Finance

Don’t give in to banks’ blackmail again

Sky News are reporting that a secret study commissioned by some of Britain’s biggest banks warns that tighter banking regulation could provoke a  double-dip recession.

Yet again, the big banks are attempting to blackmail the rest of the country in order to protect their licence to gamble and make monopoly profits with government guarantees.

Of course, the risk of a double-dip recession is real – not least because banks are failing to lend to sound businesses at reasonable rates.

Banks can borrow from the Bank of England for almost nothing, but  instead of lending this on to small businesses, they are using the cash to buy government bonds or, in the case of investment banks, more speculative assets.

This easy money pumps up asset prices, but does little to benefit the rest of the economy.

Nor is it doing much to recapitalise the banks, since they are paying out big chunks of their profits on bonuses and dividends.

In these exceptional times when the government has a controlling stake in Northern Rock, RBS and Lloyds, it should direct them to lend more to creditworthy borrowers.

It should also ban all banks – all of which benefit from government guarantees  – from paying out bonuses and dividends until they have enough liquidity (cash reserves) and capital to provide an adequate cushion against future losses.

Last but not least, the next government must urgently direct competition watchdogs to look at how best to break up the cartel that dominates high-street banks and the complex monopoly riddled with conflicts of interest that banks with  investment-banking operations enjoy.

Don’t let the big banks hold a gun to our heads again. It is their failure to lend, not the prospect of tighter regulation, that threatens a double-dip recession.

Goldman Sachs makes the case for breaking up banks

Goldman’s use of intelligence drawn from its unrivalled pool of market sources to trade on its own and its clients’ behalf – a strategy championed by Mr Blankfein – has been a competitive advantage. Bank executives speak of its ability to manage – even “embrace” – conflicts of interest that arise from its position at the centre of information and capital flows.

In plain English, big, complex banks such as Goldman Sachs make money by abusing their privileged position as the gatekeepers to capital markets. This complex monopoly must be broken up.

Hat tip: FT

Is the IMF’s proposed bank tax a good idea?

It is outrageous that governments bailed out failed banks. There were better alternatives. But given that mistake, it is understandable that governments – and taxpayers – want to get their money back.

The IMF has therefore proposed that G20 countries levy a tax on banks’ balance sheets, to pay for future bailouts or the recent one. It sounds appealing. And since finance is global, global action would certainly be more effective than different countries going their separate ways. But the big danger is that the tax – like an insurance premium – entrenches the idea that banks should be bailed out when they run into trouble.

That would be a huge mistake. It would encourage banks to continue to run huge risks, safe in the knowledge that tails they win, heads taxpayers lose. As I argue in much greater detail in Aftershock: Reshaping the World Economy After the Crisis, there is a better way to break up this racket.

  • Tighten and improve regulation.
  • Restructure banks so that they can be wound up quickly and safely if need be.
  • And break them up, to curb their monopoly profits and political power and ensure they are allowed to fail.

To its credit, the IMF acknowledges the need for governments to create effective mechanisms to wind banks up. But I doubt whether such a commitment can be credible unless banks’ financial and political clout is broken.

Can swap lines substitute for currency reserves?

This is a more technical post.

When financial panic spread even to sound emerging economies after Lehman collapsed in September 2008, the Fed responded by extending swap lines to central banks in Brazil, Korea, Mexico and Singapore, while the ECB provided them to Hungary and Poland. These unprecedented moves played a key role in quelling the panic.

The four emerging economies that the Fed helped were all well-run, but a new paper suggests that “the exposure of US banks was the single most important explanation for why the US selected to swap deals with the ‘chosen four’, as a summary on Vox explains.

Might such swap lines substitute for the vast foreign-exchange reserves that many emerging economies have felt compelled to accumulate?

Only to a limited extent, the paper concludes:

there are clear limits to substitutability between swaps and reserves. By and large swap lines are extended only to fundamentally sound and well-managed emerging markets, and to important trade partners. Crucially, sound fundamentals include healthy levels of foreign-exchange reserves. The highly selective nature of swap recipients means that a majority of developing countries will not have access to swap facilities. While swaps can contribute to the global public good of global financial stability, in fact large central banks provide liquidity support only when it is in the self-interest of their respective countries to do so. The inclusion of countries such as Argentina and Belarus – not known for strong fundamentals or sound management – among the Bank of China’s swap recipient countries points to the overarching dominance of export markets as the key criterion. Following from this, the growth of yuan-dominated swap lines may be a precursor to the eventual emergence of the yuan as a new reserve currency.

When market confidence is shattered, foreign-exchange market intervention to stabilise exchange rate becomes ineffective, even if the economy has sound fundamentals. That is, reserves fail to perform their precautionary or self-insurance function when the unlikely becomes the reality. In fact, in the case of Korea, declining reserves themselves intensified market fears and concerns, forming a vicious cycle in which adverse market sentiment drives down reserves via foreign-exchange market intervention, and the decline in reserves, in turn, further dampens market sentiment. The timing of market movements suggests that the Bank of Korea’s three swap agreements, in particular the agreement with the US Fed, played a pivotal role in calming down the growing market hysteria over a possible dollar shortage.

Taxes on capital inflows might provide a better alternative, the authors suggest.

since financial instability in emerging markets is usually the result of volatile capital flows and the fundamental purpose of precautionary reserves is to limit financial instability, some emerging markets may opt to dampen the precautionary accumulation of foreign-exchange reserves by controlling volatile capital flows. According to this argument, controlled financial integration, which retains some restrictions on capital flows, may limit financial instability. This, in turn, will limit the need for precautionary foreign-exchange reserves.

One possible solution to sudden stops and de-leveraging may be a Pigovian tax scheme, where inflows of portfolio flows and external borrowing above a threshold may be taxed at an increasing rate, reflecting the resultant higher exposure of the central bank to possible future bailout of the banking system.2 Such a tax scheme, implemented before the inflow of foreign funds takes place, may curtail exposure to the growing hazard facing the recipient country due to possible de leveraging (see Aizenman 2009). It may induce the foreign investor to internalise the externality associated with possible costs of de-leveraging, and would reduce the cost of self insurance.


Are banks a vested interest?

Oliver Kamm at The Times, a man I respect a lot, argues in his blog that banks are not a “vested interest”.

But unless I have misunderstood him, I think he is being too charitable to the banks.

He argues that “the banks are not some unaccountable lobby seeking to superimpose itself on the public interest: they are an economic sector seeking to maximise profitability within the regulatory framework”.

It’s worse than that. Banks are unaccountable, since they are not allowed to fail – and capitalism without risk of failure corrupts absolutely.

They do seek to superimpose themselves on the public interest: even now, the notion that what’s good for the City is good for Britain is pervasive among many senior officials.

Nor is the regulatory framework a given: it is shaped by banks’ lobbying and the revolving doors of finance and politics: boardroom positions for politicians and government advisory roles for bankers – including the astonishing appointment of “Win” (or should that be “Lose”?) Bischoff, the former chairman of failed Citigroup, to co-chair the writing of a report on the future of UK international financial services.

Like Oliver, I am a supporter of open, competitive markets. That’s why I find it so worrying that we have allowed a complex oligopoly that earns vast monopoly profits in the good times and passes on the losses in bad to amass such huge economic – and political – power, as I argue in my new book, Aftershock: Reshaping the World Economy After the Crisis, which is out on 6 May.

Banks are a vested interest – and a dangerous one at that.

Kaletsky endorses directing Northern Rock to lend

Britain’s banks aren’t lending, which is strangling the economy. The package of measures to support lending to smaller businesses which the government announced yesterday will do some good. But it is not enough.

As I have argued previously, the government should direct nationalised Northern Rock to step into the breach. Anatole Kaletsky endorses this position in today’s Times:

the
quickest and least costly emergency response would be to reverse the policy
of running down Northern Rock and Bradford & Bingley. Both these banks
are now fully owned by the Government and could be turned into rapidly
growing state-guaranteed lenders.

The plans to run down their lending were right in the circumstances in which
they were nationalised last year, when other private banks were functioning
more or less normally. But things have completely changed and it now makes
sense to reverse their policy of credit contraction. Northern Rock is
ideally positioned to re-expand the supply of mortgages to first-time
buyers, while Bradford & Bingley could revive the flow of finance to
commercial and social housing. The Government could also be much less shy
about exerting its majority control over the Royal Bank of Scotland and its
40 per cent stake in Lloyds-HBOS, by far the biggest commercial and mortgage
lender in the country.

Don’t want our money? Don’t worry, we don’t want to give it to you

In recent years, Western governments have voiced concerns about Asian governments’ vast sovereign wealth funds (SWFs) investing in Western companies. Some called this "investment protectionism"

But as Western banks faced collapse, they were delighted to receive capital injections from Asian SWFs – and Western governments didn’t object. In a crisis, needs must.

Now, though, Asia’s SWFs are having second thoughts.

China Investment Corp, the country’s sovereign wealth fund, will no
longer risk investing in western financial institutions because of
concerns about their viability and a lack of consistency in their
governments’ policies, according to its chairman.

“Right now we
don’t have the courage to invest in financial institutions because we
don’t know what problems we will put ourselves into,” Lou Jiwei said.

Perhaps Western governments will realise that the only thing worse than receiving investment from Asia’s sovereign-wealth funds is being denied it.

Buiter on how to make banks lend

(A) All domestic non-financial enterprises that currently have
access to bank financing and whose loans, overdraft facilities, credit
lines or whatever other financial arrangements expire during the coming
year, have the right to an automatic one-year extension of the expiring
arrangements on the same financial and non-financial terms as the
expiring arrangements. This mandatory ‘creditor standstill’ helps
existing borrowers by providing them with a breathing space. It does,
however, do nothing for new enterprises or enterprises that are not
currently borrowing.

(B) Aggregate lending targets for lending to the domestic
non-financial business sector are set by the government for each bank
(last year’s total plus five percent, say). The banks themselves can
decide who to lend to and on what terms. Any shortfall of actual
lending from the target is translated pound for pound into a Deficient
Lending Tax. Since not meeting the target amounts to throwing money
away, the banks will lend.

(C) Nationalise the banks (paying as little as possible to the
existing shareholders), fire the existing management and board of
directors, and have the government appoint a new executive and a new
board that are serious about meeting lending targets. With 100 percent
share ownership by the state, there is no risk of lawsuits about the
executive or board of the  bank not meeting their fiduciary duty to the
shareholders. Full state ownership would make transparent and formal
what is already true in substance: but for the financial support of the
government (past, current and promised/anticipated in the future),
there would no longer be more than at most a handful of viable
cross-border banks in the north-Atlantic region.

He concludes:

Things are critical. Unless the banks start lending in normal
volumes very soon, this recession could indeed become another Great
Depression. We cannot wait for the banks to find their juju. The
government may have to take it to them.

Full post here

If UK banks won’t lend, Northern Rock should

The reason why the government had to rescue Britain’s banks is not that their shareholders and executives deserve special favours, but because businesses and jobs depend on the availability of credit. There is no public interest in propping up banks that won’t lend.

For sure, banks should not be lending with reckless abandon as they did in the go-go years, but nor should they be slashing the overdrafts of solvent small businesses and jacking up the interest rates on them. If the banks refuse to lend, the government must step in. It is considering all sorts of interventions, but seems to be ignoring an obvious solution.

Political pressure on the banks has been largely ineffective so far. While Peter Mandelson, the business secretary, has said that “It’s completely unacceptable to the government and to business in this country for banks indefinitely to stop functioning as banks. We are in very intensive discussions with the banks, believe me”, jawboning alone is unlikely to succeed when banks’ priority is hoarding cash and reducing risk.

Alasdair Darling is also drafting a raft of measures to support business lending. These could include new requirements for banks to give businesses greater notice of changes in the terms and availability of credit. More ambitiously, the Chancellor is looking at ways to extend government guarantees to support new business lending.

But such is banks’ aversion to lend that the government also needs to consider bolder moves. It could insure all loans to businesses. It could lend directly to companies. And it could nationalise the banks altogether.

There is also another option that the government does not appear to be considering. It already owns a fully fledged bank: Northern Rock. Perversely, while it is urging the soon-to-be part-nationalised banks to lend more, it is busy shrinking the balance sheet of the only fully nationalised one.

That made some sense when the rest of the banking sector was private: the government did not wish a state-owned bank to undermine the private banks by competing unfairly them. But now that the whole banking sector enjoys an implicit government guarantee and the overriding priority is supporting lending to avert a depression, that objection no longer holds.

So if other banks will not lend, the government should inject a dollop of new capital into Northern Rock and direct it to make it more credit available on reasonable commercial terms. If other banks do not follow suit, Northern Rock may grow to become one of the biggest banks in Britain. But so what? It can be privatised again, no doubt at a hefty profit for taxpayers, when the crisis is over and the economy is growing again.

Addendum: Northern Rock is raising its mortgage rates today. Unbelievable.

John Kay sums up the financial crisis

Banks would normally be wary of lending to someone whose liabilities
were 50 times their net assets, but they happily lent to each other on
that basis – until, one day, they stopped. If you want a one sentence
explanation of the present crisis, that is it.

From the FT.

This is not money for nothing

Tony Blair once said that the government was best when it was boldest. Gordon Brown is – finally – heeding that advice. The government’s three-pronged plan
to shore up Britain’s banking system is bold and right. It is our best
hope of pacifying the financial panic, getting credit flowing through
the economy again and thus avoiding a 1930s-style depression.

The Bank of England’s half-point cut in interest rates is also welcome, particularly since it was coordinated
with other central banks. It signals that the US and Europe are finally
acting together to tackle the global financial crisis. But a larger cut
is needed soon: at 4.5%, UK interest rates are still far too high.

The
bigger challenge is to get banks lending again – to each other, to
companies and to individuals. They need enough cash to conduct their
day-to-day operations; secure access to medium-term funding; and extra
long-term capital to provide a cushion against bad debts and allow them
to lend to creditworthy borrowers.

The government’s plan
addresses all three of these needs. The Bank of England will supply
£200bn in short-term funding; the government will underwrite £250bn of
medium-term finance; and it will also inject £25bn in long-term capital
initially – and perhaps up to £50bn in total – in the form of
preference shares that pay a fixed return and protect taxpayers’
investment.

Headline writers may describe the government plan
as a £500bn bail-out, but that is completely misleading. The £200bn
consists of short-term secured loans; the £250bn is a form of
insurance, for which the government will be paid a fee; and the £50bn
is an investment that pays a return. This is not money for nothing.

And while it is certainly true that taxpayers’ money is at risk,
we will also share in the upside when the banks recover – as they are
much more likely to do thanks to the government’s intervention. Most
importantly, the risk of doing nothing – or of continuing to do too
little, too late – is far greater. If the banks went under, so would
businesses and jobs. By keeping the UK banking system afloat, the
government – acting on behalf of all of us – is giving the economy a
life raft.

Many of the details of the government’s plan are
still unclear. Ideally, the preference shares should pay a hefty
interest rate to properly compensate taxpayers and give banks an
incentive to seek private financing if and when they can. Taxpayers’
money should also come with strings attached, such as guarantees that
banks will use the extra capital to lend to small businesses and
individuals rather than pay extravagant dividends and unjustified
bonuses. And, of course, the plan must be implemented speedily and
efficiently.

We are by no means out of the woods yet. Global
financial markets are in turmoil; other governments need to follow
Britain’s bold lead soon. The UK economy has many other weaknesses:
consumers are overladen with debt, often secured against housing that
remains overpriced; unemployment is rising; food and energy prices
remain painfully high; and the global gloom is hardly auspicious for
exporters, despite the fillip of a weaker currency. What’s more, the
banking rescue package will swell the government’s already-large
deficit – although borrowing to invest in banks need not increase the
national debt in the long term. But while 2009 will no doubt be
unpleasant, the government’s actions should stave off economic
collapse. Amid all the gloom, that is certainly good news.

Taking stock

The time for half-measures is over. Britain is no longer in the grips of a credit crunch or even a financial crisis; it is suffering a full-on financial heart attack. Markets have seized up.
Banks will no longer lend to each other. Credit to companies and
individuals is drying up. Unless credit starts flowing again soon, a
nasty recession – conceivably even a depression – looms and with it,
massive job losses, bankruptcies, repossessions and a sharp fall in
living standards. The government needs to act – now.

But what to do? Ken Livingstone, Seumas Milne
and others argue that the government should turn its back on market
economics. Since capitalism seems to be collapsing under the weight of
its internal contradictions, the government should finish it off. More
measured voices such as the TUC’s Brendan Barbour
favour a ragbag of measures, such as a new industrial policy. But all
of them are missing the point. Righting the huge problems in financial
markets certainly requires decisive government intervention, but
lashing out at generally well-functioning product and labour markets is
perilously misplaced. The last thing a heart-attack victim needs is to
have a healthy leg amputated. The priority now is tackling the
financial crisis; everything else is a dangerous diversion.

But
while the government should not try to turn the clock back to the
1970s, it does need to change course. Its ad hoc approach will no
longer do. The nationalisations of Northern Rock and Bradford &
Bingley, and the government-orchestrated rescue of HBOS, were justified
at the time. But damage limitation is no longer enough – not least
since Lloyds’ rescue of HBOS seems to be dragging it down, too. Now
Royal Bank of Scotland seems under threat; Barclays may be next in
line. Waiting for the next bank to collapse and then picking up the pieces will not restore confidence or get credit flowing around the economy again.

Across Europe,
governments are rushing to following Ireland’s lead and guarantee
(nearly) all deposits in the banking system. Here, the Treasury has
just raised the guarantee on savers’ deposits to £50,000. But while it
may soon be forced to extend a broader guarantee, this will not tackle
the root causes of the crisis: a lack of capital in the financial
system and sheer panic.

A cut in interest rates would do some good.
Although inflation is well above the target rate of 2%, the Bank of
England should slash rates when it meets on Thursday. As the global
economy tanks, oil prices are sinking, so inflation is set to fall.
Collapsing demand means that the real threat now is deflation, not
inflation. But a big cut in interest rates will not be enough. If banks
are unwilling to lend, monetary policy alone is virtually useless – in
Keynes’ words, it is like "pushing on a string". Bolder measures are
needed.

The US has opted for a $700bn bailout. In theory, taking
bad debts off banks’ books should reassure markets that that they are
not about to go bust. Banks may be willing to lend to each other again,
their share prices may recover somewhat, and investors – not least
Asian governments and those of oil-rich states – may be willing to pump
some of their huge cash reserves into them. But the bailout route is
deeply flawed. It provides the most help to the banks that made the
biggest mistakes. It exposes taxpayers to huge potential losses. And it
does little to recapitalise the banking sector and thus encourage it to
start lending again.

There is a better way. As now seems likely to happen in some form, with the chancellor’s statement on Wednesday morning, the government should buy stakes in – and in some cases, take over – stricken banks, an approach that worked well in Sweden
in the early 1990s. With the government standing behind banks, the fear
that they are about to go bust would vanish. An injection of taxpayers’
money would strengthen banks’ balance sheets, allowing them to start
lending again. But it would not be money for nothing: the government
could acquire preference shares, which pay a hefty interest rate and
put taxpayers first in line to be repaid if a bank fails. These could
be combined with warrants (basically, options to buy shares at a future
date at a specified price), so as to give us all a share in the profits
when banks – and the economy – recover.

John Hussman, a US analyst and investor, has suggested
a novel variant of this idea. He proposes that the government provide
capital in the form of a "super-bond". This would be subordinate to
deposits, and so could be counted as capital. But if a bank went bust,
taxpayers would be repaid before shareholders and senior bondholders,
thus protecting the financial system, customers and taxpayers. The
super-bond could pay a relatively high interest rate to give banks an
incentive to shift to private financing when conditions improve, but
interest payments could be deferred until banks were profitable so as
not to drain their cash reserves now.

A government
recapitalisation of the banking sector – combined with much tougher
financial regulation to limit future excesses – would be good politics,
as well as sound economics. With Labour so far behind in the polls, its
only chance of recovery depends on rescuing the economy from the worst
crisis since the 1930s. Decisive action would marginalise the
Conservatives, who are unconvincing advocates for state intervention in
the financial system and are, in any case, powerless to act. And since
even David Cameron has been forced to concede that government injections of capital may be needed, the government has political cover to act.

Gordon Brown has shown that he can be bold when circumstances demand it. Now is such a time.

   
 
 

Shouldn’t HBOS now remain independent?

Allowing Lloyds TSB to take over HBOS was an act of desperation: even though the merged entity would dominate the UK banking market, the government signalled that it would approve the merger in order to stop HBOS going under.

But now that the government has stepped in with its bank recapitalisation and funding plan, wouldn’t it be better to let HBOS survive as an independent bank?

Britain’s bold bank rescue plan

Tony Blair once said that the government was best when it was boldest. Gordon Brown is – finally – heeding that advice. The government’s three-pronged plan to shore up Britain’s banking system is bold and right. It is our best hope of pacifying the financial panic, getting credit flowing through the economy again and thus avoiding a 1930s-style depression.

The Bank of England’s half-point cut in interest rates is also welcome, particularly since it was co-ordinated with other central banks. It signals that the US and Europe are finally acting together to tackle the global financial crisis. But a larger cut is needed soon: at 4.5%, UK interest rates are still far too high.

The bigger challenge is to get banks lending again – to each other, to companies and to individuals. They need enough cash to conduct their day-to-day operations; secure access to medium-term funding; and extra long-term capital to provide a cushion against bad debts and allow them to lend to creditworthy borrowers.

The government’s plan addresses all three of these needs. The Bank of England will supply £200 billion in short-term funding; the government will underwrite £250 billion of medium-term finance; and it will also inject £25 billion in long-term capital initially – and perhaps up to £50 billion in total – in the form of preference shares that pay a fixed return and protect taxpayers’ investment.

Headline writers may describe the government plan as a £500 billion bailout, but that is completely misleading. The £200 billion consists of short-term secured loans; the £250 billion is a form of insurance, for which the government will be paid a premium; and the £50 billion is an investment that pays a return. This is not money for nothing. And while it is certainly true that taxpayers’ money is at risk, we will also share in the upside when the banks recover – as they are much more likely to do thanks to the government’s intervention. Most importantly, the risk of doing nothing – or of continuing to do too little, too late – is far greater. By keeping the UK banking system afloat, we are giving the economy a life raft. 

Many of the details of the government’s plan are still unclear. Ideally, the preference shares should pay a hefty interest rate to properly compensate taxpayers and give banks an incentive to seek private financing if and when they can. Taxpayers’ money should also come with strings attached, such as guarantees that banks will use the extra capital to lend to small businesses and individuals rather than pay extravagant dividends and unjustified bonuses. And, of course, the plan must be implemented speedily and efficiently.

We are by no means out of the woods yet. Global financial markets are in turmoil; other governments need to follow Britain’s bold lead soon. The UK economy has many other weaknesses: consumers are overladen with debt, often secured against housing that remains overpriced; unemployment is rising; food and energy prices remain painfully high; and the global gloom is hardly auspicious for exporters, despite the fillip of a weaker currency. What’s more, the banking package will swell the government’s already-large deficit – although borrowing to invest in banks need not increase the national debt in the long term.

But while 2009 will no doubt be unpleasant, the government’s actions should stave off economic collapse. Amid all the gloom, that is certainly good news.

Better than a bank bailout

What bank investors need from authorities is clarity. A concerted,
pan-European drive to inject capital might provide it. As US fund
manager John Hussman has suggested, that injection could be achieved
via a “super-bond”, countable as capital and subordinate to customer
deposits, but ranking ahead of both shareholders and even senior
bondholders in the event of bankruptcy. That super-bond would pay a
high rate of interest, giving banks an incentive to switch to cheaper
funding. But interest payment could be deferred until the bank hit a
minimum level of profitability.

From Lex in today’s FT. Read the proposal in full here.