Is a puzzlement

Blazoned across the screen on CNBC this morning, as a US Congressman was interviewed:

"Why government is broken?"

Something literacy to do with, maybe?

Let's twist again

What does the Fed hope to achieve with its latest piece of monetary policy wizardry, the so-called "Operation Twist"? Over the next nine months, the Fed will be selling some of its holdings of short-term government debt while buying more long dated securities -- up to $400 billion's worth. The goal is to flatten or "twist" the yield curve. Not attempted since 1961, the scheme is basically a prolonged version of the Fed's regular liquidity management operations, the familiar but oddly-named "coupon pass".

The Fed's hope is that lower long-term rates will persuade businesses to invest more, pulling the US economy out of its deepening funk. The problem with this is that the US corporate sector as a whole is already awash with cash. Companies are not failing to invest because they can't find funding; they're failing to invest because of a profound lack of confidence in the future. If the plunge in global stock markets since the Fed's announcement is any guide, Operation Twist has already made that problem worse. The last thing markets needed right now was a clear signal from the Fed that it's in panic mode, but that's exactly what they've been given.

Moreover, Operation Twist is likely to make life more difficult, or at any rate less profitable, for both banks and insurance companies. A flatter yield curve will meean that banks make less money out of their customary maturity mismatching activity -- basically, converting short-term deposits into longer-term loans. It's hard to see how this will encourage them to lend. Insurers, in turn, will find it harder to maintain competitive annuity rates as long-term bond yields are forced lower. This will either take a toll on insurers' profits or -- more probably -- on the incomes of Amwerica's retirees.

By coincidence, the Fed action comes in the same week that the IMF has released its latest Global Financial Stability Report, a document of wrist-slitting gloom. One of the Fund's key concerns, evidently not shared by Ben Bernanke and co., is that loose monetary policy creates its own unique set of risks. As reported by Reuters, the IMF warns that low rates mean that "investors are struggling to meet their return hurdles. This revives the need for excessive leverage in the quest for yield".

Sound familiar? It should, because this was a big part of how the global economy and financial system got into crisis back in 2007/08. Mispricing of risk as a result of decade-long ease in monetary policy and the infamous "Greenspan put" led directly to large scale, highly leveraged risk taking, focused on the US housing sector.

We all know how that worked out, but it's hard to escape the conclusion that the Fed's latest proposed cure is more of the same. Maybe the appropriate musical reference here isn't Chubby Checker, but the much less renowned Canadian rocker Ian Thomas, whose biggest hit was "You gotta know this isn't working".

Thoughts from the road

Just a couple of random things from Toronto....

* The Basildon travellers' temporary "stay of execution" is a big story in the Toronto Globe and Mail this morning. (Incidentally the print edition of the Globe, which I haven't seen in a few years, appears to be the first paper in the world composited entirely on Powerpoint). I've written about the travellers here before, and a couple of things still puzzle me. First, how did a piece of land, formerly a scrap metal yard and adjacent to an existing, legal travellers' homesite, ever get to be classified as "green belt"? Just asking. And second, if these folk are "travellers", how come they're so adamant about staying put?

* A large ad in the paper here today with the City of Barrie offering a "prestigious" piece of land for development. The city's slogan appears to be "Barrie: Ontario's top investment ready city". Barrie has grown astonishingly fast in the last twenty years or so, but somehow I don't think the slogan had much to do with that.

* Toronto mayor and Jabba the Hut lookalike (only less comely), Rob Ford, is backing away from some of his planned spending cuts in response to mounting public anger, fronted by celebs such as Margaret Atwood. (Well, she's famous here, at any rate). Ford was on TV last night announcing some changes of heart, including one especially close to Ms Atwood's heart. Said Hizzoner: "We won't be closing any lie-berries". Just as well, by the sounds of it.

Fear and loathing on Broadgate Circle

In his menacingly humorous manner, Mark Steel told readers of The Independent this week that punishment for bankers should be proportional to that meted out to rioters and looters:

"....we could apply the same sentence to bankers as to looters for each pound's worth stolen. So as one looter was given four months for stealing two bottles of water, the average banker would be jailed for around eight billion years, though obviously they could be out in four billion for good behaviour".

If Mark Steel makes it onto the bench, then Kweku Adoboli, the latest "rogue trader" to surface at UBS in London, had better watch out. Adoboli appears to have incurred losses of about $2 billion for his bank, and his transgressions only became known when he 'fessed up to his "supervisors": as usual in such cases, the bank's own systems had failed to alert management to what was going on.

Last evening on BBC News 24, Fred Studemann of the Financial Times was on air for the usual preview of the morning newspapers, and the UBS story was front and centre. The newsreader, Chris Eakin, asked Studemann to explain in more detail what had happened. Studemann said it was all to do with ETFs (exchange traded funds), but basically told Eakin, who is nobody's fool, that it was all much too complicated for a mere newsreader to understand.

Allow me to help out, Chris. ETFs are a useless innovation, based on repackaging outstanding securities; they only exist because they allow investment banks to make big fees from putting the deals together. Regulators, as Studemann correctly pointed out, have been worried about them for some time, because a lot of the misguided genius that went into creating CDOs and the like at the height of the housing boom has been redirected into creating ever more complex ETFs.

This latest debacle has come along almost on the exact anniversary of the collapse of Lehman Brothers in 2008, and just a few days after the UK government announced it would proceed with "ring-fencing" the retail operations of domestic banks to shield them from this sort of depradation in their investment banking divisions. Intriguingly, Robert Peston has a story on his blog that suggests that the Swiss government may impose a similar split on UBS, or may even insist on the bank being completely broken up.

So for every cloud, a silver lining. The folks over at the British Bankers Association are probably contemplating slitting their wrists about now, while the likes of Vince Cable and Sir John Vickers, as key advocates of the retail/investment split, are no doubt enjoying the warm glow of smugness, with just a hint of Schadenfreude. Back at the BBC, Fred Studemann rather wearily suggested last night that banks "can never be protected" against rogue trading events of this sort. Perhaps they can't; but taxpayers can. Unfortunately, on the government's current slack-ass timetable, it's going to take eight years to put that protection in place.

* * * *

Posting will be less frequent than usual for the next couple of weeks, as I will be travelling.

Looking for a rainbow

For the second time in four years, those spoilsports at UNICEF have published a report suggesting that children in the UK are among the unhappiest in the developed world. (BBC story on the report can be found here). According to UNICEF, British parents are so busy trying to make money that they have no time to spend with their kids. To make up for that, they ply them with toys and gadgets to keep them quiet. The report makes unflattering comparisons between the way children are raised in the UK and the way things are done in Sweden and Spain.

Rather surprisingly, The Times (behind the paywall) takes editorial exception to this. It chides UNICEF on the illogical grounds that at least children are not being sent down the mines any more, which is nothing whatever to so with the point that UNICEF is trying to make. The agency's criticisms are notionally about children -- that is, after all, its remit -- but are really an indictment of the way that British society, and British capitalism, have evolved over the span of about a generation or so.

Think about it this way. According to UNICEF, large numbers of parents in the UK are much more interested in their careers than in their children. While they're out pursuing wealth and promotion, the kids are acquiring their moral codes from one another, or worse, from those nice folks you meet in "Grand Theft Auto". It makes the summer's rioting and looting just a bit easier to understand.

How did the UK get this way, and in particular, how did it get out of step with other wealthy countries? Who better to help us figure this out than the lugubrious Middlesbrough bluesman, Chris Rea? In 1989 Chris released an album called "The Road to Hell". (He promoted the album, with minimal success, all across the United States. When he appeared on the David Letterman late night show, Letterman memorably held up the album cover and said with a grimace, "I think this is his Christmas album".)

Anyway, the album is an odd mixture of paeans to America (songs like "Texas" and "Daytona") and thoroughly mournful ditties about the state of the UK after a decade of Thatcherism. In the title song, for example, Chris is driving in search of work when he has a vision of his late mother:

"I said Mama, I've come to the valley of the rich, myself to sell".
She said "Son, this is the road to hell".

And in "Looking for a rainbow", another song about people having to uproot themselves and go in search of wealth, he sings:

"Yeah we're Maggie's little children, and we're looking for Maggie's farm".

Maggie left the political scene many years ago, but the atavistic impulses she unleashed -- greed, selfishness -- haunt us still. If you don't want to take UNICEF's word for it, or Chris Rea's, or mine, there's always St Paul's First Letter to Timothy: "Radix malorum est cupiditas" -- "the love of money is the root of all evil". Or you could just ask a kid near you.

The Vickers report: just do it!

The final report of the UK's Independent Commission on Banking, the Vickers Commission, has been published today. It contains no major changes from the interim report that appeared earlier this year. The banks will be required to separate ("ring fence" is the favoured term) their retail operations from their investment banks, and to provide extra capital for them. The goal is to ensure that in any future financial crisis, the retail arms can be saved without imposing massive costs on taxpayers, while the investment banks have to fend for themselves. George Osborne has already pledged that the government will move to enact the proposals in full.

I've written several times on this blog in support of this kind of separation, so rather than rehashing all the arguments again now, I'll stick to just a few observations.

One minor surprise is that Vickers suggests that the reforms not be fully implemented until 2019, four years later than most experts had predicted. This has already led to suggestions that the government (or at least the Tories) still want to go easy on the banks. However, there is at least some logic for the later date: 2019 is also the proposed start date for the Basel III capital requirements, which will apply to banks worldwide. It's certainly arguable that the lead-in time for Basel III could and should have been much shorter, but on the basis that the date is set in stone, it makes sense for the UK changes to coincide with it.

Vickers estimates that the cost of his proposals to the banks -- which basically reflects the removal of the current implicit government guarantee against failure -- will be £4-7 billion per year, compared to earlier estimates of £10 billion. A surprising number of media commentators seem reluctant to impose these costs on the banks, even though they are a fraction of the costs that taxpayers were forced to bear not so long ago. In typically forthright fashion, Chris Dillow points out that the higher costs for the banks are "not a bug, but a feature" of the Vickers report -- see his blog on the subject here.

The Lex column in the FT opines that the banks will find it hard to oppose the Vickers proposals, but that probably won't stop them trying. One likely line of criticism is that the UK should not be "going it alone" in this way. This simply won't wash. Bank assets are so much larger in relation to GDP in the UK than in any other country, thanks to London's prized role as a financial centre, that regulators really have no choice but to adopt a belt-and-braces approach. And in any case, how long will the UK be alone in taking this approach? Any day now, France and Germany may have to recapitalise their banks to deal with the effects of a Greek debt default. It's surely inevitable that the trade-off for that taxpayer support will be tighter regulation in those countries too.

Are YOU smarter than a Tudor monarch?

Centuries before anyone had heard of John Maynard Keynes, kings and nobles understood some of the ideas that are now associated with him. If you wanted to expand the fleet or build a new castle, the best time to do it was when times were tough. The work kept the masses quiet, and you got things done more cheaply.

So it's no surprise that current pleas for additional economic stimulus include calls for governments to borrow cheap money and invest in infrastructure improvements. Even in the UK, where the government is sticking to its austerity rhetoric, key infrastructure programmes (the Crossrail link in London; expansion of broadband to remote areas) are still going ahead.

The $447 billion new jobs plan unveiled in the US last evening by President Obama also includes a big slug of infrastructure spending, with the focus on schools and roads. However, in keeping with the spirit of the times, or at least of the Republican party, the President has also included a large tax cut, in the shape of an extension of the payroll tax cut that is otherwise due to expire at the end of this year.

Even so, it's not clear that the plan can be rammed through Congress quickly, as the President hopes. Some on the Republican side are already portraying it as just another dose of the same old stimulus that, in their perception, has already failed. Notably, they can't even bring themselves to endorse the payroll tax measure, which seems to suggest that they don't oppose higher taxes in principle; they just oppose them when they apply to the rich.

There are also likely to be problems funding the measures, since Obama has pledged to do this without raising the deficit. The recent deal on raising the debt ceiling required a joint effort to find $1.5 trillion in savings by the end of this year. That was always going to be difficult, and now the target has been raised by almost a third. This approach, referred to as "finding offsets", also raises the question of just how stimulative the President's programme can be if it involves no net new spending.

Still, we can at least be grateful that Obama did not follow the unsolicited advice offered by the one and only Anatole Kaletsky earlier this week. (Behind the Times paywall; lucky you.) One of Anatole's suggestions was that the US should rebuild its infrastructure without boosting the deficit, by resorting to...public-private partnerships, UK-style. This suggests that Anatole is the only man left in the UK who doesn't recognise that PPPs and PFIs (private finance initiatives) have been one of the greatest ripoffs ever inflicted on the UK taxpayer.*

That's not Anatole's best wheeze though. He thinks the US should put money back into the hands of consumers by ordering Fannie Mae and Freddie Mac to convert existing fixed rate mortgages, on which homebuyers pay interest of up to 7%, into floating rate mortgages at 2-3% rates. Leaving aside the risks that would pose when interest rates eventually started to rise, there's a more immediate issue that Kaletsky seems quite unaware of. Fannie and Freddie would immediately face catastrophic losses, since they have borrowed long-term funds at rates much higher than 2-3% in order to finance the fixed rate mortgages.** In the case of Fannie, for example, about 80% of its liabilities are long term (average maturity: 50 months), and almost all of that is at fixed rates. Not one of Kaletsky's better ideas, and no surprise that nothing on these lines found its way into the Obama package.

* Small example for the benefit of non-UK readers: a consortium of engineering companies formed a joint venture to refurbish part of the London underground. It was given a 30-year contract, but contrived to run out of money and go broke within two years. The engineering companies simply walked away, and the whole shebang landed back in the lap of the public sector.

** Perhaps what Kaletsky has in mind is that Fannie and Freddie should use the swaps market to turn all their fixed rate debt into floating rate. That's almost certainly a non-starter, for several reasons. The sheer size of Fannie and Freddie's fixed rate debts would put severe strain on the swaps market; counterparties would be reluctant to take on such huge amounts of Fannie and Freddie risk, given the two lenders' patchy track record -- which has just prompted the eagle-eyed geniuses at S&P to downgrade them both; and counterparties might unwilling to take on such a large slug of fixed rate commitments at a time when, as Anatole has observed, floating rate money is so much cheaper. Remember, you can't add value through a swap; you can only redistribute it. Putting all of Fannie and Freddie's fixed rate liabilities onto the balance sheets of commercial lenders and insurers would have major consequences for the cost of financing outside the housing sector.

The economics of envy

A group of twenty economists have written to the Financial Times to urge Chancellor George Osborne to repeal the top 50% rate of income tax as soon as possible, on the grounds that it is causing "lasting damage" to the economy. Surprisingly, to me at any rate, the signatories are not the swivel-eyed gang of Laffer/Wanniski wannabes that you might expect. They include DeAnne Julius, always among the doves on the Bank of England MPC when she served there, and Cambridge professor Bob Rowthorn, who in earlier life was an outspoken Marxist.

It would be good to think that a decision on this issue could be taken purely on the basis of evidence as to its likely economic impact. Chris Dillow has already done a very good job of examining the evidence on his blog, and finds the case that the 50% rate damages the economy to be unproven, to say the least. A good number of commentators have pointed out that few entrepreneurs wind up paying much income tax anyway, since they tend to be compensated through capital gains or dividends or, in many cases, offshore. The 50% rate falls mainly on city workers, most of whom have little flexibility to move elsewhere just to avoid taxes, at least in the short to medium term. (Only about 320,000 taxpayers, or about 1% of the total, pay any tax at the top rate).

But enough of the facts, because the early evidence from some quarters, especially the LibDems, is that this issue will be decided by the politics of envy more than anything else. One senior LibDem has said that dropping the 50% rate would be "phenomenally immoral", inspiring this response on Twitter:

Cutting 50p tax would be "phenomenally immoral" says phenomenally pious Lib Dem Tim Farron. Even if it brought in more govt revenue?

Another LibDem ventured onto the BBC news to point out that in France and Italy, the "super rich" (his term) are volunteering to pay more tax, while over in the US, Warren Buffett (now down to a lowly fourth on the global wealth league table, but presumably still just about "super rich") regularly decries the fact that he pays a lower tax rate than his secretary. "Only in the UK", quoth the LibDem, "are the super-rich super-greedy". It must be said that if the LibDems think that a £150,000 income (the starting point for the 50% rate) makes you "super rich", or puts you in anything like the Warren Buffett wealth bracket, then they definitely need to get out more.

Still, as Chris Dillow concludes in his piece on the subject (linked above), "To worry so much about the 50p tax rate at a time when real incomes are being squeezed, unemployment is rising and some benefit claimants face real hardship is to display a rather warped set of priorities". Much as Osborne might want to axe the 50% rate, which is anathema for most of his party, it's a non-starter in current circumstances. He'd probably rather Comrade Rowthorn and his pals had made their representations in private, rather than splashing them all over the FT and exposing yet another faultline in the coalition government.

Breaking the bank

Bank shares are coming under pressure again as markets scale the proverbial wall of worry over the Eurozone sovereign debt crisis and the risk of another global recession. For the big UK banks there’s an added source of weakness: a week from today (on September 12), the Independent Commission on Banking is due to publish its final set of recommendations on the future of the sector.

The Commission’s interim report raised the idea of forcing the banks to “ring fence” their retail operations from their investment banking activities, in the hope of ensuring that taxpayers would not have to rescue the retail banks again in any future financial crisis. The final report is likely to reiterate that recommendation, fleshed out with more details about how it could be implemented.

The banks are not waiting for the report to appear. They are loudly warning that it would be unwise in the extreme to embark on such major changes when the economy is so weak. The business press is echoing these calls. Today has brought a report by the Ernst and Young “Item Club” that attempts to quantify the damage that could be done. (BBC report here). E&Y believes that separating off the retail divisions of the banks would increase the funding costs for their investment banking operations.

E&Y’s reasoning is that removing the implicit government guarantee from the investment operations (the “too big to fail” guarantee) would impel depositors and investors to demand higher returns on their money to compensate for the increase in risk. The banks would then pass that increased cost on to their business borrowers. This would allegedly push the cost of business borrowing up by 1.5% and chop 0.3% off GDP growth. It seems fair to point out that if the implicit government guarantee really is worth 1.5 percentage points to the banks, then the government has been grossly undercompensated for its past support.

Looking to the bigger picture, the argument that “this is not the right time” for such reforms looks very dubious. Any attempt to implement changes of this sort during a time of strong economic growth would certainly have been batted away by the banks, no doubt supported by the business press, with an “if it ain’t broke, don’t fix it” argument. Likewise, if the government decides to delay implementing the Commission’s recommendations until 2015 or later, and the banks have not blown up by then, they will doubtless argue that the need for such drastic reform has passed.

The government would be wise not to let a good crisis go to waste here. It should perhaps recall the comment of Steve Eisman, one of the US fund managers who made a fortune out of the 2008 financial crisis, in Michael Lewis’s “The Big Short”:

“I can understand why Goldman Sachs would want to be included in the conversation about what to do about Wall Street,” he said. "What I can’t understand is why anyone would listen to them.”

A cunning plan

In Basildon, Essex, the local council is about to attempt to evict a group of Irish travellers from a plot of land they have been living on for many years, on the grounds that the land is designated as “green belt”. The travellers own the land, which abuts another plot that they also own and on which they have legitimately built permanent homes. However, they have never been granted planning permission to build on the portion designated as green belt.

In the meantime, the coalition government is running into fierce opposition over its plans to alter the UK’s planning laws. The government argues that the existing regulations are stifling development and thus holding back the entire economy. Among other things, the changes would make it much easier to obtain permission to build on…the green belt!

Interesting, no? I don’t have a particular axe to grind on the Basildon case, but one thing which is perfectly clear to me, even before the government changes the planning laws, is that developers (as opposed to ordinary individuals) can already get away with rather a lot.

In my own area, residents (and the local council) have been trying to fight off a developer who wants to build a massive freight depot on green belt land. The land was previously a gravel pit. When the site was made good after the gravel ran out, the government made a commitment to leave it as part of the green belt in perpetuity. Perpetuity, it turns out, means “less than ten years” in this instance.

The developer portrays the scheme as a rail freight depot, which makes it look more environmentally acceptable. (There will be something like 700 spaces for container trucks – and a single-track rail spur. You be the judge.) The planning application has been back and forth, at enormous taxpayer expense, between the local council, various courts of law and the government in Whitehall, which will have the final say. A verdict from the relevant Cabinet Minister is expected imminently; given the pressure on the government to find ways to spur growth, it would be a surprise if it were to be turned down.

So here we have a huge, unsightly development on a vast, council-owned tract of the green belt that the highly persistent developers stand every chance of pushing through. Meantime, over in Basildon, the travellers are about to be pushed off a tiny sliver of green belt land that they legitimately own and which is immediately adjacent to another residential area developed and occupied by travellers. It really does seem that what you can get away with has a great deal to do with who you are.

Not clear on the concept

Late night news bulletin on BBC News-24 last evening. Business reporter solemnly notes that the government plans to move ahead with its banking reforms, despite warnings from both the banks themselves and the CBI, because it believes that "banks need to lend more and to cut risk".

If a BBC business reporter can't see the contradiction there, that's a bad thing.

If the government can't see the contradiction -- and there are plenty of signs that it can't -- that's even worse.