When in a hole, stop.....talking

In the days when I used to get paid for writing stuff like this, one of my favourite beefs was the plethora of "unofficial" economic statistics in the UK economy. There are loads of them in both retailing (BRC survey, CBI survey, "footfall" surveys and so on) and in housing (Rightmove, Nationwide, Halifax, Land Registry). Most of these are used by the body that sponsors them as a basis for special pleading, usually for lower interest rates. The media duly play along. This is annoying enough at the best of times, but in current circumstances, where the economy is wobbly to put it mildly, it can be downright dangerous.

I was put in mind of this again by today's economic releases. After all the doom-mongering of the past few months, including all the unofficial data, ONS reported that retail sales in October fell by a mind-boggling....0.1%! They were 1.4% HIGHER than in the same month of 2007. In the same month mortgage approvals rose 7%. They're still more than 40% lower than they were a year ago, but still, it could be the first sign of a return to normality in the market. Why, it was even reported that an apartment in Birmingham changed hands for more than a million pounds for the first time. (The reporter noted that it had "commanding views over the West Midlands, as if that was a selling point).

The BBC radio reporter from whom I first heard this news was quick to downplay it, noting that retailers were still planning to launch their Christmas sales well before the holiday season. Indeed, Marks and Spencer has been holding an unprecedented 20% off sale this very day. So at lunchtime a BBC News reporter found himself in a shopping mall in Swindon (which, for all I know, you may be able to see from the £1 million flat in Birmingham). It looked pretty busy, but he was quick to aver that it had been quiet up until now. He then interviewed a group of ladies of a certain age who were on a spree. They agreed that they had been lured out by the M&S sale. So far so good. But when asked if that would be the end of their shopping for the season, they were shocked at the very thought. "Certainly not", said one of them, "there's only five weeks to go now, so we have to keep at it". When asked specifically if they were altering their spending plans in light of the credit crunch, they were unanimous that they were not. It looked to me like another attempt at doom-mongering well and truly foiled.

There are dire warnings that unemployment could reach 7% by the time the economy bottoms out. That's awful, but look at it this way: that would mean that 93% of people were still working. The last thing we need in the short term is to put the wind up that 93% to such a degree that they stop spending. For now, it seems as if the retailers have been so convinced by their own cockamamie surveys that they've panicked into price cuts that they could have avoided. Good news for the consumer at an expensive time of year, but brace yourself for surveys in January reporting that sales would have been so much lower but for these price cuts. If all these folks would just shut the f**k up and wait for the official data, and if the media would stop reporting these special pleadings as hard facts, it just might be a whole lot easier to avoid a severe recession.

Spooky!

I haven't watched Spooks, the BBC's overwrought show about MI5, for ages. However, I noticed that this week's episode would pit the spycatchers against a hedge fund grandee bent on bringing down the UK financial system, so I thought I'd give it a go.

As the man who went to the James Blunt concert said, "that's an hour of my life I won't get back". I wish I could describe how the hedge fund was planning to do the dirty deed. For most of the show, it seemed to involve shorting the stock of a fictional bank. Right at the end, though, after the villain of the piece had been conned by one of the MI5 operatives, he was persuaded to "reverse his position". As far as I could tell this reversal again involved selling the stock, and he was duly wiped out for his trouble when the Government stepped up to support the bank. Maybe I missed something, though I swear I managed to stay awake for the whole thing.

If the financial strategy was incomprehensible, the details were laughable. The term "insider trading" was thrown about like confetti, but never once used properly. The climactic "reversing of position", which if I recall involved £16 billion, took less than five seconds. The Chancellor of the Exchequer (a woman, so don't you dare call her Darling) took all the big policy decisions on the fly, without any visible presence of advisors or Cabinet colleagues. The hedge fund villain turned out to be an unreconstructed Communist, not some testosterone-fuelled ex-costermonger as most hedge fund types are assumed to be. Most unbelievably of all, he was conned into changing his position when he was seduced by one of the regulars on the show, a woman who manages the amazing feat of making Sarah Jessica Parker look like Charlize Theron.

I've always been puzzled by why television has never been able to produce a worthwhile drama series about the financial world. (There was a preposterous and short-lived attempt in Canada in the 1990s, called "Traders"). One explanation, I suppose, is that programme-makers assume the business is not interesting unless there's criminality involved -- a view which may well suit the public mood at the moment. However, it would be nice if producers would at least ensure that they portray the financial world with at least a modicum of accuracy. I can't believe that credit default swaps are any harder to explain than the wildly obscure diseases that House treats every week.

Schizo Keynesian economics

Tessa Jowell is in trouble for her comments, reported in the Guardian and elsewhere, that seem to imply that the Government would not have supported the London Olympic bid if it had known a recession was coming. She's attempted to backtrack by claiming that what she meant is that the Government wouldn't bid under current circumstances (because it would be a "distraction", as if that would be a bad thing!) but it's pretty clear that she meant it wouldn't have bid in 2005 if it had known there would be a recession in 2008.

She's wrong either way. There was no reason for a bid in 2005, when the boom was in full force. But paradoxically, if the 2012 Olympics were on offer right now, it would make a lot of sense to lob in a bid. Obviously Gordon Brown and Alastair Darling's reconversion to Keynesianism hasn't yet reached the rest of the Cabinet.

I yield to none in my contempt for the way the UK Olympic movement conned the Government into underwriting this extravaganza. The initial estimates were outright lies and there are still not many people who think that the final tab will fall within the current estimate of $9.3 billion, which is almost four times what the UK taxpayer was persuaded to support a mere three years ago.

Long before Keynes was even a gleam in his father's eye, monarchs and despots understood that bad economic times were the best times to knock up a couple of new frigates on the cheap. During the great depression, Keynes famously said that it would be wise to emply people to bury money in holes in the ground and then dig it up again. Even as an Olympics hater, I have to admit that the Games will probably prove more valuable than that. The media are advocating tax cuts primarily on the grounds that it will take too long for public works projects to have any impact on the economy; here's a huge public works project that will play out over the next three years, and a senior Cabinet minister is implying it's not a good idea!

In any event we're stuck with the Olympics. So it will be interesting to see what happens to the costs as the project moves forward. The huge jump between the initial estimate and the current one happened mainly because the Olympics grandees lied to the Government and the public to get what they wanted, but there has also been some genuine cost inflation as a result of the strength in the economy. With construction workers starting to receive their P45s and materials costs in freefall, it ought now to be possible to achieve some significant cost savings. Unless, of course, the dolts who are running this show have given out a bunch of fixed price contracts, which, now that I think about it, wouldn't surprise me in the least.

The next crisis starts here

The Bank of England's astounding decision to cut its base lending rate by 1.5% is likely to have a whole raft of unintended consequences, few of them benign. Thanks to the British public's unhealthy obsession with property, the rate cut will distort the housing market and make the economy ever more dependent on credit.

The Government is playing the populist card as hard as it can, urging the banks to pass the full benefit of the rate cut on to their borrowers, or face the wrath of the public, or at least of Lord Mandelson. The scale of the furore that has been whipped up about this is amazing, considering that the vast majority of mortgage borrowers are either on fixed rates (and hence see no benefit from any rate cut) or on tracker deals, and hence see the benefit automatically. HSBC said yesterday that 97% of its borrowers were in one or other of these categories, though admittedly it is not a huge player in the mortgage market, and the numbers at other lenders may be somewhat different.

In any case, it's not as simple as the Government is making out, as of course the Government knows perfectly well. The whole reason certain banks had to be bailed out is that they were excessively dependent on wholesale funding, the cost of which is only indirectly influenced by the Bank of England rate. Wholesale funding costs, as measured by the LIBO rate, have been falling since the bailout scheme was announced. However, until the spread between LIBOR and bank rate returns to more normal levels, banks can't just cut mortgage rates willy nilly.

Banks also have to judge how far they can afford to cut the rates they pay depositors. Savers are already starting to squeal about seeing their returns cut in order to bail out what they see as irresponsible borrowers. If enough depositors start to redeploy their money out of the banks and into alternative investments, banks won't have enough money to extend new mortgages -- unless, of course, they resort to more wholesale funding, and we know where that leads.

Guess what the "alternative investments" are likely to be. There are already commentators saying that falling returns on savings accounts will drive more investors to consider putting money into the property market. Another group who may well be tempted to think the same way are pension savers, since annuity rates are sure to tumble further as official rates head toward record lows.

Where does this leave the housing market? If banks are forced to reduce the price of credit, they will be more selective about who they lend to. So the first time buyer will still find it hard to get credit, while the better-off will be piling back into the buy-to-let market. A year or so ago, the number of people owning their own homes in the UK fell for the first time in living memory. That's an unwelcome new trend that may be slow to reverse, regardless of how far the Bank of England slashes rates or the Government jawbones the banks.

At the root of all this is the UK's property obsession, and the Government's conviction, egged on by large sections of the media, that the way out of the crisis is to feed the already engorged beast. We're setting the stage for the next housing crisis before we've even seen the full extent of the current one.

Bank of Mandelson and Cable

Politicians in the UK don't seem to be able to remember which banks they bailed out and which they didn't. Last week we had Lib Dem finance spokesman Vince Cable railing against Barclays for raising money from the Middle East, admittedly on generous terms, rather than signing on for (Mervyn) King's shilling of government aid. Now "Lord" Mandelson is leading a chorus of MPs warning banks that they must pass on future rate cuts to consumers, after HSBC (another non-bailee) hinted that it might not do that. No doubt the criticism will move on to Lloyds, which is planning to refinance its Government-injected pref capital early in 2009 so that it can start paying dividends again. The effrontery!

It may be hard to imagine why the banks don't want Mandelson, Cable and the rest of the finance whizzes in the House of Commons peering over their shoulders every time they meet a customer, but let's give it a try. Those banks that got into a mess did so by lending unwisely and too much, while raising too little in deposits. Let's start with the lending side. The HSBC exec who has attracted the wrath of Mandy said that credit had been systematically mispriced over the past few years, something which now needed to be corrected. The banks mainly have themselves to blame for the mispricing, though HSBC, which has a surprisingly small share of the UK mortgage market, was not one of the bigger offenders. Margins will have to reflect risk more accurately in the future if the financial system is not to veer straight back into the ditch.

The flood of lending that resulted from low underlying rates and mispricing of credit risk outpaced the ability of most banks to fund themselves through old-fashioned deposit taking, though again, HSBC is an exception in this regard. The majority of the UK's banks were only able to keep lending by funding themselves in the inter-bank or wholesale markets. When these started to dry up in mid-2007, these banks had nowhere else to turn.

Look back over the events of the past fifteen months and you can see how these problems on the asset and liability side of the banks balance sheets played out. The first victim, Northern Rock, was undone by its reliance on wholesale funding, despite having a relatively sound loan book. Bradford and Bingley was mainly done in by a dodgy loan book (too much buy-to-let and self-certification), though its reliance on wholesale funding didn't help. The other institutions that have tottered but appear to have been saved suffered from a combination of the two problems.

The government rescue has bought time for the banks to get their houses in order, i.e. deleverage. As well as more capital, the banks need a combination of much slower loan growth, reduced reliance on wholesale funding and improved deposit-gathering. How succesful they are with rebalancing their liabilities away from wholesale funding will determine how much money they can safely lend, which will in turn determine how severe the recession turns out to be. It's going to be difficult to get it right. But cutting rates too quickly will boost loan demand and curtail deposit growth, which is the exact opposite of what's needed. Mandelson et al must know this, mustn't they?

Barclays, Vince Cable and the price of independence

Barclays plc is planning to boost its capital by raising money from investors in Abu Dhabi and Qatar. It's a complicated package and it looks expensive. Here's how the Telegraph website describes the deal:

"For starters, Barclays is paying a 14pc coupon for 10 years on some preferred-like shares. It's the highest rate yet for bank capital. True, the after-tax rate of 10pc is cheaper than the UK government's 12pc – but Barclays probably will be shelling out for at least six more years than its peers getting bailed out by the authorities.

Next, there are warrants – handed over at an in-the-money price and with anti-dilution protection. The Middle Eastern investors can subscribe to 1.5bn new ordinary shares at the severely depressed price of 198p each any time over the next five years.

Then come £2.8bn of mandatory convertible notes. Taking the 9.75pc coupon into account, the conversion price is 27pc below the pre-deal share price. There is also a generous thank you from Barclays - £300m of commissions, which get paid to Abu Dhabi and Qatar regardless of whether the deal goes ahead."

The commissions are pretty stunning, but they're really a sort of "drop dead fee", probably inserted as an inducement for the bank's existing shareholders to back the deal. (They get to vote on it later in the year). After all, they'll be throwing the £300 mil away if they don't.

The Government and most politicians are likely to welcome this initiative, but there's at least one exception. Here's Lib Dem Treasury spokesman Vince Cable, quoted on the Guardian website:

"The deal allows Barclays to strengthen its balance sheet without getting help from the taxpayer, but its terms, which are seen as generous to its new investors, drew fierce criticism today from Liberal Democrat deputy leader and Treasury spokesman Vince Cable.

"This is a scandal of mammoth proportions," he said. "Here is a bank which relies on the taxpayer to bail it out if the going gets rough but which has offered Middle Eastern investors a much better deal than the banks are offering to the British taxpayer."

Cable has been impressive throughout the financial crisis, but these comments are plain nuts. The comment that Barclays "relies on the taxpayer to bail it out" is particularly bizarre, given that the precise reason the bank is doing this deal is to avoid relying on the taxpayer.

Cable goes on to offer his explanation as to why Barclays is going down this road:

"We have to ask why Barclays it is willing to offer a better deal to foreign investors than the British taxpayer," Cable said. "The answer is simple: they don't want the British government stopping them from paying massive bonuses to their executives.

"More than the other banks, Barclays operate a high-risk casino operation which makes the bank particularly unstable but which gives very rich pickings to the top executives. The British government must not simply let this pass."

Leaving aside the accusations in the second paragraph of that quote -- which might well be actionable if uttered by anyone other than a politician -- Cable's explanation doesn't really hold up. The public likes (or should I say hates) to imagine bankers going home on bonus day with the boots of their Bentleys stuffed with crisp new 50s. In truth, most bankers get a large chunk of their bonuses paid in the form of stock, and have to wait years to convert it into cash. A deal like this one, which will certainly weigh on the stock price until the warrants and the convertibles are exercised, is the last thing they'd want.

So why are Barclays' management recommending this deal to shareholders? The classically-named chairman, Marcus Agius, says "it's all about self determination". With the press reporting today that the Government is putting pressure on the banks that have been bailed out to boost lending levels, it's not difficult to believe him.

A big day for bad ideas

On Monday evening Channel 4 showed a hastily-assembled documentary called "Don't bank on the bailout", presented by city fund manager Hugh Hendry. I didn't catch the whole thing, but the parts I did manage to see were, shall we say, unimpressive. Hendry appeared completely unaware of the difference between the annual budget deficit and the national debt. He intoned meaningless sentences like "four and a half is the new fifteen", referring to the level of Bank Rate. He invented scary numbers for the sake of effect, airily dismissing a carefully-researched study that suggested the budget deficit could reach £90 billion with the words "try £200 billion".

According to Hendry, it may be too late to avoid a recession in the UK, but if we are to do so, we need to return to old fashioned austerity. That's a great idea, Hugh. Let's prevent an accidental recession by causing one deliberately, because that's certainly what would happen if both individuals and governments stopped spending. Oddly, Hugh also wants a massive rate cut, which most of us would not see as the most obvious route to austerity. Looks like Channel 4 should stick to Big Brother. As for Hugh Hendry, he might want to spend more time with his funds, as he underperformed the market by almost 8 percentage points in the third quarter of 2008, according to Citywire.

Not that the UK has a monopoly on madcap ideas. Also on Monday, I came across Maria Bartiromo interviewing a panel of distinguished guests. First up was Arthur Laffer, he of the fatuous Laffer curve, who was bemoaning the financial market bailout because it would have to be paid for through higher taxes eventually. (Yes, it's all right for millions of people to lose their homes, as long as Art and his pals don't have to pay any more taxes). Then it was on to Lawrence Kudrow, who was foaming at the mouth at an old quote from Barack Obama, in which Obama said it was a shame that the black power movement had failed to redistribute income. Larry said the government should not worry about how much of the pie everyone got; it should just try to make sure the pie got bigger. He also asserted that Obama would use the courts to redistribute wealth if he could. Pretty clearly, Larry is one of the surprising number of people in the US who think the credit crisis was caused by the poor.

I had to stop watching at this point in order to avoid putting a boot through the TV. If I'd kept watching, Maria's next guest might well have been Jude Wanniski, reaching back from beyond the grave to call for restoration of the gold standard.