Cost Of Bank Bail-Outs

A very rocky road, and still a mountain to climb

This morning's National Audit Office report on the cost of bank bail-outs is being headlined as saying taxpayers will likely escape without loss. But it actually says nothing of the kind.

True, the NAO tells us taxpayer exposure to the special guarantee and indeminity schemes (the Asset Protection Scheme, the Special Liquidity Scheme, and the Credit Guarantee Scheme) has halved to around £500bn. But:

"The Treasury retains the unquantifiable ultimate risk of supporting banks should they threaten the stability of the overall financial system. The outstanding £512 billion is only on the explicit support already provided. Further intensification of financial instability may require additional intervention."

That massive implicit guarantee is one we've blogged many times. And let's be under no illusions - at a time when there are still huge uncertainties surrounding the creditworthimess of banks right across Europe, the market reckons our two big nationalised banks remain pretty risky.

As the NAO highlights, the market price for insuring against default by RBS or Lloyds has remained right at the top of the range for similarly sized European banks (NB a 5 year Credit Default Swap cost of 200 basis points pa roughly means the market reckons there's at least a 2% chance of default within 1 year, implying at least a 1-in-10 chance of default within 5 years).

And with that level of risk, unsurprisingly our banks have underperformed other banks in the equity market:

In other words, we're still propping up two relatively high risk megabanks that the market doesn't much like the look of.

And there's another point the NAO highlights. In order to inject funds into the banks, the government has had to borrow more. And that costs. According to the NAO:

"...the Government is paying some £5 billion a year (£10 billion so far) in interest on the Government borrowing raised to finance the purchase of shares and loans to banks. This ongoing cost is material in terms of the overall public finances and deficit. This £5 billion a year was not included in the Treasury’s previous estimates of the loss to the taxpayer, because the Treasury does not consider them to be direct costs. The estimated £5 billion a year interest on this debt is 11 per cent of the total £44 billion forecast to be paid in interest on public sector debt in 2010-11."

Whatever it says in the headline, the bottom line is that we ain't out of jail yet. Not by a long chalk.

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www.gudanggrosiran.com Categories: bank bailouts

Ripping Your Face Off

This could soon be you

One of Tyler's favourite financial market memoirs is Frank Partnoy's FIASCO, his account of life as a Morgan Stanley derivatives salesman during the 1990s:

"The derivatives group received its marching orders from the firm's leader, John Mack. Following Mack's lead, my ingenious bosses became feral multimillionaires: half geek, half wolf. When they weren't performing complex computer calculations, they were screaming about how they were going to "rip someone's face off” or "blow someone up.” Outside of work they honed their killer instincts at private skeet-shooting clubs, on safaris and dove hunts in Africa and South America, and at the most important and appropriately named competitive event at Morgan Stanley: the Fixed Income Annual Sporting Clays Outing, F.I.A.S.C.O. for short. This annual skeet-shoot tournament set the mood for the firm's barbarous approach to its clients' increasing derivatives losses. After April 1994, when these losses began to increase, John Mack's instructions were clear: "there's blood in the water. Lets go kill someone.” We were prepared to kill someone, and we did. The battlefields of the derivatives world are littered with our victims." (and see here for a longer excerpt)

Marvellous. The raw beating heart of capitalism - the very thing that's driven economic progress for at least the last three centuries. And thank God for it (terms and conditions apply - like staying within the criminal law).

There's just one thing - don't ask me to pay for any losses these dove hunters incur when they accidentally blow their own heads off.

Which brings us back to the key question of HTF can we let busted banks go bust without destroying Mom and Pop's savings and wrecking the economy?

Because two years on from the Crash, and despite all the brave talk, our politicos and regulators have still not agreed how to do it. There's been no serious discussion of the obvious step - splitting the high street "utility" banks from the casino banks down on the Wharf (aka a new Glass-Steagall - eg see this blog). Instead, energy is wasted on chasing headlines over bankers' bonuses and bank levies.

This morning Liam Halligan has another excellent article on real bank reform, highlighting a speech made this week by Bank of England Governor King:

"King has now gone as far as he can in calling for the committee to recommend a radical bank split, without publicly ordering them to do so.

"In the end, clarity about the regulatory perimeter is both desirable and unavoidable," said the Governor of the Bank. "Radical solutions offer the hope of avoiding the seemingly inevitable drift to ever more complex and costly regulation."

According to King, City big-wigs are now making "dubious claims to resist reforms that might limit the public subsidies they have enjoyed in the past".

The Governor is taking on one of the world's most powerful lobbies. Among those at the top table, he is doing it almost alone. That's why the rest of us need to get squarely behind him."

Hear hear.

As we've blogged many times, we urgently need to break up the banks. They should not be allowed to exploit the unavoidable taxpayer guarantee on high street deposits in order to raise cheap funding for playing the tables. And as we saw all too clearly in the Crash, our regulators are simply not smart enough to manage institutions that cover both high street and casino activities. Splitting is the only serious option.

But among those City big-wigs, there's hardly an acknowledgement the issue even exists. Indeed, when at the recent Tory Conference Tyler put the question to a City panel chaired by FT editor Lionel Barber, Barber immediately moved on to the next question. Nobody on the panel (including Treasury minister Mark Hoban) was even prepared to acknowledge the question, let alone attempt an answer. Pathetic and worrying.

So let's remember precisely what's going on.

The losses of the banks have been passed on to us taxpayers. We are now holding the baby, courtesy of effective bank nationalisations and continuing blanket guarantees covering all banks. At the same time the printing press has been slammed into overdrive, driving interest rates for savers down close to zero, and well below the inflation rate. The banks are being encouraged to fund their losses and recapitalise themselves by ripping the face off savers.

And on the subject of inflation, we are all quite aware that UK inflation continues to run well above the supposed 2% target - RPI inflation is up at nearly 5% pa, and even the government's preferred (and sytematically lower) CPI measure is over 3%. But do we all understand how bad the international picture looks?

Commodity prices in dollar terms are up 50% from the post-Crash lows, and still increasing:

And things have got even worse since September (the last month shown in the IMF chart). According to the Economist Index, dollar prices have risen by a further 8%, taking the 12 month increase to 31%.

Deflation it ain't, and in sterling terms the picture is even more alarming. The Economist says sterling commodity prices have risen by 35% just in the last year.

Against that background, the US Treasury was last week able to sell a bunch of its index-linked bonds (TIPS) for an extraordinarily high price. For the first time ever, it was able to issue these bonds on terms that guarantee their holders will lose money in real inflation adjusted terms.

Why would anyone buy such things? Because they're scared stiff about future inflation and would rather lock in a known modest loss now than take a chance on a much bigger inflation loss later on bonds that are not index-linked. Yes, my friends, out there across the Atlantic the inflation storm clouds are gathering.

So what to do? How can you make sure it's not your own sweet face that gets ripped off in the coming hurricane?

To be frank, there's not necessarily a lot you can do. One way or another we in Britain have to accept a permanent cut in our consumption to work off all that debt we've built up. In the process - whether through higher inflation, higher taxes, or job losses - an awful lot of faces are going to get ripped.

The one thing we can do is make sure we don't allow our politicos to wriggle out of the difficult decisions needed to stop the same problem arising again somewhere down the road. Which is why we should do what Liam H suggests - back Merv as he pushes to break up our dangerous too-big-to-fail megabanks.

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www.gudanggrosiran.com Categories: bank bailouts

Time To Bank The Banks

Taxpayers could use some of that

The banks are back in the serious money. Hurrah!

Well, hurrah if you're not a saver being ripped off on your bank deposit account, with near-zero interest rates in the face of 5% inflation. Or a borrower paying through the nose for a meagre sliver of credit. As long as you're a banker, you can afford a very loud hurrah indeed.

But bank shareholders, surely they ought to be cheering as well. And that includes us taxpayers, because we're still sitting on all those bank shares.

Just as a reminder - in case you'd somehow forgotten - we currently own not just the Crock, but also 27.6 billion (yes, I did say BILLION) shares in Lloyds, and an astonishing 90.6 billion shares in RBS.

Hurrah!

The question is why aren't we selling them yet?

We've blogged this before. Not only does the government have no business owning commercial banks, but the price of these things has moved right back up again. Indeed, Lloyds is now back above our 72.2 pence average purchase price - we're actually in profit!

Tyler's fag packet says that at current prices our stakes in Lloyds and RBS are worth £68bn. Money we could use immediately to reduce our gigantic national debt.

What's that?

Hold on because bank share prices are bound to head even higher?

My friend, if you feel that way, my strong advice is to remortgage your house and family and snap up some RBS shares while stocks last.

The truth is that nobody has the faintest idea where bank shares are heading. And governments should not be in the business of punting around in the equity market with our money.

********

Tyler is now taking a few days break.

But as a parting shot, let's just note the public appeal to help victims of the catastrophic floods in Pakistan (you can donate here).

Obviously we all want to help. But most of all we want our government to get emergency relief out there fast.

Is DfID up to that?

Why does it always seem that serious help takes so long to organise and arrive on site? Disaster zones seem to be crawling with western TV reporters long before the official relief effort finally gets into gear.

As we've blogged several times, the vast bulk of DfID's £7bn budget goes not on humanitarian relief of the kind they're dying for right now in Pakistan, but on economic development where the evidence of success is virtually non-existent (eg see this blog). The priorities seem entirely wrong.

It makes Tyler angry.

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www.gudanggrosiran.com Categories: asset sales, bank bailouts

The People's Banks

It's the new market model Comrade

In case you'd somehow forgotten, we taxpayers are forced mega-investors in a number of banks.

Our two biggest holdings are RBS and Lloyds. In the case of RBS, we own 84% of the equity, and in the case of Lloyds, 41%.

These holdings cost us a total of £65.8bn - £45.5bn for RBS, and £20.3bn for Lloyds (not forgetting that we have also agreed to pump a further £8bn into RBS should they need it, giving us an overall potential exposure of £74bn - see this blog).

Now, this afternoon Tyler attended a fascinating roundtable discussion organised by Public Finance magazine. And the first issue on the table was how to get the best value for taxpayers from these stakes.

So what do you think? Sell, hold, or do something else?

Well, here's what Tyler thinks. To maximise taxpayer value we should get started on a sales programme soonest. The price of bank stocks has recovered hugely since the pit of the crisis, and with official interest rates close to zero, right now banks are once again steamingly profitable. Over the last 12 months, Barclays shares are up 140%, and the broader financial sector has roughly doubled. And both are now above their levels before the Lehman collapse.

And our holdings?

Hmm... not quite so good. In fact, despite the roaring bull market, we are still underwater on both Lloyds and RBS. In fact, at today's prices, our combined stake is only worth £57bn - £8bn down on what we paid.

Well how can that be, you exclaim. Surely we bought in at rock bottom fire sale prices - we must have shared the market ride since then.

Unfortunately not. True, there's been some modest appreciation since the absolute pit, but our banks have been held back. Partly, that's because the market knows we're going to sell at some stage. But more fundamentally, it's because the market doesn't like the message it gets from our politicos on the future of these banks.

In particular, it worries that politicos will stop RBS and Lloyds paying to attract and retain talent (which is why RBS is widely thought to be haemorrhaging key players), and also that politicos will direct lending activities.

And this afternoon's discussion was an interesting illustration of why the markets are right to be concerned. Because in arguing that continued political control is eroding taxpayer value, Tyler found himself in a minority of one.

The consensus view around the table was that HMG should balance getting a good price for our stocks against two other objectives: the need to increase competition in the banking sector, and the need to increase lending to "desirable" borrowers.

So we needed to think in terms of breaking up our banks in order to increase the number of competing providers in the market, and getting our banks to lend more liberally in order to improve the overall flow of credit to business. Tyler's view of maximising taxpayer value was felt to be far too narrow.

Fine. But let's just remember a couple of unfortunate facts:

1. Increased competition should be good for consumers, but almost certainly not for bank shareholders. And if we break up our banks without changing the competition rules for everyone else, we ain't going to get much of price.
2. Governments are rubbish at picking winners. If we insist on our banks lending more to "desirable" borrowers, the banks will lose more from defaults. A recent government study of experience with the Small Firms Loan Guarantee Scheme noted that the two-year default rate was between 25% and 45% - a disaster in commercial terms (and see this blog).

Of course, if you think it's worthwhile taxpayers spending a large chunk of our £57bn on desirable social objectives like more competition in high street banking and cheaper loans for worthy borrowers, then fine. Absolutely fine.

But speaking as a taxpayer, Tyler would far rather use the money to pay off some of that horrendous debt.

(And also, there's no economic reason to wait until our shares have broken even against our purchase price. Bygones are bygones, and we should focus on getting the best price attainable now).

PS If you've got an hour or eight, you really should read yesterday's Treasury Select Committee report - Too important to fail. True, it doesn't come to any definite conclusions on what we should do about the risks posed by overlarge banks, but it is an excellent overview of the issues.

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www.gudanggrosiran.com Categories: bank bailouts

Without Touching The Sides

Worth £30 mill of anyone's money

When cuddly Alan Sugar was chairman of Tottenham Hotspur, he precisely captured the big problem with football club economics: all the money gets pooped out to overpaid prima donna players, passing straight through the club "without touching the sides".

Which is why one of the key "metrics" employed in analysing football club finances is the wages/turnover ratio. During Sugar's time at Tottenham the average wage/tunover ratio across the Premier League soared from forty-something percent up to a scary sixty-something:

We can all see how it happens - revenues ultimately depend on footballing success, and footballing success ultimately depends on the prima donnas on the pitch. Nature therefore ensures that the money gravitates down through the alimentary canel and deposits itself in their greedy ingrate offshore accounts. And that's how in 2001-02 the Italian clubs ended up paying a totally bonkers 99% of revenue in wages.

And talking of greedy ingrate prima donnas, it's bank bonus season again.

So what percentage of bank revenues do you reckon get paid out in pay and bonuses? 60%? 70%? Given all the noise and fury, you might even guess an Italian job 99%.

But no. A recent analysis by the Wall St Journal reckons that although bankers pay and bonuses will soar by an average 18% this year, the overall cost of compensation and benefits will total an extraordinarily modest 32% of bank revenues, down from 40% in 2008 (figures refer to the 38 largest US banks and securities firms, but you have to guess the position won't be very different here).

Wha!??! you squawk. That can't be right! The WSJ must be lying on behalf of its evil capitalist paymasters!

Hmmm... maybe. But most of these banks are public companies and the true information will be in the public arena soon enough to make lying unattractive.

The fact is that bankers' pay is sky high not because they as individual bankers are holding their employers to ransom, but because bank revenues are up so strongly. Revenues have jumped 25% not in comparison with miserable 2008, but in comparison with booming 2007. Here are some current headlines:

Now, you and I and most of the non-banking world, understand that this extraordinary earnings boom is not down to the prima donnas on the pitch, but to us - the poor bloody taxpayers. We're the ones who've provided the loans, guarantees, and low interest rates from which the banks are profiting so handsomely.

And we did it not so the prima donnas could get wedged even more comprehensively, but so the banks could rebuild their capital reserves and start lending again to those famous hard-working families and viable small businesses. We are being taken for schmucks.

So what to do?

The idea of the moment is St Obama's new $90bn tax on banks. Yes, it's political, and yes, the cost may eventually get passed onto bank customers, but actually - and Tyler is amazed to hear himself agreeing with the Saint - it's A Good Idea Ltd.

As we've blogged many times, we taxpayers ultimately have no choice but to guarantee the banking system, and it's only right that they pay us a proper insurance premium to compensate us for the risk. Yes, the costs may get passed on to the customers, but as in any line of business, customers should always pay the true cost of the service - we should not subsidise banking any more than we should subsidise manufacturing.

And good for George for today embracing the insurance idea - he should step a plane across to Washington soonest to coordinate some details with the yanks.

But, as we've also blogged many times, we need to go further (eg see here). We cannot afford banks that are too big to fail, and it is a dangerous delusion to think we can solve the problem through better regulation. As we saw from the clownish antics of the FSA and the SEC during the bubble years, our regulators will never be that smart.

One widely canvassed idea is to increase the cost of being big. Either through higher percentage insurance premia/bank taxes for megabanks, or through more onerous reserving requirements, Big could be made so expensive that it became commercially unattractive. The banks would then break themselves up into smaller units which we could afford to see fail.

There is some merit in that idea. But we do need to remember the key historical lesson retaught to us by the Crock - failure can never mean retail depositors losing out. Otherwise the entire banking edifice collapses in a maelstrom of pavement queues and piles of cash stuffed away under mattresses. Only a bank's equity holders and wholesale depositors/bond holders can be allowed to go down.

Another idea - one we've supported many times (eg here)- is to split High Street retail banking away from investment casino banking, ie a new Glass-Steagall Act. The High Street banks would continue to enjoy a taxpayer guarantee on the bulk of their liabilities, but would be subject to significant retrictions covering both borrowing and lending. The casinos could do pretty well whatever they liked within the law, but if they got into trouble they could not come crying to taxpayers for a bailout. They'd be left to sink.

One thing's for sure, the banks cannot be allowed to carry on biz as usual. We taxpayers have had enough. And if the Saint and George are to be believed, our politicos have at least now realised they need to take some action. Another dose of political posturing will not be enough.

PS Other people's pay is endlessly fascinating. The world's highest paid footballer last year was reportedly a certain Mr Becks Golden Balls Beckham on €32.4m (£28.7m), although the vast bulk of that came from off-pitch ads for pants (pic). The highest paid on-pitch was Lionel Messi of Argentina and Barcelona, on €28.6m. Britain's best paid banker is reputed to have been Roger Jenkins of Barclays Capital, who is said to have coined £75m in 2006 (although in fairness, that slumped to a derisory £40m in 2008).

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www.gudanggrosiran.com Categories: bank bailouts, bankers

Rich At Our Expense

Purrrrrrrr

By a strange coincidence, this year's Public Sector Rich List from the TaxPayers' Alliance is published just as the row over bankers' bonuses explodes once again.

The Rich List first. This year, the TPA has discovered 805 public employees earning more than £150,000 pa (and that excludes local authority employees, who are covered in the TPA's companion study, The Town Hall Rich List). Among the "highlights" (data relates to 2008-09):

• 8 people got more than £1m pa
• 333 earned more than the Prime Minister
• The group's average pay rise was 5.4%, compared to 2.7% for a nurse and 2.3% for a teacher
• The group's average total remuneration is £226k per annum; by comparison, according to the Institute of Directors, a managing director of a private organisation with a turnover of between £50 million and £500 million (about the size of a typical quango) could expect to earn £141k and an executive director £87k.

And for the first time, the Rich List includes executives from our nationalised banks (but note it's only board members - ie it doesn't including all those high rolling traders and investment bankers who remain anonymous because they are not on the boards). There are 30 of them, including the List's top earner, Mark Fisher of the Royal Bank of Scotland, on £1.4m.

Which brings us back to those banker bonuses, with over 5000 of the varmints apparently in line for over £1m apiece - ie a total bill in excess of £5bn just for the top guys.

Should we care?

You bet we should. As my Lord Myners was explaining all day yesterday, these bankers have been bailed out with squillions of taxpayer dosh. Apart from the effectively nationalised banks (ie RBS and Lloyds), all the other UK banks are being propped up with open-ended taxpayer guarantees on their liabilities. WTF should we allow them to walk off with barrowloads of our cash?

So what of their threats to resign and go off to work for Goldmans?

Call their bluff, we say.

Look, the key reason we're still in this mess is because Brown has not grasped the nettle we've blogged about so often (eg here). However it's dressed up, we need to split high street retail banking away from investment banking (aka a new Glass-Steagall).

High street banking should go back to being a low risk utility type operation, fully guaranteed by taxpayers but heavily regulated and subject to a hefty annual insurance charge to pay for the guarantee. Pay packets would soon return to the the more modest levels that always used to exist in our high street banks.

In contrast, investment banking should be much less regulated, a thousand flowers should continue to bloom, but there should be absolutely no taxpayer guarantee, either explicit or implicit. Investment bankers should pay themselves whatever they like, but if their bets go wrong, they should be left to incinerate.

We desperately need to get on with this. The existing arrangements are not only grossly unfair to taxpayers, but over time they will hobble our nationalised banks into oblivion. Whatever they decide to do, they will not be able to match their competitors bonuswise, because we won't let them. They will inevitably go the way of all nationalised industries before them - second-rate and a drain on national prosperity.

So what would we do right now?

Irrespective of international agreement, we'd announce our own Glass-Steagall. From say, end-2011, any bank wishing to offer UK high street accounts guaranteed by the taxpayer would have to comply with new regulatory requirements. And those requirements would include complete separation from any entity offering investment banking services (there would be other restrictions as well, covering such matters as asset and liability liquidity).

Meanwhile, we'd say to our nationalised banks yes, you can continue to pay bonuses, but they have to be in the form of deferred equity in your new post-2011 offspring. Cash? Forget it.

Throughout history, so-called "rent seekers" have sought to capture government so as to extract unwarranted financial gain at the expense of taxpayers. But whether in the public sector or the private, taxpayers should not be expected to underwrite the riches of others.

PS And talking of rent seekers, the furore over Climategate is gathering pace. The conflicted tax-funded global warming industry has now woken up to the threat, and is trying to argue that lies and distortions from East Anglia aren't that important to the case - loads of other "respected" scientists have come up with the same results independently. Except of course, it isn't like that. As the splendid Prof Philip Stott pointed out on R4 Today this morning, the whole global warming biz is an inverted pyramid, resting on the work of about 40 scientists. And 39 of them work at East Anglia. Well, no, I made that last bit up, but it is only around 40, forming a very tight groupthink mutual support network. But like the man said, you can't fool all of the taxpayers all of the time.

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www.gudanggrosiran.com Categories: bank bailouts, bankers, eco wibble, public sector pay

Bank Job - Are Taxpayers Better Off?

On a day that has been spun as the most momentous in British banking history (that's what they said on the BBC anyway), A Darling proclaims his latest bank job:

"What we have here is a better deal for the taxpayer."

Riiiighttt.

Sounds a little unlikely.

As we understand it, the key points are:

• Taxpayers are buying another £25.5bn of RBS shares (taking our total equity stake to 84%), with a further £8bn earmarked for possible probable further purchases
• Taxpayers are buying another £5.7bn (net) of Lloyds shares, maintaining our current 43% stake post Lloyds' planned capital raising
• Altogether, this is an additional £31.2bn going into bank equity immediately, probably going up to around £39bn in due course.
• The amount of toxic assets taxpayers are insuring under the APS (Asset Protection Scheme) is being cut by £300bn
• Lloyds is withdrawing its £260bn of toxic assets from the APS altogether
• RBS has cut the total assets it is insuring in the APS by £40bn to £282bn, and also increased its excess (ie it will now pay the first £60bn of losses); for that it will pay us an annual insurance premium of £700m (one-quarter of one percent)

So does that lot add up to a better deal for taxpayers?

Well, the fact that we're now insuring less of that toxic debt must be a good thing. So we can give that a tick.

But not quite a full tick, because although we now have less direct exposure to toxic losses, we have also lost the future insurance premia Lloyds had agreed to pay us. They totalled £15.6bn, and all we'll now get is a one-off £2.5bn penalty exit fee. Which isn't quite fair, given that we wrote that insurance when it looked like the sucker really was going down. It's like a traveller on a crippled airliner taking out life insurance, and then cancelling it once the plane has landed safely.

So net net no more than a semi-tick on the toxic debt front.

As for our £39bn additional equity injections, it's difficult to see how that makes taxpayers better off at all. Because the money will have to come from incurring yet more government debt. And we've got more than enough of that already.

Oh yes, the government claims we will eventually make an excellent return on our investment. But how do they know? If the prospects were that good, RBS and Lloyds would be able to raise all the extra money from private investors.

And if we taxpayers wanted to borrow to invest in bank equity (which is what HMG is doing here), then we could do it off our own bat. Under Darling's plan, we're being forced to subscribe to a mega-hedge fund specialising in financial "recovery" stocks and managed by the Simple Shopper. We all know how that ends.

So dealwise, Darling's new bank equity purchases get a big red cross.

What Darling did not do today was to grasp the giant elephant that is still rampaging around the banking hall - to wit, the question of splitting the megabanks between their retail and wholesale components (the new Glass-Steagall). Compared to that issue, the promise to spin off a few bank branches and Direct Line is so much loose change.

As long as we taxpayers remain locked into guaranteeing the combined balance sheets of all our megabanks, adjusting  the Asset Protection Scheme is really not much comfort. We might be less exposed to losses via the APS, but we are now exposed to a further £30-40bn of potential losses on our increased equity stakes. And we remain fully on the hook for all losses over and above the banks' equity capital base.

George, you're going to have to do better than this.

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www.gudanggrosiran.com Categories: bank bailouts

Splitting The Megabanks

The idea of splitting our megabanks between their high street and casino components is fast becoming mainstream.

We've blogged this many times of course (eg here), and last night the Governor of the Bank of England amplified his own call for such a split. Calling our open-ended taxpayer guarantees "the biggest moral hazard in history", he says:

"Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are...

The aim of policy should be to minimise or eliminate that subsidy. Separation of activities helps not hinders that objective, not least because it is the mixture of activities that reduces the robustness of the system."

And we need to get on with it. As we blogged here, zero interest rates and QE mean that the next bubble is already well on the way. This morning the FT's Martin Wolf - labeling our international megabanks cuckoos in the nest - says:

"We must focus on the core issue. Trying to make financial systems safer has made them more perilous... There is a danger that this rescue will lead to still greater risk-taking and an even worse crisis at some point in the not too distant future.

Either we impose a credible threat of bankruptcy, or institutions we have to support are made safer, or, better, we have both of these. Open-ended insurance of weakly regulated institutions that take complex gambles is intolerable. We dare not return to business as usual. It is as simple – and brutal – as that."

Yes, the G20 and the international banking establishment want us to focus on better regulation (such as so-called macro-prudential regulation). And that certainly has a role to play. But we are fooling ourselves if we think our regulators will ever be clever enough to cover all the necessary bases. Governor King is someone who's seen the difficulties of regulation up close and personal, and he says:

"The sheer creative imagination of the financial sector to think up new ways of taking risk will in the end, I believe, force us to confront the “too important to fail” question. The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion."

Naturally the megabankers don't want to be broken up - which is why their own economists and pundits issue all those dire warnings about how break-up would undermine the British economy.

But we taxpayers simply can't afford to go on as we are. Relative to GDP, the financial crash hit us harder than any other major economy. As Wolf reminds us, the IMF says UK banks are facing writedowns on bad loans of around $600bn, which is 60% of the US total in an economy that is well under 20% of the size. Bearing risks of that magnitude is not sustainable either for taxpayers or our economy.

So if we're all clear about that, the next question is why are our politicos still in the dark?

Well, of course, they're not really in the dark at all. The reason they don't want to split the banks is that for the last 30 years the financial sector has been the UK's big success story. Broadly defined, it has created 6 million jobs (see this blog), and generated huge amounts of tax revenue. Given our rocky future, politicos of both main parties don't want to accept the Golden Goose may have turned into a cuckoo.

But that just won't do. Yes, there are risks in splitting the banks - especially if we do it unilaterally - but inaction runs the very real risk of an even bigger catastrophe just down the road.

Moreover, we don't reckon a split would lose us the entire investment banking industry. We'd still have the skilled labour force and infrastructure (including the English language) most other European countries lack.

And we could substantially soften the move with some accompanying measures designed to keep the bankers here - eg rescind the new 50p tax rate (see this blog), pledge to end retrospective bank windfall taxes, and promise to continue light touch regulation for non-high street banks. We should have no problem with bankers getting rich - as long as they don't do it at our expense.

Come on George. Think of us taxpayers. Surely you can't be that dependent on megabanker subs?

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www.gudanggrosiran.com Categories: bank bailouts, bankers, central banks

Breaking The Bank

The original bank breaker was 91 when he filmed this

What about those bankers, eh? What are they thinking of? No sooner do we bail them out, then they're stuffing their pockets again.

As we've blogged before, we have no problem with highly paid bankers.

Highly paid bankers, we like. As far as we're concerned, they can pay themselves as much as they can stagger home with.

It's just their huge subsidy we don't like. We don't see why we should subsidise them to make a fortune at our expense.

To reiterate (see here for fuller version), our bankers have always got a whacking great subsidy from the rest of us via the explicit and implicit guarantees we provide on their debts. Which, as long as they were laying all those lovely golden tax revenue eggs, we were prepared to turn a blind eye to.

But when a whole batch of those eggs smashed open and we saw they weren't real gold, we naturally got somewhat pissed. Especially when the IMF told us it would likely cost UK taxpayers $200bn.

So given that, and given the fact that some of these banks are now in direct public ownership, and given the fact that their profit surge reflects the extraordinarily low interest rates implemented to shore up the banking system, you might have thought they'd go easy on the old bonus bonanza for a while.

Wouldn't you?

Nah.

No chance.

So what should we do?

As we've said many times before, the obvious and necessary step is to break retail high street banking away from investment casino banking (a new Glass-Steagall). We continue to guarantee (and heavily regulate*) high street banks, but investment banks are on their own. Granny's high street bank deposit is safe, but the Bastard Corporation's super-enhanced Teir 2 capital notes are not.

And we announce it loudly to the world. We say: "London remains the global centre of casino operations, and we will do everything to enhance its position, including light touch regulation. We celebrate and embrace its high rolling players. They can snuffle up as much as they like; they can buy up Holland Park and Oxfordshire; we will never impose punitive personal taxation upon them. But... and this is an important but... nobody should assume we are guaranteeing them at the tables, because we are not. If they lose your family fortune, it stays lost. Buyer beware."

Ah, you say, that's all fine and large. But Lehman was already a pure investment bank, yet when it went down it brought down the roof. So would a new Glass-Steagall actually work?

Sure, Lehman was a pure investment bank, so in theory its collapse should not have brought the world down. But the problem was that everyone had assumed the US government would stand by it. Nobody had ever said what we're proposing is said now, so when Paulson pulled the plug, it came as a huge shock. Nobody was any longer sure of anything.

If the rules were spelled out clearly in advance, we wouldn't have that problem. And because their cost of capital would increase, investment banks would find it much harder to grow so big they could never be allowed to fail.

Focusing on bankers' bonuses is focusing on entirely the wrong issue.

*Footnote - We've heard it argued that experience with the Crock shows that splitting investment and retail banking isn't the real issue - after all, the Crock was a pure retail bank. But actually, all the Crock proves is that our retail bank regulator was incompetent. The FSA did a truly shocking job of regulating Northern Rock, as the subsequent enquiries showed. And that experience ought to make us even more wary of assuming those same stumbling regulators are somehow capable of regulating global megabanks which incorporate both retail and investment banking under one roof. It's pure fantasy.

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Grandstand Governance

You're paying for this

Does anything useful ever come out of these global grandstanding opportunities?

This week's G20fest was billed as the moment when "world leaders" would agree a new governance regime for the international financial system. This was the moment when the banks would be brought to heel, and when the big surplus nations (especially the Chinese, but also the Germans and the Japanese) would be bound into a new economic settlement in which they would spend and import more.

In practice of course, we'll get none of the above. Instead, we're going to get an agreement to have even more G20fests. Whoopeee!

The real purpose of these meetings has been highlighted all too clearly by the horrifically embarrassing sight of our unloved dead duck Prime Minister* scurrying round the UN kitchens trying to pin down St Obama for a photo-op.

As is painfully obvious, one year on from the Great Crisis, our rulers have made virtually no progress on sorting out the issues that gave rise to that crisis.

There is no agreement with the surplus nations on how they will do their bit by correcting the imbalances in their own economies. And there is no agreement on how we can protect ourselves from a future global banking collapse.

Indeed, on the latter point, as City veteran Terry Smith reminded us on BBC R4 Today this morning, our rulers are refusing even to discuss the giant elephant rampaging around their gilded conference halls.

The pachyderm in question? As we've blogged many times (eg here), we need a new Glass-Steagall to separate high street banking from investment (aka casino) banking. We can no longer afford to have the two activities co-existing in the same megabanks.

Because although we all learned from the Great Depression in the 30s that taxpayers have to guarantee high street deposits, we most certainly do not need to guarantee banks' casino activities. And it was our implicit guarantee of those activities that allowed the players to access the cheap funding, that inflated the huge bubble, that finally popped last year.

Sure, in theory we might be able to keep ourselves safe through better smarter bank regulation, rather than resorting to the crude blunderbuss of Glass-Steagall. But in practice, we just ain't that smart.

Among other things (as the now reviled Alan Greenspan always said), no regulator or central banker has ever come up with a way of definitively identifying a bubble before it pops. And even if they did, politicos riding the wave of an economic boom would never sign up for sticking in a pre-emptive pin.

And in the real world, those superbright all-seeing regulators of myth and legend don't actually exist. Indeed, our own bumbling regulators couldn't even control the relatively simple activities of the Crock.

No, to make ourselves secure, we need to split retail banking from investment banking. Just like it always used to be.

And we need to do it on an international basis, because otherwise the megabanks will simply migrate to the countries where they are not required to split.

So why hasn't the G20 tackled the elephant?

Well, because for one thing the megabanks don't want them too. And for another, the politicos are desperate to avoid anything that might smother the recovery, and breaking up the banks would inevitably restrain the future growth of credit.

Which is a problem.

Because taking a view slightly longer than the next election, a return to easy credit is the one thing we do not need. And unless we take the necessary action now - while minds are still concentrated by the crash - the will to act will simply evaporate (if it hasn't already done so).

Might we expect more from Cam and Os? Sadly not. They have already indicated they have no plans for a Glass-Steagall.

So unless St Vince somehow finds his way to the controls, it looks like taxpayers are skewered on the banking hook for the forseeable future.

Gaaaaaaaaah.

*Footnote We've already blogged the BBC's mini-series the Love of Money, but last night's nearly made me swallow my false teeth. Entitled Back from the brink (click on link to watch again), it painted Brown as the saviour of the global banking system. No really. It reckoned the man who spent this week trying to get his snap taken with Obama, came up with the genius solution, which was for taxpayers to inject capital into the banks rather than simply buying/guaranteeing their toxic assets. Apparently nobody else apart from Brown and that Shitty woman had thought of that. Maybe the BBC overlooked the fact that within days of Lehman's collapse - and weeks before Brown's emergency purchase of all those bank shares - the idea of government equity injections was being openly discussed all over the place, including the FT, and even our own humble blog here. Surely even the BBC can't rewrite history this soon after the event?

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Socially Useless

According to FSA head Lord Turner, much of the activities of the City of London are "socially useless".

Er... how does he reckon that?

Unless Tyler has got this wrong, the City has long been Britain's big success story. It has generated a large chunk of our national income, paid humongous taxes, and provided hundreds of thousands of highly paid jobs. It's also paid for all those cheap clothes and tellies we now import from China:

Doesn't sound useless. In fact Tyler reckons it sounds jolly useful indeed.

What's that?

The cost of the bank bail-outs has negated all the apparent benefits?

Well, yes, you certainly have point there. The IMF reckons the bailouts will eventually cost UK taxpayers $200bn, which we could certainly live without.

But even if you accept - as we do - that we need radical new safeguards against a recurrence (eg see this blog), taking a long view, net net we're still well in profit on the City.

Long-term, we'd be much worse off without it. We never earned much of a living from turning out Austin Allegros, even though back in the 60s and 70s the commissars virtually to a man considered manufacturing to be far more socially useful than mere "paper shuffling" in the City (who can forget the damage inflicted by Wislon's notorious Selective Employment Tax directed against our useless service industries?).

So the head of our financial regulator should not be shooting his mouth off about swathes of the City being "socially useless". Especially since - as we noted earlier in the week - at this very moment many of the City's movers and shakers are actively considering moving and shaking themselves out of Britain altogether. Which they could easily do.

Turner is in the unfortunate and frustrating position of presiding over an organisation that has bogged up bigtime (eg see here for its appalling lapses over the Crock disaster), has zero credibility, and which will soon be abolished. Presumably organisational morale is rock bottom.

But that is no reason for him to tour leftwing political salons talking the City down. There are plenty of others around to do that - most of whom, like the BBC, have seized on his Lordship's remarks with glee.

Someone needs to tape his gob shut soonest.

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Hostage To Bankers

Pay up, or the economy gets it

Tyler likes markets. He trusts them far more than governments. He especially trusts them to deliver far better value for money than we're ever likely to get from governments.

But for markets to work their magic, the players need to be playing on a level(ish) playing field. And the problem we've got with these rapidly re-wedging bankers is that the field is very far from level.

The fundamental issue is the one articulated by St Vincent de Cable - banking profits are privatised but banking losses are nationalised. Whereas the bankers keep the vast bulk of the upside for themselves, any serious downside is shuffled off onto us taxpayers.

This week we were stuffed with our latest helping of downside, including 75% of the future losses on a highly dubious £260bn debt portfolio owned by Lloyds, and a further £700m salami slice of the Crock's rotten loan book (remember when we were being assured that the Crock's problem was one of liquidity rather than solvency? See here for a teeth-grinding reminder).

Meanwhile, every BBC bulletin is headlined by news of yet more banker bonuses, and demands that the government step in: bonuses should either be capped, or better still banned altogether. And while we're at it, shooting a few bankers outside the Mansion House wouldn't be a bad idea either.

So why is Comrade Brown so reluctant to act?

We know why.

He's desperate not to do anything that might damage the last-minute economic recovery he's praying for, and whacking the bankers might do just that.

He's also trying to stoke up bank profits so that they can start paying tax again. As we've blogged before, booming tax revenue from the financial sector paid for much of Brown's public spending slurge, and the current slump has blown a huge hole in the finances. According the Centre for Economic and Business Studies the tax loss from the collapsed finance sector this year alone will be nearly £30bn.

He's also acutely aware that the major banks do not have to stay in London.

In particular, HSBC may very well go back East. They are well advanced with their plans to list on the Shanghai Stock Exchange, the Chinese government is desperate for them to return, and it's surely only a matter of time.

Just as it may be only a matter of time before the ambitious Barclays/Lehmans operation relocates to New York. As BOM correspondent JW points out, if they are serious about rivalling JP Morgan, they'll need to move closer to where he keeps his cigars.

So there are certainly some big risks involved in pissing off the bankers.

But for us taxpayers, there are also some big risks in letting them get back to biz as usual - and we're not talking about their personal bonuses, which are a politics-of-envy sideshow.

As we've just seen demonstrated in vivid technicolor, we are currently standing as the ultimate guarantor of the entire shooting match.

That is a horribly expensive place to be. The IMF reckons the current bank bailout will cost us £200bn, or £8 grand for every single household (see here). And even if that doesn't escalate further (we're betting it will), the next bailout could be even bigger.

Sure, there's much talk of smarter regulation, including flexing regulation so that it toughens up during boom/bubble periods.

But recent events have shown us all too clearly we can't rely on our regulators to act smart. After all, they couldn't even regulate the Crock's pretty simple business, let alone being capable of spotting and calibrating bubbles to the extent of providing a sound basis for our entire regulatory stance.

So I'm afraid we have to KISS. We have to keep our regulatory structure so simple that even the stupidest regulator can operate it with a reasonable expectation of keeping us safe.

And that does mean breaking up the big banks. Just like the Governor of the Bank of England told us, if a bank is too big to fail, it's too big.

Crucially, we do have to split High Street retail deposit taking from investment banking activities - ie we need to implement our own Glass-Steagall Act (see this by the indefatigable Mr Stelzer).

The taxpayer has to guarantee high street bank customers against default on their own personal savings. Because history tells us that modern economies simply cannot operate if everyone keeps all their savings under the mattress.

But that is no reason to guarantee a bank's liabilities to its wholesale creditors. They are mainly other banks and professional investors, and they should be required to consider the risk of default before ever committing funds. If they get it wrong, they should take the hit.

Still less do we want our High Street banks visiting any of those famous casinos. Taxpayers should not be required to guarantee anyone at the tables - especially in a game of winner-takes-all.

The simplest way of ensuring all this is our own Glass-Steagall. We'll guarantee High Street bank deposits placed with regulated fire-walled High Street deposit takers, but nothing else.

In the circs, it's the only sensible to do. Surely everyone can see that.

Er, no. Neither Labour nor Tories are intending to do it.

Why not?

Because the bankers have scared the living bejeebers out of them. The bankers have threatened to leave and the politicos don't have the nerve to call their bluff.

So the playing field remains heavily tilted. Against us.

As the Major keeps saying, if you go bust owing the bank £500 grand, you're in trouble. If you go bust owing £500 million, the bank's in trouble. But if you go bust owing £500 billion, the taxpayer's in trouble.

The trouble is, speaking as a taxpayer, we just can't afford it.

PS Tyler can't remember if he's said this before, but back in the early 70s, he spent three months working for the NatWest bank, including a spell behind the counter. God, it was boring. But it was safe. And steady. It didn't go bust, and there were never queues on the pavement outside (see here for an uncensored clip from Bank Managers on the Job, 1975).

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