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.