Risk aversion

Financial markets are having kittens at the possibility that the Ireland bailout package may require some of the country's creditors to take a "haircut" -- that is, to get back less than 100 cents on each dollar they have loaned. Here's Robert Peston's view, from the BBC website:

There is, as I've written here many times, a powerful moral case for imposing some of the costs of rescuing Ireland on those banks and financial institutions which fuelled Irish banks' reckless lending binge by lending to them.

It's not just a moral case. The case for bankers to take a haircut is firmly founded in the very financial theories that market participants always like to use to baffle outsiders.

Financiers pride themselves on their supposed ability to price risk, and Ireland (or Greece or Spain, or for that matter France) has always been a riskier credit than Germany, which is the benchmark for the Eurozone. Because of that, Irish (or Greek or Spanish...) bonds have always offered a higher yield than their German equivalents. The difference in yields is known as the "credit spread" and it's intended primarily to compensate investors for the fact that in buying Irish bonds, they're taking on a greater risk of default than they would if they bought Bunds. (I say "primarily" because the spread may also in part reflect a lower degree of liquidity in the market for Irish debt as compared to Bunds). Even the rating agencies, about whom I will not normally allow any positive comments on these pages, have figured this out, and rate Irish and other bonds below those of Germany.

So the very simple question is this: if investors have willingly accepted a higher yield on Irish bonds as the price of taking on the greater credit risk, what right do they have to refuse to take a "haircut" now that Ireland is in trouble? The wailing and veiled threats from banks look like an attempt to change the rules while the game is underway; or, to be less delicate about it, they look like blackmail.

This is not to suggest that imposing these costs on the banks now would be easy or pain-free. The banks themselves still have a way to go to restore their balance sheets, and another hit to their capital bases now would not be helpful. At the same time, if there can be no losses on higher risk assets, then the whole credit and risk system has arguably broken free of its moorings, whether moral (Peston) or logical (me). For the long-term health of the system, the IMF, EU and their bailout partners need to ensure that banks and investors no longer asume they can always lay off their bad decisions on the taxpayer.

Ah, bless!

I love this, from a report (from The Times website) on Wednesday's round of student protests:

Sarah Tomlinson, who was waiting behind the police line for her daughter Katie, 16, to be released, said that she was angry that her child had been kept in freezing temperatures without food or water for more than seven hours. She added that she had been chased down the street by police.

Margo Turner, whose 17-year-old son Sam was also trapped, said: “I think it’s appalling. I was really scared when the police horses charged. It’s their democratic right to protest. They are going to university in 2012 and they won’t be able to afford it.”

Quite right too. What kind of country do we live in when mummies take their kids to a demonstration, and the police can't even provide a risk-free riot scene?

Biffonomics

Judging from some of the media comments on the Irish debt crisis, the Taoiseach is not the only Big Ignorant Fecker involved in this shambles.

The UK's anti-Europeans are, of course, out in force. The crux of their argument is that if Ireland had not joined the euro, it wouldn't have got into this mess in the first place, and if it had still managed to get into a mess, it would be able to restore its fortunes simply by devaluing, an option that membership of the euro precludes.

Chris Dillow has very effectively refuted the first of these. He cites the Greenspan/Bernanke Fed as evidence that the ability to make policy independently is no guarantee of avoiding asset bubbles.

What about the devaluation argument? At the simplest level this can be exposed through a reductio ad absurdam: since the eurozone countries are each other's main trading partners, it would be logically impossible for them all to devalue against each other. More practically, how likely is it that the stronger members of the eurozone, notably Germany, would allow Ireland to continue to enjoy the other benefits of the eurozone if it resorted to a blatant beggar-my-neighbour devaluation? (One commentator today has even suggested that Ireland, perhaps along with the other PIGS, might leave the euro, devalue and then rejoin, which would surely never be acceptable to Berlin or Paris).

More broadly, the whole devaluation argument founders on the fact that it is all but impossible to identify any country that has ever devalued its way to wealth. And no, China doesn't count: refusing to allow your currency to appreciate is not the same as devaluing it, though the Chinese are starting to see at least one of the normal consequences of devaluation: rising inflationary pressures. (As an aside, it would be interesting to see if those calling for Ireland to devalue are the same people who have been castigating China for its cheap currency policy. But I digress).

Devaluation is a sign of policy failure. Leaving aside fuddy-duddy technical stuff like the elasticity of import and export demand, it only works if it's used to provide a breathing space for policy adjustments: restraint of domestic demand, fiscal correction and so on -- exactly the kind of changes, in fact, that the Irish government is looking to implement now in return for the bailout funds. The notion that the bailout is an unnecessarily painful choice, and that things would be just fine if Ireland could just devalue its currency and go its own way, is simply nonsense.

Ireland's problems stem from a toxic combination of unprecedentedly low interest rates (which, given the antics of the Greenspan Fed, might well have been the case even if the euro had never been invented), unsustainable fiscal policy (the fate of the 12.5% corporate tax rate remains uncertain at the time of writing), aggressive banks and weak regulation. Even at the time, the government's decision at the height of the financial crisis to guarantee all deposits in Irish bank looked like a huge misjudgment. As we are now seeing, Ireland could never have made good on the guarantee, and its sole effect was to excuse the banks from taking a hard look at the value of the assets on their balance sheets. Those problems were only deferred, not solved. Even with the bailout, it remains to be seen whether they can be solved without Ireland's creditors taking a nasty haircut.

The race to the bottom

Negotiations over the inevitable bailout of Ireland have apparently been held up because Brian "Biffo"* Cowen's government is insisting that it wants to retain its rock-bottom 12.5% corporate tax rate. Well, you can't really blame them, can you? I mean, it's obviously worked brilliantly so far, hasn't it?

These days, footloose corporations are entirely shameless about blackmailing and threatening countries that won't do exactly what they want. Already a gang of US multinationals is warning Ireland that they will reconsider their position in Ireland if the government has the temerity to hike the corporate tax rate. Nothing like fair-weather friends, is there?

The aggressiveness of the multinationals and the spinelessness of national governments has created a sort of fiscal race to the bottom. Ireland appears to have won the race, and it's not a pretty sight. But it's probably too much to hope that bigger and less indebted countries might take the hint and start standing up to the bullies.

* BIFFO = BIg Ignorant er, Fellow From Offaly. Best political nickname ever??

Problem is, he's not entirely wrong

Back from a few delightful days in la France profonde, and time to catch up with the UK news. A royal wedding on the horizon -- oh joy! Another lamentable England showing at football -- yawn. And so on.

The story that's most caught my eye, however, is the resignation of Lord Young, an unpaid advisor to the coalition government, after comments he made on the impact of the recession led to a political uproar. This account is from The Guardian:

Lord Young.....told the Daily Telegraph that low interest rates meant home-owners were actually better off. "For the vast majority of people in the country today they have never had it so good ever since this recession – this so-called recession - started."

He dismissed the 100,000 job cuts expected each year in the public sector as being "within the margin of error" in the context of a 30 million-strong workforce, and said complaints about spending cuts came from "people who think they have a right for the state to support them".

The former trade and industry secretary also said people would look back on the recession and "wonder what all the fuss was about".

A lot of this is nasty, old-fashioned Toryism, which is not surprising when you consider that Lord Young was a favourite of Margaret Thatcher (and is a close friend of David Mellor). But is he altogether wrong about the way "the vast majority" has experienced the recession? It's true that the upscale papers are again full of vaguely distastetful hints on how the comfortably off can tighten their belts (Smaller cupcakes? A week instead of 10 days at Verbier this winter?) Yet his lordship is surely right to suggest that the collapse in tracker mortgage rates has been an unmitigated boon for indebted home- (and second home-) owners, many of whom are dyed-in-the-wool Tory voters.

That's why it's the not the lazy Tory cant that Lord Young spouted that's the real embarrassment for the government. It's the parts that are true. Despite what David Cameron professes to believe, we're not "all in this together". If you're a welfare recipient or receive social housing assistance you're certainly going to be "in it", right up to your neck. If you're waiting on important but non-critical surgery, you may be out of luck. If you're a low-paid public servant, you could well be lining up at the Job Centre before too long. But if you borrowed up to the hilt during the recession and you've held on to your job -- and that describes millions of people in the UK, even if it's not the "vast majority" that Lord Young claims -- the worst thing you have to worry about is VAT going up in January, and maybe the loss of the child tax credits that you were just paying into a college fund anyway.

Ed Miliband has condemned Young's comments in a predictably lame way:

"....I think his remarks are frankly disgraceful and many of the people who are struggling up and down this country with the consequences of the recession that we had, the consequences of the spending cuts that we are seeing, will be insulted by his comments."

If young Ed had his wits about him, he'd have demanded that his lordship be kept around to continue providing his inadvertent insights into what the government is really up to.

When the levy breaks *

This can't possibly be true, can it? I mean, so far I've only seen it on the Guardian website. It appears that the Treasury is worried that the Government's much-vaunted levy on bank balance sheets may raise more money than expected....so they may reduce the size of the levy.

It would be hard to overstate what a dumb move this would be from a PR standpoint -- and if you don't believe me, just scroll through the article to read the comments from Guardian readers.

The levy's not much more than a gesture anyway: nobody could seriously argue that an annual charge of 0.04% of a bank's balance sheet comes anywhere close to the value that the banks derive from the implicit backstop provided by the government. But when the Government is banging on about "fairness" and how we're "all in this together", it's an important gesture. Reducing it in response to the supposed threat that banks might relocate to more friendly jurisdictions would only feed suspicions, and not just among Guardianistas, that the spending cuts aren't really about cutting the deficit at all: they're about a Thatcher-style shrinking of the state.

Already this week Nick Clegg (or "Clegglet" as I heard him described on Radio 5 this morning) has had to eat his words on student fees. Can't wait to hear what that old bank basher Vince Cable has to say about the levy.

* Yeah, I know it should be "levee".

He depicts a riot

The Metropolitan Police are taking flak for underestimating the risk that this week's student protests in London might turn violent, as of course they did. The media, however, took no such chances, turning up mob-handed to provide lurid coverage of the mayhem. I was going to write a piece suggesting that the media overkill may have had something to do with the outbreak of violence, but I could never have done so as brilliantly as Peter Brookes in The Times.

Meanwhile, an academic -- well, a lecturer in cultural and communications studies, whatever that is, at Goldsmiths College, whatever that is -- anyway, an "academic" has published an open letter commending the violence. Here's part of his argument:

“The real violence in this situation relates not to a smashed window but to the destructive impact of the cuts and privatisation that will follow if tuition fees are increased and massive reductions in higher education funding are implemented.”

Dear God! As a veteran of student unrest in the 1960s, I well remember exactly the same logic being deployed to justify mayhem and destruction. Some mediaeval gate or other would get damaged by a mob, and someone would pop up to say that the real violence was had been perpetrated by the long-dead soul who put the gate up in the first place.

By coincidence, this very week I read a newly-written piece on the infamous Garden House riot of 1970 in Cambridge. Only one senior member of the university was charged with any crime in connection with those events, and he was later released without coming to trial. I'll spare him the embarrassment of publishing his name here, because he now denies any malicious intent in the whole affair, in terms that are little short of craven. That's not altogether how I recall his role at the time, but then again, it's a long time ago. Still, the perpetrators of this week's violence, or those planning any such events for the future, might want to keep in mind that the "academics" who are egging them on are unlikely to be the people who wind up in front of the judge.

Honour among chefs

The media are having fine sport with chef Gordon Ramsay this week. Both his culinary empire and his private life have been under the microscope for a couple of years, as a result of the financial crisis and rumours that Ramsay had been involved in a lengthy affair.

Not long ago, Ramsay "parted company" with his long-time business manager, who also happened to be his father-in-law. Unsurprisingly, this did little for relations within the family, which would have been nobody's concern but for the fact that this week Ramsay took the thoroughly bizarre step of hauling the dirty linen out into the open, by sending an open letter to the London Evening Standard. (The Standard, Gordon??? Things really are slipping). The letter, ostensibly addressed to his mother-in-law, was a heartfelt (if not entirely literate) plea for her not to let the whole nasty business estrange her from her daughter, Gordon's wife Tana.

Over the past year, Ramsay's company Gordon Ramsay Holdings (GRH) has had to close some of its restaurants outside the UK. The group has parted company with a number of distinguished chefs who have gone out on their own, amid rumours of fallings-out with Ramsay. Ramsay's latest TV series has achieved abysmal ratings. The media are now gleefully speculating that the whole Ramsay empire may be about to crash and burn.

Maybe so, but here's something to keep in mind. A good number of famous chefs have run into trouble in the last couple of years as customers have thought twice about paying £30 for a plate of seaweed foam. More than one has declared bankruptcy, leaving large and small creditors and suppliers high and dry -- then immediately re-opened for business, scarcely missing a single service, and attracting almost no criticism from the media. When GRH ran into financial trouble, it was rescued by an injection of personal funds from Ramsay himself, and, ironically, from his now estranged father-in-law. Honourable, that, and reason enough to hope that Ramsay will be able to hold on to what remains of his little empire -- and his family.

The rocky road to Seoul

As the G20 summit meeting in Seoul looms, things are looking a bit fraught, even though the recovery from the financial crisis is largely intact. The emerging economies are expanding strongly, Germany is pulling the Eurozone along and the UK is doing much better than expected. Even the US has seen its latest growth data (for Q3) revised upward, and employment rose in October, with the private sector leading the way. No, the reasons to be fearful are provided by the policymakers, who are starting to say, and in some cases to do, dangerous things. In a sense, the timing of the G20 couldn't be worse, because it will give the governments and central banks the opportunity to turn a non-crisis into a catastrophe.

Much (but by no means all) of the pre-summit contumely is directed at the US Federal Reserve's decision last week to proceed with a second round of quantitative easing. You only have to watch CNBC for five minutes, especially if Rick Santelli is on, to realise that the Fed's move is not widely supported even within the US business community. Outside the US, the reaction has been downright vitriolic, led by Brazil (on behalf of the emerging markets) and Germany, which still knows a bit about currency debasement and inflation. When the head of the Bundesbank describes the latest policy moves as "clueless", even a US central banker might be brought up short, though there is no reason to suppose that Bernanke will do anything other than robustly defend his decision as he tucks into the kimchi this weekend.

The unrelenting surge in the price of gold (another all-time high today), palladium and platinum (multi-year highs) and just about every other commodity you can name shows that investors have figured out the Fed's game as clearly as has the Bundesbank. Having sustained its standard of living (and fought a couple of wars) on borrowed money through the past decade and more, the US is now brazenly seeking to inflate away the debt burden. It's hardly surprising that the creditors (i.e. just about everyone else in the world) might be getting a little snippy.

It's one thing getting angry and lecturing the US, of course: not much harm can come of that. The problems will arise if other countries start to retaliate. There are a few worrying signs out there of countries starting to fight their own corner rather than look for co-operative solutions. Brazil is taking the capital controls route, and last week, in a blast from the very distant past, Canada's government blocked a takeover bid (by BHP Billiton for Potash Corp of Saskatchewan) on the grounds that domestic natural resources should remain in Canadian hands. If the free movement of capital and goods falls victim to the caprices of national governments, the prognosis for the next few years will get a whole lot gloomier.

And in a reminder that the last big mess still isn't close to being cleaned up, Ireland is teetering on the brink again, on fears that the Cowen government's austerity budgets will be defeated in the Dail. Ireland's CDS spreads blew out to new highs on Monday, signalling rising fears of default.

As they head for Seoul, not the world's most relaxing town, policymakers need to take a deep breath and remember the Hippocratic oath: "first, do no harm".

She must be joking; except she isn't

Former Immigration Minister Phil Woolas has been expelled from the House of Commons for dirty tricks during this year's general election campaign. Woolas went to great lengths to smear his LibDem opponent as a friend of violent Islamists. None if it was true, but it helped Woolas eke out a narrow victory, which the aggrieved LibDem promptly and successfully challenged in court.

It's clear that Woolas's people recognised the desperate situation their man was in: the smear strategy was known among his campaign team as "sh*t or bust".

That's not the laughable part though. This is.

The Labour Party has disowned Woolas. According to The Daily Telegraph, Harriet Harman, the party’s deputy leader, said his legal challenge would not be supported and added: “It is no part of Labour’s politics to try to win elections by telling lies.”

That statement deserves the same description as poor old Phil's campaign strategy. Except without the "or bust" part.

Put that thing away, Ben!

Before he became Fed Chairman, Ben Bernanke was recognised as an academic expert on the Great Depression. He famously noted that the modern-day Fed would always be able to prevent such a thing from ever happening again, because it could, if need be, drop money from a helicopter to stimulate demand. He thus acquired the sobriquet "Helicopter Ben", though in the rarefied world of the dealing rooms, it was common to hear a more technical expression: "Bernanke's chopper".

Ben may have been as surprised as anyone when the 2007-08 financial crisis gave him the opportunity to put these theoretical musings to the test, in the form of the $2 trillion quantitative easing (QE) programme. This week the Fed announced it would try to give the sluggish US economy a further boost through a second round of asset purchases, referred to as QE2, though this time the scale will be a lot smaller: about $600 billion between now and mid-2011, or about $75 billion a month.

The Fed's decision had been widely anticipated and had polarised opinion, among politicians and pundits as well as economists, even before it was announced. Bernanke took the unusual step of securing the front page of The Washington Post for an article explaining his rationale.

This may not have been the best idea, though Bernanke is certainly on solid ground when he describes the uninspiring state of the US economy:

"....we could hardly be satisfied. The Federal Reserve's objectives - its dual mandate, set by Congress - are to promote a high level of employment and low, stable inflation. Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 percent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer. The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills".

However, he is far from convincing when he tries to make the case that more QE is the answer; and this claim, made just a day after the Fed made its announcement, is surely a huge mistake:

"This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action".

Yeah, well, that's what used to happen with the old "Greenspan put", Ben, and look how well that turned out. Also according to Ben,

"Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion".

Can anyone any longer seriously believe that the reason the US economy isn't growing is that there isn't enough money swilling around? There was no shortage of money in 2007, but that didn't prevent the financial crisis. Thanks to the first round of QE, there's a whole lot more money now, but it doesn't seem to be producing much traction, mainly because banks are still much too uncertain about asset values to step up lending to any meaningful degree. (The same, by the way, can be said of the UK, the other major economy to resort to QE since the financial crisis).

It's becoming clearer by the day that the main reason the first round of QE "worked" (the US economy has been growing again for more than a year) was not so much that it led to healthier financial markets as that it boosted confidence. In 2008 markets were pleading for something to be done, and QE was the right move; but with so many experts and market participants sceptical about what can be achieved this time, it's unlikely that QE2 will generate a lasting surge in confidence.

In the meantime, observers outside the US are becoming increasingly critical. In Toronto, the Globe and Mail bluntly observed last week that QE is "just another name for devaluation". Central banks in emerging economies are warning that the first round of QE has already produced a bubble in their markets (care to explain how that helped the US economy, Ben?) and are angry that the Fed is pressing ahead with more of the same.

Today Bank of England Governor Mervyn King announced that he will be keeping his own chopper sheathed for the time being. It may not be long before we are all wishing that Ben Bernanke had kept his under wraps too.

The float and the bubble

Way back when, US companies had a neat trick to boost profits, known as "playing the float". Here's an example. If you were a Maine resident waiting for a settlement from your insurance company, you would receive a cheque drawn on a bank account in Hawaii or the Pacific Northwest. Even after you'd presented the cheque to your local bank, you wouldn't actually see the money in your account until the cheque had wended its way all the way back across the continent (by train) to be cleared. If you lived in LA, your cheque would be drawn on somewhere like Manchester, New Hampshire.

The jet age, and now the internet age, have put the crimp on such shenanigans, though I believe that relatively remote spots like the Dakotas still see a disproportionate amount of clearing activity. After all, even an extra day's use of the funds is worth something to a large company.

I can report that the game of "playing the float" is also alive and well in the UK. I'm one of several hundred thousand domestic gas customers entitled to a refund from our former gas supplier -- no names, but its initials are npower. (For those lucky enough to be unfamiliar with the story, npower overcharged its customers for gas back in 2007 and was careless enough to get caught out). About a month ago, I got a letter from the company advising me that my refund would be £28 or so. I had to return the letter with certain added details so that they could verify that I really was entitled to the refund, which is fair enough.

So then they credit my account, the same one they enthusiastically debited each month back in 2007, with the refund, right? Wrong! OK, so they send me a cheque, then? Wrong! This week I received a letter with a couple of barcodes on it. I had to present this to my local Post Office, together with two pieces of ID, in order to receive the refund in cash.

So this morning that's what I did, spending a pleasant 25 minutes lining up behind people sending Christmas parcels and such before getting up to the counter. There the hapless clerk had to type the 18 digits of my driving licence number into her terminal, verify my other piece of ID, scan the barcodes, stamp the letter from npower and count me out my cash.

The clerk said she thought the reason npower was using this astoundingly primitive method of providing the refunds was that some of the older customers might not have bank accounts. That might be true, but I'd bet that even more of them live in places where the local Post Office has closed. And in any case, non-possession of a bank account never seemed to stop npower from getting its scruffy mitts on the money in the first place.

It's all blatantly a float play. How many people will walk into a Post Office clutching their npower letter, see the pre-Christmas queues and walk right back out, then forget to try again until its too late? (You have six months, according to the letter). How many will be unable to get to a Post Office at all because their local branch has closed? It all serves as a reminder of why I switched from npower in the first place.

Not that I'm spoiled for decent choices in the UK's "competitive" domestic gas market. One of the suppliers has just announced a 9.4% increase in its gas prices, and the rest are certain to follow very soon. This comes against the background of a global gas supply "bubble", which is expected to last anything from three years (according to Qatar, the world's largest LNG exporter) to a decade (according to respected independent analysts). In the very short term the UK is awash with gas because LNG cargoes destined for France were diverted here because of the recent strikes.

The company raising its prices, Scottish and Southern, claims to have lost £58 million supplying domestic customers in the past year, yet mysteriously it managed to eke out a profit of £1.25 billion in its overall business, virtually all of which is gas-related. I smell another refund in the offing -- maybe I should get in the queue at the Post Office right away.