to help us get out of the present crisis. It’s no good saying it is global, when an important part of it was made in the UK under the eye of Brown’s Regulators.