Political Economy

On the 27th September 2009 I made a speech to the English Democrats AGM and autumn conference entitled “  The ABC of Banking Regulation” (http://bit.ly/u2vCYM). I made the speech because as I said, “It [the bank crisis] happened because we had the lightest touch, and probably the most dysfunctional, bank regulatory scheme going”. The recent report on the Royal Bank of Scotland failure (the RBSR) by the Financial Services Authority, who were responsible for regulation, appears to agree with me.

Overall I am happy with the progress to date. Some of the matters I suggested have turned up as proposals or have been enacted. But we still face tough times and there will have to be a greater degree of  implementation of these ideas if we are to build a stable base for the future.

My A was accountability. I suggested that in order to achieve this we should have something akin to the Sarbanes-Oxley Act in the USA. The difference would be that bankers, the directors and senior managers, would go to prison for 5 years and suffer a £5,000,000 fine if their bank needed saving by the authorities. I still think that this is the one regulatory change that would ensure compliance with prudential banking practices. The RBSR is suggesting fines and exclusion from working in banks again for those who transgress. This is far from enough.

I had two Bs, both of which have been taken up by the coalition government. First was to put the Bank of England in charge of the regulation of banks and other depositary institutions. The second was based on a law in cybernetics called “Ashby’s Law of Requisite Variety”. Put simply this states that any regulator must have as wide a range of control measures available to it as there are ways of change in the system. The economic system is, and always will be, subject to wide gyrations that we call “boom and bust” caused by a variety of events. The regulatory authority must have a similar wide range of responses available and not just, as in the Bank’s case, the ability to raise or lower interest rates to control inflation. The coalition’s response to this suggestion has been the “Financial Policy Committee” which has wider powers of intervention.

I had three Cs; clarity, capital and compensation.

Clarity referred to stopping the ability of banks to create opaque, multilayered derivative product that are sold “over the counter” and thus in secret. The dangers are self-evident. The opaque nature of the the security makes it much more likely that that collapse will occur and the secret nature of the transaction means that banks do not know who holds this toxic junk and so will stop lending to other banks, the so-called “contagion” effect. The Frank-Dodds Act in the USA is in the process of moving these transactions to open exchanges where much greater clarity exists. The final report of the Independent Commission on Banking (The Vickers Report) has proposed the banning of dealing in derivatives by the ring-fenced commercial arms of banks whilst the investment banking arms going through a process to improve clarity, somewhat.

It became clear that banks relied too much on borrowing and not enough on their own capital as well as having a deficient method of risk calculation, which would in itself lead to too little capital. I was being far too optimistic. The RBSR infers that there may not have been any risk calculation on occasions.

The new rules under Basel III will increase capital levels and the UK wants to increase the levels of capital held by larger banks even more (the EU on the other hands wants to reduce the levels of capital proposed). It was clear that increasing the levels of capital would result in lower level of lending and liquidity in the banking system. This is very evident in eurozone banks, where the appalling level of management of the system, has meant European banks withdrawing cash from the international system where its effect will be felt not just in the EU but in developing countries as well as elsewhere in the world.

I suggested that some of the problems of increasing capital could be overcome by requiring (investment) banks to insure against sudden, but infrequent, requirements for increased capital. This could be done by a mixture of government and private sector insurers, provided that the premiums that go to the government are deposited in a ring-fenced fund to keep off the sticky fingers of politicians who, when it comes to giving goodies to voters using someone elses money, can show a degree of “stickiness” that far exceeds that of your average banker!

The third C is compensation. I suggested that commercial banks could be subject to a significant regulation including control of compensation. In return directors and senior managers would not be subject to custodial sentences if the banks needed saving. The RBSR suggestions concur with my mine on this matter.  The question of excessive compensation is still an issue and solutions are still being discussed. There is no sign yet of criminal penalties, a situation that needs to be speedily changed.

My D was for division. I felt then, and still feel, that investment banks and commercial banks must be split. The Vickers report is recommending a half-way house of strict firewalls. I hope this succeeds but fear it will not. We should remember that investment bank are by nature risk taking and piratical institutions. If they were not they would not be successful.  Whilst a group of greedy investment bankers have within their line of sight a pile of someone elses money sitting in deposits they will move heaven and earth to get their hands on it. The subterfuges they will employ will often not be discovered by the regulators who will end up being powerless to stop it. Only the strong threat of a prison sentence could have any hope of stopping this behaviour.

If we are to have a strong banking regulation system in a sea of lighter touch regulation it will be all too easy for the banks in the later environment to undercut UK regulated banks in their product and service pricing hence leading to a decline in English banking. To do this we need to take powers to tax companies, fairly, that have used foreign products that are cheaper due to easier regulation. This should not extend to taxing solely on the basis of cheapness, some of which is due to efficiencies. There is no sign of this yet. This was my F

My L was for government to stop being lead by the nose by bankers and to start leading themselves. This, at least in the UK, but not it would appear in the EU, is starting to happen.

The score to date is zero for A, two for B, two halves for C, a half for D, a zero for F and one point for L, a total of four and a half out of nine suggestions or 50%. We still have a long way to go. It will be interesting to see what emerges.

 

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The Financial Times reported today that 35% of City professionals were dissatisfied by the size of their bonus!

Apparently some 79% of them got a bonus this year, paid out of a bonus pool of £7 billion which was much the same as the previous year.

Things look good in all directions in the City with job opportunities up by 6,426, the highest since August 2008 whilst the average salary of those who found new jobs in March was £54,445. Overall 89% had salaries that were higher or the same as last year.

This dissatisfaction with bonuses is despite the fact that earnings in the City rose by 5.4% in the three months to February. This is more than twice the level of everyone else whose pay rose, on average, by 2.2%.

Some 79% of City professionals earned a bonus this year; 38% got more, 43% about the same and 19% got less. The fact that some 35% of them appear to be unhappy with their lot begs the question about why we should be happy with them. There are many words that rhyme with “banker”, some are rude but many would say that they describe the City professional perfectly.

This month the Royal Free hospital in Hampstead said it would loose 450 jobs, many of them clinical in order to save £40 million. At this rate the £7 billion of bonuses is equivalent to over 78,000 jobs in the NHS.

Recently a senior City regulator said that he could discern little that was socially worthwhile in what the City did. Was he correct? What do you think?

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I received the following email message from Frank Roseman, the English Democrats prospective parliamentary candidate for the Cities of London and Westminster (http://www.voteenglish.org/london-candidates/). Interestingly it looks as though Gordon is a snob, always toadying up to the wealthy.

“Just a few interesting facts about Gordon Brown

1 – We used to have 6 independent regulators to regulate the different
divisions of the financial services industry, including our Banks.

(Margaret Thatcher knew what the Banks were like and in the 1988
Finance Act she bound the Banks up in regulation to prevent them from
being reckless!!!)

Then Gordon Brown became Chancellor on 6th May 1997

Gordon’s banker friends said “We want all these regulators to go. We
don’t want regulators watching everything we do”

AND GORDON SAID OK

So, Gordon announced on the 20th May 1997 (2 weeks after becoming
Chancellor) that the six regulatory bodies would be broken up and a
new Financial Services Authority would replace them. The FSA had
virtually no powers over the Banks and he also took away the powers
from the Bank of England to enforce regulation on them.

The result is the devastation we are all suffering today.

————————————–

2 – We used to have a Monopolies and Mergers Commission

Then Gordon’s banker friends said we don’t want the Monopolies and
Mergers commission telling us who we can and cant “Take Over”

AND GORDON SAID OK

So, in 1998 Gordon scrapped the Monopolies and Mergers Commission and
created a replacement called the Competition Commission, with very
much reduced powers and different ideas of what used to be regarded
as a “Monopoly”.

The result is the Massive Corporations we have today who are ruling
and shaping our lives for their own benefit and profits. Not to
mention the massive Monopolies held by some of these corporations
through the forced purchases of all their competitors

————————————-

3 – We used to have pension regulations, which for many decades had
included something called “The Pensions Cap”

The pensions cap set a limit on how much pension any scheme member
(including directors) could get from an occupational pension scheme,
irrespective of how high their earnings were. It was there to protect
the ordinary members pensions, and to prevent Directors paying
themselves obscene salaries and then draining the pension funds with
huge pensions.

Then Gordon Brown’s banker friends said that they wanted the pensions
cap removing so that they could get pensions related to their obscene
earnings.

(The whole Pensions industry gave him warnings of the effects it would
have. Even the Inland revenue put forward objections)

BUT GORDON SAID OK

Because Gordon never likes to disappoint his banker friends

So Gordon took away the Pensions Cap in 2005 and then some of his
friends were able to leave their boardroom positions with huge
pensions!!!

For example Fred Goodwin [ex CEO of RBS] was apparently entitled to a
pension of over £700,000

If Gordon had left the pensions cap in place that would have been a
mere £125,000

Well done Fred and your mates!!!

(The Superannuations Division of the Inland Revenue have kept a record
of what it should be, in readiness for when we get a new chancellor
who sees fit to re-instate it. George Osborn has pledged to do that).
The record of Pensions Cap limits are available to view on the
Revenue’s website

The result of this is that along with Gordon’s “Tax Raid” on pension
funds starting July 1997, over four thousand UK company pension
scheme’s have closed their doors to new members and many of them have
had to close down altogether, leaving millions of workers without any
pension provision.

This man Gordon Brown “professes to be a socialist and “for” the working man

The working man’s main form of long term financial security had for
many years been his company pension scheme, something to look forward
to at the end of a life of hard work, his reward, light at the end of
a long dark tunnel.

Gordon has put an end to that by destroying the most valuable asset of
the average British worker.

*****************************

IT IS ONE OF THE GREATEST TRAVESTIES OF JUSTICE THAT THIS MAN WHO
PRETENDS TO BE “FOR THE WORKING MAN” HAS IN FACT BEEN HIS WORST ENEMY
FOR THE LAST THIRTEEN YEARS AND WILL LEAVE A LEGACY THAT WE WILL STILL
BE CLEARING UP FOR MANY YEARS TO COME.

THE REAL INJUSTICE IS THAT ITS ALL BEEN DONE IN AREAS WHICH ARE
TOTALLY OUT OF SIGHT TO THE GENERAL PUBLIC AND BEYOND THE
UNDERSTANDING MANY

GORDON RELIES ENTIRELY ON PEOPLES IGNORANCE TO GET AWAY WITH HIS INDISCRETIONS

GORDON’S MOTTO OF: “DENY EVERYTHING AND ADMIT NOTHING”

SEEMS TO BE WORKING QUITE WELL FOR HIM SO FAR!!!

—————————————-

4 – LASTLY, WHAT GORDON LIKES TO CALL THE “GLOBAL BANKING CRISIS”

Have you noticed that we were the first to be in it and are the last
to be out (and whether we are out is very speculative!!!)

As he has openly admitted, The Royal Bank of Scotland was the worlds
biggest bank.

So when RBS and HBOS were about to go BUST in October 2008 and they
had to be bailed out overnight so they did not take the entire country
down with them, (that by the way was almost certainly a decision made
by the hierarchy in Whitehall for which

Gordon loves to take the credit)

As the worlds leading banks now all lend money to each other on a
collosal scale, isn’t it obvious that the worlds biggest bank going
down would have a devastating effect on all the others it dealt with.

This “worlds biggest bank” had also sold bad mortgage books to other banks.

Most of the Banks in Europe which ran into crisis were dragged into it
because of the crooked dealings of our big Banks. A fact that both
Germany and France were quick to remind Gordon Brown of at the G20
emergency meeting shortly after the crisis.

There are many other of Gordon’s indiscretions, far too many to list
here, but perhaps the few biggie’s shown above will give some insight
into how Gordon operates.

By the way have you noticed how he has suddenly become interested in
Social issues now an election is looming and seems to be able to
promise the world when, as Alistair Darling put it a few days ago,
there is not a penny left in the bank!!!

Think very carefully before casting your vote for this man who is
probably the most extreme capitalist of the past century while
pretending to be
“for the working man”.

GORDON WORSHIPS THE SUPER RICH AND POWERFUL AND CANNOT SAY NO TO THEM

Please pass this on to all you can, the whole population should know
these few facts before the election.”

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I initially planned to post this in November. However the economic outlook was confused at the time, typical of a turn in the economy, and since I wanted to encourage readers to make their own decision I decided to wait a couple of months.

The Bank of England helpfully provide a pamphlet to explain Quantitative Easing (Q.E.) http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm#

In this the Bank explains that its approach to Q.E. is to purchase assets from private sector institutions, banks, pension funds, insurance companies and non-financial firms, for example. They do this to ensure that the risk of banks holding on to the money is ameliorated. If the Bank buys gilts from a commercial bank the money will end up as reserves of that bank and is capable of being lent on, subject to the bank’s desired reserve ratio. If the Bank buys its gilts from a non-financial firm or a pension fund the money will eventually end up in a deposit account in a bank, where it is available for lending on, subject to the bank’s required reserve ratio. The money supply effect will therefore be similar.

In its pamphlet the Bank describes it monitoring process. It will monitor

1. The terms and conditions offered on loans?
2. Are corporate debt markets easier for companies to borrow in?
3. What is happening to asset prices (such as shares and house prices)?
4. Are banks lending again?
5. What is happening to the supply of money?
6. Is household spending increasing?
7. Is company expenditure increasing?
8. What is trend in inflation?

Whilst the Central Bank is buying government securities and lowering the interest rate, the government, struggling to deal with reduced tax revenue as a result of the recession, will be selling government securities and finding it is helped by the central bank buying them in. This is called ‘monetizing’ the government’s debt.

In effect the government is printing money to buy its own debt. There is a risk that the government will become addicted to monetizing its debt, pimping its central bank to buy more and more. The classic case is, of course, Zimbabwe where things went so far that in the end the currency had to be junked. In truth many Central Banks are up to it.

But this is not the only economic stimulation in the UK. There is the matter of the governments deficit budget spending. Currently in excess of £175 bn in the current financial year this provides a huge stimulus. Moreover Prime Minister Gorden Brown is driven not by financial prudence, but by a constant concern for his image and by his reckless desire for reelection  at any cost, to anyone. As a result we are told that this stimulation will go on for years. This season should remind us that after the gifts of the kings there followed the slaughter of the innocents!

This gives the chancellor and the Bank three choices. The first is to stop or reverse Q.E. whilst continuing with the budgetary stimulus. The second is to continue or stop Q.E. whilst reducing the budget deficit by a material amount. The third is a mixture of the two. For example this could mean stopping Q.E. whilst making some adjustment to the deficit by increasing taxes generally or cutting government expenditure. A start on the latter has been made by the recent increase in VAT back to its original 17.5%.

If Q.E. is not reversed there are two key risks. The first is that there will be a large stock of bonds in the Bank’s hands “overhanging” the market. This is likely to lead to higher volatility and possibly higher interest rates as a result. The second risk is inflation, possibly severe inflation, and a return to a credit boom. The risk of cutting budgetary expenditure is increased unemployment and reduced demand in the economy.  It seems that you are dammed if you do and dammed if you don’t!

So, let us get back to basics and see what is happening to the eight indicators of the Bank of England.

1. Loan terms. A recent report in the International Financial Review was entitled “From Famine to Feast – a review of the corporate bond market”. The bond markets were open for the entire investment grade spread
2. In Europe certainly corporate borrowing appears easier.
3. Asset prices are increasing
4. Banks are lending but the government has had to increase its support for SMEs
5. The liquidity preference of corporations and individuals is still high
6. We have seen record retail spending this Christmas
7. The trend of company expenditure is not yet clear.
8. Inflation is increasing.

So, what should the Bank of England do? Is it time to reverse Q.E. or are the hints of the Chancellor, that there will be budget cuts, sufficient to dissuade them from this action?

Why not make your own choice and take part in the polls on the sidebar?

Next post will be on climate and weather and how the government and local authorities could have made better forecasts of the chance of cold weather than they appear to have done. There really is no place for the string of excuses we have been treated to!

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Quantitative Easing (QE). Now there’s a phrase to ruminate about. It was created by Dr Richard Werner, Professor of International Banking at the School of Management, University of Southampton. He used this phrase in order to propose a new form of monetary stimulation policy by the central bank that did not rely rely on traditional methods of stimulating the economy which appeared to have failed in Japan.

When you make a deposit into the bank, the bank will lend out that fraction of the deposit that will leave it with its desired or regulated reserve ratio. So if the reserve ratio is 10% the bank will lend out up to 90% or £90 out of every £100 you deposit.

The bank into which the £90 loan is deposited will in turn lend out 90% or £81 of this deposit. The money merrygoround continues until the banks have lent out £1000. Your £100 represents the 10% reserve ratio. This represents an increase in the money supply since all depositors can access the £1000. But if there are many hundreds of thousands of depositors the chance of this happening at the same time is very low, unless there is a run on the banks. Banks therefore depend on the average of all deposits and withdrawals  in a day netting out to almost zero.

This simple analysis is, in fact, not quite correct. If the £100 you deposit has been withdrawn from another UK bank then that bank will have had to reduce its loans setting up a merrygoround in the opposite direction. So in this case there will be no net change in deposits. For this reason it is possible to treat all UK banks as one when doing this sort of analysis.

The Money that comes from central banks, however, is new money. When it is deposited in a commercial bank it can be lent out and start the money merrygoround without any corresponding opposite reaction.

When a crisis hits the banks they have a problem of knowing which of the loans or investments they have made are sound. Because of this they will all decide to hold more cash, perhaps 30% more, so that their desired reserve ratio is now 40%. If the banks had £1000 of loans and £100 of cash they will now wish to call in any loans they can, like overdrafts, so that they now have £250 in loans and £100 in cash in order to meet their, new, desired reserve ratio. This 75% reduction in loans would, if allowed to happen, cause havoc in the economy.

The solution is to give the commercial banks sufficient money to stop this happening. In this case deposits would have to increase by £300 to have the desired effect. Now with £400 a loan base of £1000 can be supported.

To do this the Central Bank buys government securities and perhaps high grade corporate bonds from the banks using new money created for the purpose. This gives the banks more money, so allowing them to increase their deposits to the desired £400 required to stop the loan recalls.

Buying in the government securities from the banks causes their price to increase and this means that, happily, interest rates drop. Just what you want in a crisis!

If you now do nothing the crisis will abate and banks will now increase lending so as to get back to their 10% ratio. But they now hold £400 to act as reserves. This means that deposits, and hence money supply, will increase to £4000 compared to the original £1000. So much money going into the economy so quickly will lead to massive inflation. What can be done?

Well the central bank will now try to sell the securities and bonds back to the banks in return for the excess cash. The bankers will protest. After all they are lending to companies and people just as the government wanted them to. But, eventually, they will sell the securities back, not of course at the high price the central bank originally paid, but at a much lower price. This will give the banks a(nother) good profit and interest rates will as a result of the lower price go up, so helping to choke of any incipient inflation.

Of course the Central Bank must commence selling the securities back to the banks at the correct moment. Too early and any recession is extended, too late and rapid inflation occurs.

What could possibly go wrong? Next week the grizzly story!

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