Category: Blog

There has been a lot of comment on the state of the economy, the Credit crunch and the banking problems over the week-end. It is time to re-examine the views of this blog, and the responses from many of you.

I have argued:

1. The US and the UK will avoid recession but will experience a slow down, sharp in some areas and sectors. Some are trying to talk us into recession, by claiming the US is already in one, but the numbers tell us otherwise. It is quite clear that the Fed, the Treasury Secretary and the President will do everything they can to avoid recession in the US.
2. Inflation will remain unpleasant for the first part of 2007, but in a year or so will have reduced. Most of you disagree strongly, believing the current inflation will persist, and if the authorities do too much by way of cutting rates and making money available will trigger a faster one. I see no evidence that inflation is passing from energy and commodities into wages. We instead seem to be entering a period when real wages will be squeezed, limiting the second round inflationary effects.
3. The authorities need to do more to make the markets more liquid to ease the banking problems. So far the Fed has been very active, doing all it can. The Bank of England seems to be reluctantly coming round to the same conclusion. The ECB is half way there, making cash available but not cutting interest rates. Many of you dislike the advice I am giving, but the authorities seem to be moving in the direction I think is right.
4. The banks will gradually be recapitalised by rights issues, new share issues, and money from the cash rich parts of the world – Asia and the commodity producers. This is gradually happening.
5. UK house prices will fall, along with commercial UK property prices and US house prices. Some think UK residential property price falls unlikely because we are building so few new houses whilst new household formation is greater. I still stick to this view, because the mortgage market is tightening substantially. I accept there is no need for Florida style falls as we do not have the same over building problem and did not have the same degree of excess in sub prime mortgages.

Today Anatole Kaletsky has written one of his thoughtful pieces. He states that the banking crisis is a liquidity crisis, not a solvency crisis. A liquidity crisis is when banks need more cash to pay out depositors and other creditors than they have readily available, and find it difficult to sell their other assets quickly enough to raise the cash. A solvency crisis is when banks do not have enough total assets to meet all their liabilities, so they need to raise substantial new capital.

I agree with him that Northern Rock and Bear Stearns both were liquidity crises – depositors and creditors lost confidence in the institutions and demanded more cash than the institutions could immediately lay their hands on without official help.
The one thing we have to remember, however, that is not in his article, is that a liquidity crisis if badly handled by the banks and the authorities can become a solvency crisis. If Institution A is experiencing a run on its cash, it needs to sell assets quickly to raise more money. This, in poor markets, can drive the price of these assets down to unusually low levels. All banks then have to mark down the value of their assets on their balance sheets, as even high quality assets can no longer be sold for good prices in such conditions. This can lead to some institutions no longer having sufficient assets to cover all their liabilities, so they need to raise more capital or they get into trouble.

This is why some of us recommend that the authorities should help the markets by intervening to keep the price of high quality financial assets up to realistic levels. If the Central Banks stand by and watch as well run institutions are forced to sell high quality assets for well below their normal value, they are allowing more serious problems to emerge in the banking system as a whole. It is in everyone’s interest that high quality mortgage debt, high quality bonds and corporate debt should sell at realistic prices, related to the current structure of interest rates. In a liquidity crisis the price of good quality assets can be driven down too far, putting pressure on well run financial institutions.

Today Christians unite to celebrate the resurrection of Christ. The Good Friday story was a bleak one. Worshippers hear of the betrayal of Jesus by Judas, the denial of Christ three times by Peter before the cock crowed, and the Gospel story of how the Jews demanded the crucifixion of Christ from Pilate. The sorry discovery of Christ in Gethsemane, the denial in the Temple and the endless trials by the Jewish and Roman authorities make grisly reading. Easter Sunday replaces all this sombre news with the joy of the knowledge that Christ is risen. The Sunday story tells of the three women preparing to go to the tomb – Mary Magdalene, Mary the Mother of Jesus and Salome, only to find the entrance stone rolled away. They hear the news that Jesus has risen.

Today Easter takes place in Britain in a largely secular country, where a majority do not believe Jesus was the Son of God, and do not think he rose from the dead. Easter has been overwhelmed instead by commercial interests celebrating the new life of spring through Easter bunnies and Easter eggs in chocolate.

It is a testament to the power of the Christian message and the enduring nature of the Christian story that so much of our secular debate 2000 years on from those events in Palestine should still be about the values of love and justice that Jesus stood for, recorded by his disciples through the Gospels and the Acts of the Apostles. It is a testament to the deep rooted Christian values that we still have an established Church of England, and see the growth of the Catholic and non conformist Churches alongside the official religion. Whilst a majority do not believe, a majority will sit through the occasional Church service at times of need or for the bigger events in their lives, and most will have some understanding of the Easter story.

Indeed, more will have a view on the events that befell Jesus than will understand what their Easter egg is about. There are arguments over the origins of the Easter egg. Some think it was always Christian – a blood red painted egg to celebrate the new life inside, purified by the blood of Christ. Some think the egg was allowed as part of the diet again only after the end of Lent, so Easter Sunday was the day to celebrate the change of menu. Some trace the eggs back to a pagan goddess, Eostre. In several places there are ancient ceremonies of egg rolling hard boiled varieties with or without painted shells. Faberge took the art of the egg to new heights with their amazing jewelled precious metal eggs given to lucky recipients as Easter gifts.

All agree that the egg is a symbol of new life and hope. The Easter hare, who transposed into the Easter bunny, is a symbol of fecundity and spring activity. Many celebrate with a meal of Spring lamb; some remember the Simnel cake with its characteristic chicken and egg decorations over marzipan. Simnel cakes probably date from medieval times, when they would have eleven marzipan balls around their top to represent the eleven true disciples of Jesus. It is a delightful story that Lambert Simnel, the pretender to Henry VII’s throne, devised them when he was given work in the royal kitchens as his punishment for rebellion.

A happy Easter to all my readers.

I would like your thoughts on what is reasonable and unreasonable conduct for an MP. In a series of Moral mazes I am going to pose some everyday dilemmas that could face an MP. I do not have any particular MP in mind for any particular scenario, but these are all possible scenarios that could arise.

The first series of issues arise with the MP’s ability to offer refreshments to guests in the pleasant Commons dining rooms looking out over the Thames in the historic Palace of Westminster. Which(if any) of the following should be a) permitted b) against the Commons rules c) against the Criminal Law?

1. The MP decides it is too dangerous to invite friends and relatives, preferring to be sure by not using the facility.
2. The MP invites a rich acquaintance from the constituency to dinner. They do not discuss party funding, the guest turns out not to be a donor, and the MP pays for the meal himself.
3. As 2 above, but the guest says at the end of the meal he has enjoyed it so much as he earns so much more than the MP he will pay the bill. The MP allows him to do so.
4. As 2 above, but two weeks after the dinner the guest is approached independently by the MP’s party, and willingly gives a donation to the party. The MP is unaware this has happened.
5. The MP invites a rich acquaintance from the constituency to dinner and does mention during the course of the dinner the poor state of his party’s finances.
The guest makes an independent donation without telling the MP after the dinner.
6. The MP invites a rich guest to dinner who has already given to his party, to say thank you to him.
7. The MP invites a rich person to dinner, tells him of the poor state of party finances during the course of the meal, and follows up 2 weeks later to ask for a donation.
8. The MP’s party organisation offers a meal with the MP at the Commons as a raffle prize in an expensive raffle to raise money at a fund raising event. The MP hosts the dinner for the prize winner.
9. The MP offers a meal for two at the House with him as host to a local charity. They sell the offer as a prize to raise money.
10. The MP allows his family to come to dinner at the Commons to celebrate a private family event, and pays the bill himself.
11. The MP allows members of his family to come to an event at the Commons, and allows another family member to pay the bill and act as the effective host.
12. The MP acts as a host for a company from his constituency who want to lay on a dinner for themselves and leading customers in the Commons. The company pays the bill. The MP attends as official host and receives a free dinner for his trouble.
13. The MP acts as host for a private sector body or lobby group to hold a drinks reception in the Commons to put their point of view to other MPs and Ministers.
14. The MP acts as host to a public sector quango to present its case to MPs over a meal in the Commons.

There is much debate about moral hazard. If the Bank of England offers more money to the clearing banks when they need cash, isn’t that bailing out banks who have lent too much to the wrong people? Won’t they just do it again and again?
No, that is not the case. The money markets have frozen. The banking system cannot sell good quality debt on to others at times in current conditions. If the Bank of England steps in if needed and buys some of the highly rated corporate paper and the better mortgages, it is not underwriting poor loans to people who cannot repay. It is keeping the system going when the markets generally have failed, owing to the fear that dominates and the flight to quality by the banks themselves.
I don’t want the Bank of England taking onto its own books poor quality loans that may turn out to be worth less than the deal price. I do want it to make cash available to good banks if and when it is needed, in return for good quality assets that would in normal times be easy to sell in the market close to their face value.
That seems to be what is emerging from the Bank. That will be most welcome, and will reflect what the Fed has been doing for the US banks for sometime.

Let me wind you up this morning, by supporting a Labour Minister who is thought to have made a gaffe.
Jim Knight dared to say he saw a very good lesson being taught by a charismatic teacher to a large class – I think he may have said as many as 70 pupils.
He did not say he wanted all classes to be that size. He did not say small classes were bad. He merely offended against the iron law of the British public sector – things can only get better if productivity falls. Quality is said to increase as you apply more teachers to the same number of pupils, or more nurses and doctors to the same number of patients. The public sector cannot, according to it own rules, do more with less or better with fewer.
It was especially rash of the Minister to give this errant opinion just before the main Spring teachers’ conferences. It leaves him and his view open to easy ritual denunciation.
It would be welcome instead if the intelligent people charged with the duty to educate our young would apply some of their own thought to the conundrum of class size.
Of course it is often good to be able to teach a small class, offering more individual attention. But isn’t it also sometimes a good idea to have a very large class, so more can hear the brilliant lecture, the person with unusual experience or the challenging point of view?
I am often invited into schools or universities to give a lecture about economics or politics. Quite often I am asked to teach far more than 30 in one go rather than the more normal 20-30 in a typical class. No-one thinks that is wrong, or suggests I am wasting my time because so many have come to hear. It is still possible to take questions from those who are most interested and have a point they want me to consider.
So why can’t trained teachers sometimes do the same to good effect? Jim Knight is for once right. He now needs to be brave enough to think it through with the teachers – and maybe ask why standards of literacy are so good in some overseas countries where average class sizes are bigger than here in the UK.

Today the Regulators start their search for the bear raiders who spread false rumours yesterday.
Meanwhile, the Bank of England should repeat that as the apex of our large and strong banking system, it will make enough liquidity available on a continuing basis so the markets function better and bear raiders have less chance to peddle their unpleasant trade. The authorities must use all their powers to protect decent institutions from false rumour and from artificially frozen markets.
The US authorities have responded postively and quickly. The Bank of England and the ECB are also important players. A strong united front from the Central Banks, facing the bears down and reassuring depositors by showing that they will do whatever it takes to support the many good banks there are in the system is what is now needed.
The UK government needs to act with and through the Bank of England. Ministers took the decision to throw so much resource into saving and nationalising Northern Rock, so they need to show the Bank of England that it by areement work with Treasury resources to keep the rest of the banking system liquid if needed. We do not want the authorities restricted in their actions because of the amount of Northern Rock support already on the books.

Yesterday the Commons debated Post Office closures. This century the Post office has been struggling to make a profit on both its counters businesses, and in its main mail delivery activity. The former has been damaged by the government’s decision to switch a lot of its business away from Post Offices to automated systems using the internet, the latter by the growing competitive challenge mounted by competitors. As the Post office confessed in its own Report for 2006-7, the competitors are 40 more efficient than the Post office putting its business under considerable pressure.

It is sad to see the decline of this once proud and profitable nationalised industry. The Counters business lost £99 million on revenue of £868 million last year, a painful level of loss. The government has agreed a staggering £4 billion package of financial support for the business, and has managed to keep that within state aid rules. The 2007 balance sheet shows the Group in net deficit to the tune of £2.2 billion – in other words the liabilities of the Post office exceed its very considerable assets by that amount. The Post Office may have many properties, a big fleet of lorries and vans, a vast array of sorting and delivery equipment, yet add it all up and it’s not enough to cover all the future liabilities. That’s why it needs the government funding package and revenue subsidy.

The main reason is the pension fund.It is the crowning riony that the government’s attack on pension funds by tax and regulation should have brought the main fund of a principal nationalised industry so low. Future employees will get a less good deal, as the management wrestles with the huge deficit. The company has to show the £5 billion deficit on the fund on its balance sheet, and has to make large payments each year into the fund to try to repair the damage. It still employs over 200,000 people directly, as well as the franchisees that run its still substantial network of sub Post Offices. The management is currently battling to cut the future costs of the pension scheme, against Union objections.

The debate in the Commons was largely about the consultation process itself, and the way the management and government go about identifying the 2500 Post Offices they think they need to close to cut the losses. The problem is that closing too many all in one go can make it more difficult in the short term to return to profitability and generate the cash the Group needs. Closures entail costs, whilst they reduce revenues. Unless the Group cuts its overheads more than proportionately it can struggle to get to profit by the negative approach of cutting.

The middle and senior line management of the Post office is not trusted to run their own assets or to grow their own businesses in the way that would be common in private sector activities. Finding new business activities that would adapt well to sales over the Post office counter would be a better model than trying to close too many offices all at once. Trusting managers to redevelop valuable property sites for other uses and to use the cash they free from that to buy or build purpose built facilities in more accessible locations would be a help. If the Post office insists on closing lots of smaller offices, it needs to understand that many of the larger offices are not big enough or modern enough to handle their existing business, let alone the extra business that will be visited upon them following the closures.

The Directors last year between them received over £7 million of pay and bonus, so they have plenty of incentive to get it right. There need to be more and better incentives further down the line, and more power to individual managers to make a difference. I find that the Post office is gripped by the incapacity to change because it is a highly centralised operation, where the measure is cut costs, rather than grow the business.

The oddest thing about this slowdown and credit crunch is the delayed reaction – or the lack of reaction – of the UK housing market. Shares have slumped. Commercial property prices have fallen substantially. Retailers have complained about the squeeze on their customers. Yet house prices are still slightly up on a year ago, and the last few months have seen only small declines in the national figures.

When I last wrote about this I ventured that high Stamp duty. Home Information Packs and higher mortgage and transaction costs were encouraging people to sit tight and not move. The market was short of supply, just at the point when otherwise it might have gone down. Fortunately unemployment has not been shooting up, and people have been able to meet their mortgage payments even though their budgets are under more pressure. There has been an uneasy equilibrium created by inertia and the new impediments to selling and buying.

We may still, however, be in a for a slow but painful decline in house prices. There is plenty of evidence that new buyers are finding it more difficult to obtain a mortgage. Gone are the deals offering total borrowings in excess of the house price, and gone are the days when you could get by without a deposit. US interest rates may be plunging, but UK general rates are much stickier, and banks and building societies are keen to rebuild margins by charging more for a mortgage relative to the general level of interest rates.

There are those who say they do not think lower interest rates will make any difference to the Credit Crunch – indeed that seems to be the fashionable position. They link this with fears about inflation in the UK getting out of control if any action is taken to cut rates. This is a strange misunderstanding of the position.

Lowering the general level of interest rates could be crucial to avoiding the slowdown of the housing market becoming something worse – a price crash. As part of the Credit Crunch is the banks’ unwillingness to accept mortgages as good assets when lending to each other, anything that makes it more likely more of the outstanding mortgages can be serviced and repaid by their owners would be good news. Surely more people will be able to afford the mortgage if the mortgage rate comes down, than if it stays up or even goes higher? In the USA the authorities have grasped it. They are fighting the battle of the bulge of the sub prime. If too many sub prime mortgage holders give up on the mortgage, then the losses will multiply through the banking system and more credit will be destroyed. The UK may not have had such an extreme version of sub prime lending as the USA, but similar dynamics apply in our housing market.

If the UK house price slide gathers pace, then more people will be in negative equity. Once the house is worth less than the mortgage, more people are inclined to give up on it. If more people lose their jobs, more will struggle to pay the high mortgage bills they currently face.

Meanwhile, it is difficult to see how we can become alarmed by inflation against the current background. The public sector is at last taking a tougher line on public sector wages. There is no evidence of inflationary pressures building up on private sector pay, as the market for goods and services is still competitive enough to make passing on big cost increases difficult. Private sector bonuses, especially in the financial sector, will be well down, deflating total remuneration. We have a few more months of bad figures to live through from the impact of raw materials prices and energy. The authorities need to be fighting against too sharp a slowdown from the Credit Crunch, rather than fearing an inflation that seems unlikely to get out of control.

Yesterday Parliament continued with what this government laughingly calls a budget debate.
It wanted to ignore the fear that stalks the markets (See my post of March 15th).
Outside the cocoon of the Commons chamber fear continued to spook the markets. Large sums of money were made available to the banks to ease them through the persistent credit crunch and liquidity crisis. The US were tidying up the loose ends of the rescue of America’s fifth largest investment bank. The dollar and the pound were in freefall, bank shares crashed, and the Chinese market fell as the authorities there threatened higher interest rates to combat inflation.
Inside Parliament the government had decided the whole day could be given over to debating climate change again. We have recently had a full day on this topic as part of the so called EU scrutiny, and will have a second reading soon of the government’s Climate Change Bill. Surely that would be the appropriate time and place to discuss green taxes and regulations, not the budget day debate that coincides with such gripping and worrying events in financial markets?
Hilary Benn was the appointed Cabinet Minister, who dutifully droned on with his script about worthy green initiatives. Most speakers in the debate stuck to the guidelines that yesterday was the day to speak – often for the umpteenth time – about lower emission cars, cleaner homes and higher taxes on profligate energy users – but not on the most profligate of all, the government itself.
I decided to break the silence, and seek to connect the Chamber to the real world beyond. I made a speech about the need for reform of the Bank of England so it is properly equipped to influence and control our money markets, to keep them more liquid. I recommended giving the Bank back the power to run government debt issuance, and the power to supervise the day to day actions of the clearing banks.
I explained how the Bank would both need to cut interest rates and make cash and government paper available to the banking system in exchange for their higher quality paper that the market currently does not trust.
Those Labour MPs that have engaged at all with this crisis take a certain delight in seeing a true “crisis of capitalism”, and seem happy to think rich people in the City will suffer. I tried to explain to them that banking crises hurt us all. Those most in need of credit because they have the least by way of income and assets will suffer first and longest, as they will be squeezed out of the lending market by the pressures.
When Angela Eagle came to “reply” to the debate she surprised even me by the way she simply ignored all that anyone had said during the course of the proceedings, making no attempt to sum up or respond. When I asked for a specific reply to my proposals on strengthening the Bank of England she told me there is currently a consultation on that and I could contribute. As far as I was concerned I had just contributed, but these Labour Ministers now do not think that an MP contributing to a debate in the Commons is responding to a consultation! Gone is the idea that everything said in the Commons is taken seriously, and referred to the appropriate department and officials for consideration.
The Treasury had been stung into some bland prose which Miss Eagle read out about the crisis. We were told that it is serious, but because it is international we cannot do anything on our own and it will all be taken care of by international co-operation.
Has the once great Treasury of the UK really come to this? Is it now just the office boy of the EU and the US authorities? Does it have no understanding of its own of this crisis? As the supervisor of the world’s largest banking centre does it have no leadership to offer? For how much longer is the Treasury going to remain mute and inactive, hoping the problem will go away?

A quick haggle, a visit to the lawyers, and a bank is bought and rescued over a week-end in New York. That’s the way to do it. It makes the UK’s attempted private sector rescue of Northern Rock look ham fisted, long winded and ultimately unsuccessful in comparison. The US authorities have once again acted decisively, with vigour and purpose, to prevent the banking collapse getting out of control.

This week we can expect further interest rate cuts in the US following on the 25pt reduction in the discount rate announced overnight. All this US activity is producing two main lines of criticism of the US authorities which we need to consider.

The first is the criticism that inflation is not under control, so cutting interest rates in premature and dangerous. It is difficult to hold both this view, and the view that the US is now in recession or is about to go into recession. The Fed clearly fears the forces that are restraining activity and cutting jobs more than it fears the inflationary forces that are evident and left over from the easy credit days that have now gone. Whilst I remain sceptical about the claim that the US is now in recession, it does seem that the impact of the housing crash and the drying up of credit means the threats to activity levels are more important than the threats of further price increases. I back the Fed’s judgement that their main enemy today is too little credit and activity, not too much.

The second common criticism is that by cutting so far so fast, and by using so much of its financial fire power at this stage, the Fed will have nothing left if it fails to work. This is an even more bizarre argument. It is saying if you use your umbrella in the wet and the wind today you may damage it, so it will not work next time. If you take that view everytime the weather’s bad what is the use of the umbrella? The Fed has good reason to suppose this is just the kind of crisis it has to respond to strongly by cutting interest rates and putting liquidity into markets. If they get it right they will make a relapse less likely. If they do not try with what they have there will be a very serious banking crisis.

Since last August I have been commenting on how different the approach of the US authorities is to the approach of the UK authorities. It has taken just four days to rescue the assets and what remains of the business of Bear Stearns. More than six months have passed and we are still a long way from finding a private sector rescuer for Northern Rock. The Treasury and the Bank now have much less flexibility to deal with any other financial catastrophe, because their balance sheets are stretched by taking on the Rock. Meanwhile the Fed is well on the way to laying off its problems with the Bear.