Friday, 19 June 2009

To the right

Thankfully, I could never be a Tory, but given the lack of relevant thought on the Left its interesting to read the blues are apparently getting their shit together when it comes to the credit crunch and coming up with some ideas (as opposed to any commitment to concrete policies and/or clear proposals).

The biggie it seems is significantly changing the role of the Bank of England in relation to the financial system. You can read about much of what underpins this suggestion, idea and/or potential policy in a Centre for Policy studies paper written by Sir Martin Jacomb, deputy chairman of Barclays from 1985 to 1993 and a director of the Bank of England from 1986 to 1995.

His paper states “The Tripartite Arrangement needs to be recast. The FSA should become a subsidiary of the Bank of England. Its relationship with the Bank should be similar to that of the MPC.” And “Responsibility for the stability of the financial system as a whole should be entrusted to a third subsidiary, the Systemic Policy and Risk Committee. This would report in much the same way as the MPC.” Besides which “The idea of a greater role for EU regulation of UK financial services must be resisted.”

It’s almost too easy to rip the pish out of Sir Martin. There’s his grasp of history i.e. facts, like when he refers to Northern Rock as “the first run since Overend Gurney in 1866” and a “national disgrace”; mebbe aye, mebbe no except the last was in 1878 when the City of Glasgow Bank failed, a far more significant matter because it prompted the widespread adoption of limited liability and as such fundamentally changed the relationship between investors and companies in Britain. Even better according to Wikipedia Sir Martin also described insider trading a few years back as a "victimless crime", suggesting a somewhat interesting moral compass. Finally, the easiest criticism to make is that he’s simply an auld duffer who isn’t so much presenting an argument as moaning on over a rather good brandy about how it wasn’t like this in his day.

Its also good sport to see a think tank set up by Sir Keith Joseph articulating how to intervene in markets, but I guess that’s a somewhat more esoteric point. But, hey ho, if this is the cutting edge of Tory thought lets give it a think because politically it’s an absolute blinder.

1) It would establish real, clear blue water between the Tories and Labour who are much keener on retaining the existing tri-partite balance between the FSA, Bank of England and Treasury.

2) By replacing the tri-partite structure it denigrates what Labour previously did.

3) In the grand scheme of things i.e. compared to say quantitative easing, its relatively easy to understand.

4) It’s relatively easy to sell via soundbites e.g. a new dawn for financial regulation, a fundamental break from the past, CHANGE, CHANGE, CHANGE! Etc.

5) It doesn’t cost much – a new committee here, a new organisational structure there and bingo. Which in turn means you can go on Newsnight and say its a fully costed policy and aren’t we prudent.

And that’s about it really. What the principles and tools underlying all this CHANGE! might be aren’t really mentioned. Keeping out EU regulation is also as silly as a spotty sock with multi-coloured toes. Sure it’ll play well to home county duffers, UKIP voters and what not, but as the Fortis Bank collapse made unavoidably clear multinational banks require well co-ordinated, multinational regulation.

All that aside, I personally agree that the Bank of England needs more teeth. But, thats because I think the FSA is the banks' ineffectual bitch more than anything else. This made it interesting to see Adam Posen’s appointment to the MPC. For the FT what matters is he’s “an axeman” who in his testimony to the US congress on banks stated “have top management replaced and current shareholders wiped out.” Setting aside the city boy toss, the fact an expert on the Japanese lost decade has been appointed to the MPC should actually be making us all shit in our boots as to the prospects of that happening here. Second, he has clear, technical, detailed views on the reconstruction of the financial system.

That his appointment was swiftly followed (do these feckers actually co-ordinate this stuff I wonder? Nah, no chance) by the Governor of the Bank of England stating in a speech that “We (he?) need instruments to prevent the size, leverage, fragility and risk of the financial system from becoming too great” and that “If some banks are thought to be too big to fail, then, ... they are too big”, is kinda interesting cos it leads back to auld duffer Jacomb’s emphasis on a beefed up Bank of England give or take the Governor also making explicit reference to the important stuff (e.g. policy instruments & leverage), that actually matters and about which the Tories aren’t saying hee haw.

So it looks like a bun fight is developing with the only people supporting the FSA being the current government. This is doubly fun because the standard criticism of senior Bank of England appointments is they’re too academic i.e. what you really want is some posh, clubbable debt salesman (e.g. a banker) regulating the stability of the financial system (see the hassle over Charlie Bean becoming deputy governor fer instance). Moreover, besides the bloody obvious vested interest and maintenance of regulatory capture - which is the technical term for "being the banks' bitch" - this also plays well in Britain due to the widespread suspicion of people who can think.

Given this reality it’s hardly surprising the FSA stands out amongst the various regulators for being dominated by ex-bank workers unlike say the CEO of OFWAT who is a regulator and civil servant thru and thru. So with the Bank of England making some clear moves to try and increase its overly academic authority (1), it makes you wonder what the banking industry’s rear guard action will be. I’m guessing based on personal experience (a) they’re too thick and arrogant for the most part to realise before it starts approaching legislation and (b) the sole argument they will subsequently make against anything they don’t like will be that it undermines Britain’s position as a financial centre (the subtext here being tax revenues, tax revenues), regardless of whether a proposal is actually perfectly sound from the perspective of the economy as a whole.

Bunch of cock really.

(1) Alternatively it’s a cry for help because the Chancellor, the FSA and various city interest groups have already stitched things up.

Tuesday, 16 June 2009

Pubes and crumbs

On the basis that the neo-liberal (or is it Anglo-Saxon?) model of capitalism has crashed and burned the past 20 months, I figured the Left might have something to say about it all. I was wrong. The Fabian society, that venerable centre left lot, have recently published a paper on housing apartheid in Britain, which is very nice give or take the collapse of the housing market. Red Pepper, those fiery mixers of environmentalism and socialism have published some half-decent accounts of why things fecked up, but the main proposal seems to be more legislation supporting credit unions, which is lovely, but still a fringe activity. The New Left Review on the other hand has, as ever, put things in a wonderfully global perspective (1) before tossing one off over the applicability of Marx’s theory of value. I kinda gave up on the Scottish Left Review and who cares what the Socialist Workers are saying. Presumably, it’ll involve some quotes from Imperialism the Highest Stage of Capitalism others from the Grundrisse and Das Kapital combined with a critique of reformism and bobs yer uncle or aunt depending on his or her particular gender orientation.

Shame really. You spend however many years waiting for the inevitable collapse of capitalism and when it arrives you've hee haw to say. Being theoretically inclined or at least someone who likes the odd typology or two, I figure I’ll try and highlight where we are in terms of the politics of it all, the participants and outputs.

Stage 1: This is the “Fucking hell” phase and/or “We must do something!”

This is (was) the initial response to the credit crunch and later on to Lehman Brothers. The key participants at this stage would be Prime Ministers, Chancellors, CEOs and Central Bankers.

In terms of outputs absolutely everything is on the table because the key objective is fire fighting i.e. stopping things collapsing. Hence quantitative easing, part nationalisations and kidding on not cutting benefits equals the rediscovery of Keynesianism.

Stage 2: This is when “We must stop this ever happening again!”

Its also when bank execs, the great and the good e.g. very old, possibly incontinent bank chairman and quango bitches along with the British Bankers Association, senior Treasury civil servants and junior ones who really are on a fast-track, CBI directors, Deputy Central Bankers and terribly senior regulators get involved. All of the bods from stage 1 are still in the frame, but only to receive reports, chair committees and steering groups and intermittently give reassuring speeches/launch papers.

The output here in the first instance is proposal documents, position papers, suggestions and speeches, giving way to more concrete reports setting out strategies and principles after the feedback has rolled in.

Stage 3: This is the intentionally reassuring, almost back to BAU stage because “We are taking care of things”.

Would the Prime Minister be involved? Gordon Brown might be given his apparent temperament (and if he’s still PM), but essentially everything has been handed over to middle and senior managers who, with the aid of wonderfully expensive consultants, have been tasked with putting the outputs of stage 2 into practice. This is when stuff gets set in stone and some poor sod discovers he’s lumbered with implementing various stupid ideas signed off by committees stuffed with terribly, terribly senior bods.

Right now I think we're working thru stage 2. For me January was the tipping point when it came to stage 1. This was when RBS shares fell once again prompting rumours about full-nationalisation, except it eventually became clear it didn’t matter how low RBS shares fell, the government wasn’t for nationalising. Thereafter the sense, felt acutely last year, of waiting for something else to fall over, was lost. No more major institutions it seems will be allowed to fail, not even in the US.

Alongside this and from a British perspective the Bank of England is maintaining a stream of speeches that refer to the new tools needed to combat asset bubbles and the FSA issued a huge document setting out various proposals i.e. they feel able to lift their heads up to outline what they think things will be like after the credit crunch. More importantly, the US just saw Timothy Geithner outline some ideas of what the US re-regulation of financial services will look like, which matters because it sets the benchmark for what everyone else will do (I liked the response of US bank bods to the Geithner proposals reported in the FT “yes, but these are proposals” i.e. piss off.)

All of which brings us back to what the Left has to say that’s of any relevance at this vital stage.……………………….. still waiting ……………………………. anyone any questions or suggestions? No? Shame that as it’s only the re-regulation of a global financial system that’s brought about the worst economic downturn since the great depression. Best just leave it then to the same bankers, regulators, government ministers and civil servants who either caused or facilitated it in the first place.

Actually it’s worse than that. Besides the very real moral, economic and political issues this all raises, it actually impacts on the drivel the left has been churning out in teh meantime. Take the Fabian society’s housing apartheid – if there’s no more cheap credit available for owner occupiers and buy to let investors to actually buy houses and fewer get built, how can this apartheid (what a disgustingly inappropriate use of that term), be addressed? Similarly, new housing regs impose higher environmental standards, so no housing market = less environmentally friendly homes, whaddya think of that then Red Pepper? Or theres PFI/PPP that good old trade union, lefty bugbear that was built on the assumption cheap credit would always be readily available. So should we connect what credit markets will look like in this brave new re-regulated world (heres a clue – more expensive) to debates over whether PFI/PPP will ever pass value for money tests in future (or whether these will simply be flexed to accommodate this?) Ah well.

Hence me stealing a phrase a mate came up with in a completely different context. The pubes are the gits involved in stages 1 and 2 and the left. The crumbs? That’s what the rest of us will be left with at the end of the downturn.

(1) For me Robert Wade’s recent NLR article on things is an honourable exception to this for the most part.

Tuesday, 9 June 2009

From Riga to Wall Street

If you can remember the British Exchange Rate Mechanism (ERM) experiment and Black Wednesday you’ll have an insight into a bit of the Latvian economy’s current plight. Latvia, like Britain, pegged the exchange rate of its currency to another, stronger currency. In Latvia’s case it’s the Euro, which has increased in value. The standard response here for maintaining a peg is to raise interest rates, drawing in foreign capital to prop up the exchange rate. Latvian central bank rates are accordingly a good chunk higher than the ECB’s right now.

The downside to this is straightforward; higher interest rates typically dampen down economic activity. In addition, propping up an over-valued currency misses out on the benefits of a cheap one i.e. if its cheaper to buy Latvian then exports are more competitive, domestic goods have an advantage over imports and more drunken Brits will go on stag weekends to Riga.

The particular problem Latvia has is the currency peg led to Latvians borrowing en masse in foreign currency to the extent that over 80 per cent of Latvian households now have debt denominated in Euros (for debt read mortgages). So if the currency is devalued by say 10% allova sudden everyone in the country owes 10% more. Now that’s an awfy good way to muck things up. It also means monetary policy is stuffed big time leaving fiscal measures the order of the day. Except for Latvia this means cutting public spending hard at a time when the economy is forecast to shrink by 20% this year alone.

By contrast the IMF had this to say yesterday about Euro Area fiscal policies “Given the large automatic stabilizers in the euro area, the discretionary measures currently adopted seem broadly appropriate, with further stimulus to be set aside for contingencies.” – the automatic stabilizers being benefit payments and what not which increase along with unemployment at the same time as tax revenues fall.

So the apparent consensus is Euro-area government shouldn’t cut public spending and should allow government borrowing to increase whereas Latvia needs to cut public spending regardless of Latvians no exactly being well off to begin with.

The bigger picture here is if Latvia devalues its currency or the economy collapses, then the question becomes which Baltic state will be next. Plus there’s the Swedish banks that were doing a big chunk of the lending who might find themselves well stuffed by all these Latvian borrowers defaulting.

All this leaves me wondering if the Latvian economy is being sacrificed to avoid a domino effect that could undermine the well-being of the broader Baltic region. Such an event could in turn undermine global confidence in the financial system just as its getting itself back together again.

if this is the case though shouldn’t more be getting done to help them? I mean in April Latvian unemployment reached 17.4% and is going to keep on rising meaning we’re looking at at least one in five people is going to be on the dole in a country where mass emmigration has been making the unemployment statistics look better than they actually are for years!

So there you are then, Latvia is totally stuffed and the degree of economic distress and all that brings is well beyond anything we’re going to experience. At the same time it’s just been announced 10 US banks are now allowed to repay the funds they’d previously received from the US TARP fund. The motive here is relatively straightforward – if they no longer have obligations to government, government is in a much weaker position when it comes to imposing restrictions on executive pay. Shame that the economy would benefit more from these banks using these funds to actually finance more lending, but what the hey, we can’t have the financiers who caused all this in the first place missing out on their bonuses for 2 years on the trot.

To get a sense of how much taxpayer help this involved just one US bank (JP Morgan) received $25bn in support. By contrast the Latvian government is going to cut public spending so as to get the next tranche of just $10.4bn in aid from the IMF.

So sure Latvia is looking to membership of the Euro in 2012 I think it is when presumably/hopefully/fingers-crossededly all this will be less of an issue. But, between now and then the economy is going to be absolutely humped and with it hundreds of thousands of peoples lives. And it gets worse because the reality, judging by the British experience throughout the twentieth century, is that over-valued currencies tend not to stay over-valued for ever and eventually get devalued, which implies much of the current Latvian pain is being endured for no good reason. But, hey ho, an eventual devaluation would at least allow Western investors to run in and buy up everything worth buying in the country.

In the meantime it appears that in much the same way that the Latvian government hacking back on public spending on the basics of life is necessary to maintain confidence in the global financial system, so is paying US bankers mega bonuses. Regardless of the fact I’ve only read about all this, it’s still difficult to avoid the bad taste it all leaves. Plus, if I was a Latvian I would be thinking what the fuck? And what the fuck has all this post-Soviet Union look West, not East actually got me i.e. theres potential political consequences here.

Thursday, 4 June 2009

James Purnell is a shite

When the Treasury select committee first looked into private equity, my impression was that the "expert witnesses" spent much of their time, initially at least, explaining what private equity actually was and how it worked.

This is understandable. Labour MPs are for the most part either public sector professionals or professional politicians. They have barely, if any, experience of the financial services sector nor much understanding of it. For the most part their grasp of economics typically sucks major ass as well. Right now we are in the most serious economic crisis since the great depression. This originated in complex financial instruments. Looking at the Labour party I'd guess only a very small minority have a reasonable grasp of all this.

This is a tragedy because financial services in Britain are currently being re-regulated. Doing so badly will be a disaster for the economy given it's economic as well as social, moral and political implications. Changing leaders and cabinet ministers is a good means of ensuring it is done badly.

The Tory party, in my view, have been a waste of space thru-out the credit crunch. Any discussion I've seen involving a Tory bod has been a waste of time because they have barely understood whats going on and have had no meaningful or practical alternatives to offer. Again this is understandable because in my view the Labour government has actually responded very well to the current crisis. Its easy to find examples of failure (e.g. overly complex mortgage benefit arrangements) and then theres the pre-credit crunch policies and their implications re: government borrowing. But, on balance the response has been a good one - wide-ranging, relevant, flexible and innovative.

Set against this is James Purnell's resignation and resignation letter. In my view he's decided Labour will get humped in the next general election, but so what? Government's tend not to survive serious economic downturns regardless of a leader's ability to "connect with the people". Accepting that and getting on with things regardless would be a genuine example of public service.

Instead, Purnell is playing a long game - its not about whether Gordon brown remains prime minister tomorrow or whether Alan Johnson can lead Labour to victory in the next election (his failure in turn clearing the way for David Miliband), its who might be foriegn or home secretary in a Labour government in 10 years time. By taking this stand today he is attempting to establish himself as a political big beast tomorrow. It strikes me as reasonable to assume his personal ambition is a key factor here.

Except, he is helping to destablise an administration that is, in my view, doing the best it can and doing better than most other Western governments. This is a tragedy given just debating whether Gordon Brown should remain prime minister by itself recently knocked down the value of the pound i.e. made things more expensive for everyone in Britain.

Alternatively, Purnell genuinely believes what he is doing is for the best. If so he is a fool. The current political climate is about trying to comprehend the revulsion felt by much of the electorate over MP expenses. The expenses scandal is a bad thing, but, it would be much better to have the economy sorted first. I can only read Purnell's actions as a genuinely selfless act from the perspective of the Labour party with Gordon Brown being positionined as the fall guy for the selfish actions of however many Labour (& Tory & Liberal) MPs. Except given this is undermining the government's ability to function and lets be blunt, it's future calibre at a critical juncture, it leaves Purnell placing party before country.

Purnell is himself involed in the expenses scandal. He is now the former work and pensions secretary who claimed more for food each month than an unemployed person recieves in benefits to cover their food, drink, utility bills, clothing and entertainment. As such he has no moral authority whatsoever. As a professional politician he lives at a significant remove from real life. It strikes me this distance is a key factor in his thinking and decsions.

Purnell has certainly made a name for himself, just not the one he is hoping for.

Wednesday, 3 June 2009

Skin in the game

At first glance the sub-prime debacle looks like a classic example of the “principal agent problem” where the principal seeks to align the agent’s interests with his or her own.

The principals here were the buyers of sub-prime debt. The agents were the brokers who sold the debt, the mortgage companies that provided it, the financial engineers who packaged it into asset backed securities and the investment bankers who sold it on to principles as securitisations.

Whereas the principal was looking for a nice, safe earner, the agents’ immediate interests didn’t include the safety of the individual credits. This was because the credit risk involved had been transferred to the principal leaving the agents to chase the fees and commission each new mortgage sale generated. Unfortunately, despite the principle having a clear interest in the underlying credit risk of what they were buying, they had less information about this than the agents. This was why rating agencies were so important; by rating the credit risk attached to the debt packages they performed the necessary due diligence on the principal’s behalf. So whether the interests of the principal and agent were aligned became apparently immaterial. Besides, anyone trying to sell on dross would be subject to reputational damage and a loss of trust that would undermine their ability to sell on their debt in future.

Neither of these checks turned out to be any good. The rating agencies, conflicts of interest aside re: who was paying their fees, got it wrong. Simple. End of. As for reputational risk well if everyone is selling dross, everyone’s reputation is damaged and the market as a whole is affected rather than individual reputations.

The big, big challenge is bankers, politicians, bank regulators and central bankers want securitisation to come back again. Securitisation gave retail banking customers indirect access to institutional investor cash, which they used to buy houses. This made new home owners happy along with builders and stamp duty collecting governments. But, most of all it made all the agents listed above smile like idiots. Unfortunately, right now no one can do a residential mortgage securitisation and sell it onto anyone other than a central bank. With the securitisation market effectively dead and no signs as yet of it recovering nobody is smiling.

This is a major factor when it comes to explaining why the regulations covering securitisation are going to be changed; there are too many vested interests at work for it just to be left to die. Instead bank regulators and central banks are going to try and make it more secure in the hope this will eventually prompt the return of private investors.

One of the main developments here is being led by Charlie McCreevy, the European Commissioner for Internal Market and Services, who is seeing to the introduction of a “5% retention for securitisation”. This means that the people trying to sell on debt will have to retain at least 5% of it. The logic of this is the principal-agent problem writ large because by retaining a small tranche of it the agents will be left with a vested interest in making sure its safe or to quote Charlie the change will mean in future they will retain some “skin in the game”.

It’s a nice idea. In fact for what its worth I’m all in favour, it’s just it’s also a little bit pants and here’s why; if you sell senior debt like a mortgage, worst case scenario at least you can call up the house, sell it and try and get some of your money back. However, if you provided equity instead you only get any crumbs left after the senior debt provider has tried to get their loan back i.e. chances are you’ll get hee haw.

This fundamental difference in risk is why equity investors (think dragons den) typically charge a lot more than lenders. Now, leaping from housing to the commercial property market, yes it saw plenty of commercial property securitisations, however it also saw more and more lenders providing more and more debt AND equity or in Charlie’s terms more and more banks had more and more skin in the game, yet they still fucked it all up.

The real issue for me is what kind of institutional and cultural arrangements see banks continue to throw money at asset bubbles even after they’ve burst regardless of whether they’re principals, agents or jabberwockies. 5% retention? 50% retention? Who cares, rather its about institutional investor expectations and the ability of corporate leaders to manage them, marketing departments that don’t understand the markets they lend to, executives fixated on next quarter’s sales targets and organisational sycophants who know damn fine well the way to get on is to fall into line rather than to apply commercial judgement and common-sense and question whats actually going on.

To give a practical example of this my understanding is in one bank an economics team were quietly advised well into last year not to use the term credit crunch in their reports in case a particular executive read them; because he didn’t believe there was a credit crunch all external analysis had to skirt around the issue. Now how fucked up an organisational culture is that? What kind of risks does it pose and should that level of institutionalised stupidity not also be a target for regulators?

Similarly, the debate over pay and bonuses also strikes me as pants. The big emphasis right now is on deferring compensation with the principal agent problem appearing to underly much of the thinking. Except for executives much of their compensation is already arguably deferred due to the emphasis on share options. Similarly the existing emphasis on rewarding people in shares also means they have a vested interest in the future performance of their employing organisation (think of the comments made by the bank execs summoned by the Treasury select committee about how much they’d personally lost).

I’d argue instead that deferring rewards simply hasn’t enough bite and that 2 additional measures are needed. The first is clawbacks – you do a deal today that ends up costing money in 5 years time? Clawback!Gie us some of your cash and if you haven't got it we'll bankrupt you! The second concerns severance terms.

Right now any banker of any seniority exists largely outside employment law i.e. the amount they’re likely to receive based on a standard compromise agreement of 6 months salary (with the first 30 grand tax free) relative to the maximum award for say constructive dismissal means they have no interest in taking their employer to an industrial tribunal unless they can claim some gender discrimination was going on in which case the potential pay out is uncapped (ahh, so that’s one reason why sacked gay and female financiers flag up gender issues!). Then theres the reputational aspect that means someone even moderately senior who fucks up big time is typically given the opportunity to resign rather than be sacked, which avoids any of the conflict that could lead to a banks institutionalised incompetence hitting the news.

So there’s arguably a culture in corporate banking of throwing money at human resource problems until they go away and/or sweeping them under the carpet. Changing what an employment tribunal can award to a salary multiple and/or the existing limit, whichever is higher, would address this and expose banks to more scrutiny because it would see more bankers taking banks to employment tribunals, which in turn get reported on by the media. Alongside this I’d also suggest reworking executive severance terms into two phases alongside a basic performance clause whereby people e.g. Fred Goodwin, who feck up get feck all. So this would take the standard executive benchmark of share prices and use it to assess (1) the applicability of existing reward policies and then (2) their application with a clear justification issued at each stage that requires signed approval by say a non-executive committee. You’ll still get people fucking up right enough, but hey ho at least they won’t have as much cash left to console themselves with. And for those that question the fairness of treating executives differently, they already are by specialist executive pay teams and consultancies that operate alongside the bods who work out how much to pay everyone else.

A P.S. 17th June - shoulda realised - a big thing with originators keeping a chunk of the debt is it clogs up their balance sheets. If they could sell it all on then their capital base is irrelevant. if they have to keep a slice, then the amount of debt they can originate is constrained by their capital base. So skin in the game is all very well, but here it seems to mean limiting the growth in mortgage finance.