The Bilderberg Connection – for conspiracy theorists everywhere

The secretive Bilderberg Group, long a favourite of conspiracy theorists and target of anti-globalists,  are holding their 2009 conference in Greece over 14-17th May.

As Paul Watson of globalresearch.ca reports  ”Elitists [are] divided on whether to quickly sink economy and replace it with new world order, or set in motion long, agonizing depression”.  The way he writes it, this lot are puppet-masters pulling the strings that control the World and acting as kingmakers selecting future leaders they approve of.  His heading claims that the Group “plans economic depression“. 

Wow! Not quite up their with fellow Bielderberg critic David Icke who is on the record as believing the the Queen is a reptilian humanoid.

The fact is that the majority of policy-makers world-wide are working with deeply flawed economic theories.  This meant that they failed to see the crash coming until it was too late and don’t really understand it even now.  Not quite Master-of-the-Universe stuff even if many have been remunerated on the basis that it was.

A more rational explanation would be that the Bielderbergers, like anyone else, can spot a rising political talent and that they are free openly to discuss unpalatable truths about just what a big mess we are in in a way they don’t always like to when they know the press is hanging on their every word (even if conspiracy theorists sometimes get hold of garbled versions of their debate).

For what it’s worth there are hard choices to be made roughly along the lines Watson sets out.  Should we purge the system of its accumulated excesses as quickly as possible or try to keep the economy staggering on despite the difficulties until things improve?  The first option implies an intense, but relatively short depression, the second implies a long drawn out affair, possibly lasting 20 years.

I favour the first option, most politicians lean to the second, but I fear the mess may be too big for that to be deliverable; (or, to put it another way, I think the government will run out of credit and bankrupt us before they’ve filled the hole they dug earlier).

Change we can believe in – if only!

A funny thing has happened almost by stealth sometime in the last two weeks or so.  Progressives, who might be excused for thinking that Obama’s election would indeed lead to “change we can believe in”, have had to admit that he’s getting it wrong, badly wrong as far as the financial crisis is concerned.

Now an excellent interview with William Black on Bill Moyers Journal provides much of the context and moreover shed an uncomfortable light on developments on this side of the pond.  (The video is about 30 minute long but well worth it.  A transcript is provided if you prefer).

William K Black is now professor of Economics and Law at the University of Missouri, Kansas City and was formerly a regulator during the savings and loan crisis of the late 80s. 

Black’s thesis is simple; the financial crisis is driven by fraud on an epic scale.   He explains to Moyers how it works:

WILLIAM K. BLACK: Well, the way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you’re a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there’s going to be a disaster down the road.

BILL MOYERS: So you’re suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?

WILLIAM K. BLACK: Yes.

He goes on to explain that the big banks knoew perfectly well that the liar loans and the like were fraudulent, but that complex financial instruments were deliberately created so that swindlers could exploit them.  The fraud became widespread.

BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?

WILLIAM K. BLACK: No, and that’s a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, “Trust, but verify.” They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.

And now there’s a cover up.

BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?

WILLIAM K. BLACK: Absolutely.

But the whole thing tracks back to a small number of individuals.

BILL MOYERS: This wound that you say has been inflicted on American life. The loss of worker’s income. And security and pensions and future happened, because of the misconduct of a relatively few, very well-heeled people, in very well-decorated corporate suites, right?

WILLIAM K. BLACK: Right.

BILL MOYERS: It was relatively a handful of people.

WILLIAM K. BLACK: And their ideologies, which swept away regulation. So, in the example, regulation means that cheaters don’t prosper. So, instead of being bad for capitalism, it’s what saves capitalism. “Honest purveyors prosper” is what we want. And you need regulation and law enforcement to be able to do this. The tragedy of this crisis is it didn’t need to happen at all.

Which brings us back to the beginning.  How is a highly intelligent man like Obama getting it so badly wrong?   Ditto Gordon Brown?

Banana republic

Glenn Greenwald hits the bullseye with a superb post on Salon.com comparing the US now to Russia and Argentina during past crises.   His article is a must read by any standards.

He starts by quoting Desmond Lachman, a former IMF official, who describes his experience of Russia and Asia.

I still recall the shock I felt at a meeting in Russia’s dingy Ministry of Finance, where I finally realized how a handful of young oligarchs were bringing Russia’s economy to ruin in the pursuit of their own selfish interests, despite the supposed brilliance of Anatoly Chubais, Russia’s economic czar at the time.

And.

I often heard Asian reformers such as Singapore’s Lee Kuan Yew or Japan’s Eisuke Sakakibara complain about how the incestuous relationship between governments and large Asian corporate conglomerates stymied real economic change.

Greenwald observes (following Yves Smith) that this is now also the road the US is on.

 … Citibank and Bank of America are now using TARP funds they received not to extend more loans (the ostensible purpose of the bailout), but rather, to buy up more and more of the very distressed assets that Geithner insists they need to be relieved of, because they now know that, under Geithner’s plan, they will be able to sell them at a substantial profit courtesy of public funds (i.e, the Government will buy those crippled assets at well above their current market price).  

Quite simply, this is looting of the public purse by a powerful elite.  Greenwald goes on to put his finger on the central problem.

The key dynamic underlying all of this — the linchpin that allows it all to happen and, historically, the primary hallmark of a deeply broken nation — is the total elimination of the rule of law for the ruling class, with a simultaneous intensification of the law as a weapon against the citizenry.  Does anyone expect there to be any widespread prosecutions for those most responsible for the looting, systematic fraud and grand-scale theft of the last decade? 

It’s not quite as bad as that here in Britain as yet but we need to be alert; it’s a very slippery slope. 

The choice is between holding unequivocally to the rule of law or becoming just another banana republic.

(H/T naked capitalism)

Doing the fair thing is doing the right thing

Today’s cut in base rate to just 0.5% is horrible (though not unexpected) news for savers.  Anyone who has been prudent and saved to build a nest egg for their retirement or against a rainy day is getting hammered by the loss of  income; many retirees will be forced to dip into capital to survive.

But, apart from the obvious point that Gordon Brown’s once-vaunted reputation for prudence is now deader than the proverbial parrot, what does this tell us about his government’s priorities.  How is he proposing to spread the pain about, who will loose most and who will loose a little.  Will there even be some winners?

Forget all the economic jaw jaw.  We need a debate explicitly and in terms about what is fair and what is not fair.  If, as most Lib Dems fondly believe, ‘fairness’ is a core principle of their party then NOT having this debate is a gross dereliction of duty.

Moreover, it has become abundantly clear that most mainstream economists don’t have a clue about how the economy works, or they would have seen it coming – which they didn’t (with remarkably few exceptions).   The proposition that we should leave it to those who got us into this mess to save us from it is laughable.

This matters because I have an old-fashioned belief that doing the fair thing is in fact doing the right thing.

So, what is the government doing – and what should they be doing?

Their approach was and is to get lending restarted so we can all go back to where we were – carry on as before – no lasting harm done - trebbles all round.   But many banks have so much bad debt that they are bankrupt - zombies kept alive only by government guarantees of billions.   This will be a burden to taxpayers for decades to come – a massive inter-generational transfer.   Is this fair?

But the banks winnings are not limited to the immense cost of capital injections and guarantees.   Their gross margins (the difference between the interest rates they pay savers and the rates they charge borrowers) have gone through the roof.    So both savers and borrowers are also loosers.  Is this fair?

(An anecdote illustrates this.  A friend who runs a high quality small business with a strong balance sheet was recently looking for a modest loan.   Several banks quoted 10.5 – 11.5% for a secured loan.  Until recently he could get loans at around 9% unsecured or 2% over base rate secured.  Multiply the gross margin they are getting – say 10% – by all their loans and this is a LOT of money).

The government’s clear policy is to thus to fill the black hole in the banks’ finances thorough a combination of government cash injections and rolling up bumper profits (those monster gross margins) over many years.  (At the moment we are not ’seeing’ these profits because they are being cancelled by write offs of bad debt).  Unfortunately we just don’t know how big the banks’ eventual losses will be nor therefore how long this will take.  At least a decade is a reasonable bet but an ongoing capital famine – for that is what would result - would be a disaster for businesses and would-be house buyers alike with opportunity costs that would be incalculable.  Is that fair?  

Also today the Bank of England has announced that it is to begin ‘quantitative easing’ (aka printing money) to boost liquidity in the banking system and therefore – hopefully – demand.   No-one, least of all the Bank, seems to have any confidence that this will work.   Neither do I  for it fails to address the core problem of too much debt.   What it may well do is stoke inflation that would wipe out the capital value of any remaining savings.  Is that fair?

This crisis started when debt was allowed to balloon to unaffordable levels; it will end only when debt is once again affordable.

The tragic truth is that there is no painless or even fully fair way to get debt down.  Realistically, killing the zombie banks that carry most of the bad debt is the only way to go and is less unfair than any alternative.   (Their branch networks and supporting systems would continue as before but under new management – they are the ‘Money National Grid’ and a vital part of the economy).  Killing zombie banks whose greed got the better of them is entirely fair.

(Interestingly, this is the solution that the private sector has come up with for rescuing firms that have been coaught out with unaffordable levels of debt.  Recent weeks have seen a slew of  ‘pre-pack’ administrations (i.e. bankruptcy) where a new company emerges the next day purged of its accumulated mistakes).

In the meantime the government should not pour taxpayers money into propping up bankrupt institution that have collapsed themselves by their own greed.  If it continues to prop them up there is a high probability that it will bankrupt itself – any that would be the ultimate unfairness.  That’s the scenario we shouldn’t have to face.

Shredding Sir Fred – and friends

Rewarding senior executives for failure has become all too  common in recent years.  The £16 million pension awarded to Sir Fred Goodwin, former boss of RBS, may make him ‘media hate person of the day’ but his is only the latest in a long line of payments for destroying perfectly good companies.

Gordon Brown may view it as ”unacceptable” and be taking legal advice about how to claw it back but surely we need to draw the general lesson here and not just beat up on one case – however offensive that case might be. 

And that general lesson should surely encompass the thought that all rewards – including salaries, bonuses and pensions – should be commensurate with results.   In other words the perfectly justified public anger over this case (and banking bonuses generally) could and should be harnessed to put through some long-overdue changes to corporate governance.  

In too many large firms the rights of shareholders (and that means most of us through pension funds etc.) have been expropriated by a breed of self-serving managers who serve no higher goal than short term greed.  It is too easy for a dominant Chairman to pack his board with yes-men who can be relied on to lock arms and push back against even the most determined efforts to question pay awards or strategy.  No wonder we are in a mess.

Corporate governance needs to move on from being the domain of buccaneers and kleptocrats to one of managers who actually serve the longer term interests of shareholders (and in practice therefore also of employees and the wider society). 

So what can be done?

I suggest that legislation to restore shareholder control is the democratic and effective way to go.  Legislate that directors of public companies may only draw a salary package up to a maximum of a specified multiple of average wages in their firm – say a generous 20x.  That should be more than enough for anyone to live on!   Any remuneration above this level (whether as bonus or pension etc.) would be subject to two votes by shareholders -   the first to agree and set up a bonus scheme and a second vote five years later to confirm (or deny) any sums awarded under such a scheme.

In practice the shareholders would be pension funds etc so they would use such powers responsibly and sparingly but the threat of being able to do so would be a powerful deterrant to bad behaviour in the first place.

If it turned out that the Directors had been utterly foolish and/or negligent then the shareholders would have the right to decline to pay the accrued bonuses.   However ,shareholders would be constrained to behave fairly and not unreasonably or they would find it impossible to attract and retain quality management.

Funds accrued could earn interest while in trust so there is no ultimate loss to the directors involved – only a delay so that any short-termism is exposed.

And just imagine; if such legislation were introduced in the next few months and backdated to late last year,  it might even catch Sir Fred.

That would seem perfectly fair.

The Real Great Depression

The Credit Cruch is certainly a big event but how apt are the frequent comparisons with the Great Depression of 1929?  

In a fascinating piece, historian Scott Reynolds Nelson suggests that the Panic of 1873 is a much closer model.  He recalls that his 96 year old grandmother says her grandparents had a much harder time in what she calls the “Real Great Depression”.  As he puts it:

The problems had emerged around 1870, starting in Europe. In the Austro-Hungarian Empire, formed in 1867, in the states unified by Prussia into the German empire, and in France, the emperors supported a flowering of new lending institutions that issued mortgages for municipal and residential construction, especially in the capitals of Vienna, Berlin, and Paris. Mortgages were easier to obtain than before, and a building boom commenced. Land values seemed to climb and climb; borrowers ravenously assumed more and more credit, using unbuilt or half-built houses as collateral. The most marvelous spots for sightseers in the three cities today are the magisterial buildings erected in the so-called founder period.

But the economic fundamentals were shaky. Wheat exporters from Russia and Central Europe faced a new international competitor who drastically undersold them. The 19th-century version of containers manufactured in China and bound for Wal-Mart consisted of produce from farmers in the American Midwest. They used grain elevators, conveyer belts, and massive steam ships to export trainloads of wheat to abroad. Britain, the biggest importer of wheat, shifted to the cheap stuff quite suddenly around 1871. By 1872 kerosene and manufactured food were rocketing out of America’s heartland, undermining rapeseed, flour, and beef prices. The crash came in Central Europe in May 1873, as it became clear that the region’s assumptions about continual economic growth were too optimistic. Europeans faced what they came to call the American Commercial Invasion. A new industrial superpower had arrived, one whose low costs threatened European trade and a European way of life.

As continental banks tumbled, British banks held back their capital, unsure of which institutions were most involved in the mortgage crisis. The cost to borrow money from another bank — the interbank lending rate — reached impossibly high rates. This banking crisis hit the United States in the fall of 1873. Railroad companies tumbled first. They had crafted complex financial instruments that promised a fixed return, though few understood the underlying object that was guaranteed to investors in case of default. (Answer: nothing). The bonds had sold well at first, but they had tumbled after 1871 as investors began to doubt their value, prices weakened, and many railroads took on short-term bank loans to continue laying track. Then, as short-term lending rates skyrocketed across the Atlantic in 1873, the railroads were in trouble. When the railroad financier Jay Cooke proved unable to pay off his debts, the stock market crashed in September, closing hundreds of banks over the next three years. The panic continued for more than four years in the United States and for nearly six years in Europe.

He notes that in much of eastern Europe the problems were widely blamed on foreign banks and Jews.  Americans tended to blame themselves and many turned to what became fundamentalist religion.  He goes on to conclude that:

…when banks fall on Wall Street, they stop all the traffic on Main Street — for a very long time.

And that:

In the end, the Panic of 1873 demonstrated that the center of gravity for the world’s credit had shifted west — from Central Europe toward the United States. The current panic suggests a further shift — from the United States to China and India.

I agree although I think better and more honest leadership in the Whitehouse will make a huge difference.

An open letter to Baroness Shriti Vadera

Dear Shriti,

Congratulations on your appointment earlier this month as Parliamentary Under-Secretary of State for Competitiveness and Small Business.  You take up the post at a crucial time.

Small businesses around the country are already being hit hard by the credit crunch and will be hit harder still in the near future as its consequences rip through the economy with dire consequences for employment, future tax revenues etc.  The whole country – and not just small business - needs you to be an effective and powerful voice at the heart of government for good sense and good finance.

As a former banker you will know that all business – large or small – depends on inputs of capital, labour and materials in varying proportions.  The credit crunch bears very directly on one of these – the cost of capital.  As you will also know, there is very rarely an absolute shortage of anything; more typically there is a shortage at an affordable price and that is why the question of price matters so much – and not just availability which is how the press mostly reports it.

In a posting I made yesterday I calculated (albeit in an approximate back-of-an-envelope sort of way) that the bailout plan would result in retail interest rates of around 16%.   Just a few hours later I settled down to watch the Channel 4 News only to see them carry an item about small businesses being trashed by – you guessed it - interest rates of 16%.   A small business owner rightly commented that this is, “almost a credit card rate”.  

To put this in context, I was able to get a loan at 7% to finance the purchase of a small business some years ago from the retiring owner.   At 16% it would not have happened and several people would now be unemployed.  It is no exaggeration to say that if the rate remains at anything like 16% businesses around the country will be decimated.  For this to happen at a time when sales revenues are down anyway will be a double whammy.  (Come to think of it double whammies are bit of a Labour speciality).

Moreover, many are now calling for interest rates to be slashed ASAP to stimulate the economy and there is little doubt that a cut, perhaps as much as 2% will be made soon.  However, Gordon Brown’s cunning bailout plan would prevent this feeding through to the real economy. 

In your Channel 4 interview yesterday you effectively conceded the point saying that, “as their [the banks] own cost of funding has increased a problem has emerged, that they are seeking to pass it on“.  Well, yes!   Go to the top of the class!  But, the banks cost of funding has increased because the government of which you are a part decided to increase it; this is the inevitable consequence of sticking the banks with a penal interest rate.  In the final analysis the banks will not pay this, business will and we will all be poorer for it.

It’s all very well for your boss to pose around like he’s some sort of economic genius, but it’s actually pretty obvious that he’s totally out of his depth (though to be fair, rather less so than Dave from PR). 

Unfortunately the civil service doesn’t help much either – as a body they have never had to engage fully with issues of cost or price (as opposed to temporary famines in departmental budgets which are quite different).  They need to learn that taxpayers are not a magic money tree.  In fact this also bears on the ‘competitiveness’ part of your brief; we need a government that understands that its role is, in part, to help individuals and businesses cut costs.  Not by subsidies obviously, but by doing things differently, better, more efficiently.

So we need a root and branch change, both in the leadership and the engine room.  In the meantime, please do what you can and explain to your boss that he should make some key changes to the bailout plan as it now stands.

Yours etc.

Liberal Eye

Some very murky corners

The devil is always in the detail, bank bailouts not excepted.  Now there is a row about the terms that illuminates some murky corners of government thinking.  BEWARE!  NEW STEALTH TAX COMING.

Under the current version of the plan most of the taxpayers’ money will be in the form of ordinary shares but some (£9bn out of £37bn) will be in the form of redeemable preference shares – effectively a loan with conditions.  Conditions include (a) interest set at a penal 12% and, (b) no dividends to be paid on ordinary shares until the preference shares are redeemed (i.e. until the loan is paid off).  The idea is allegedly to encourage the banks to pay back ASAP – which is fine as far as it goes, but …

Firstly, the larger object is to bail out the banks – not to punish them with a penal interest rate.  I don’t know what the govt’s cost of borrowing is currently, but I don’t think it’s anywhere near 12%.   I quite understand (and in fact agree with) the notion that someone should carry the can for this, but it’s spiv bankers that should be punished – not the institutions where they worked. 

The banks have been compared in recent days to the ‘financial plumbing’ of the economy.  Quite so, but if you are the victim of a cowboy plumber who wrecks your loo you don’t then go and take a sledge hammer to the boiler and pipework in a fit of rage.  Government should be mature about this.  The quickest way to ruin a bank is to increase the price it has to pay for its funding.

Secondly, it will be difficult for the banks to lend for mortgages or businesses if their marginal cost of capital is 12%.  Normally they would have to add a ‘retail markup’ onto their cost of capital so 12% wholesale becomes perhaps 16% retail.  How many will be able to afford this for their mortgage or business loan?  With inflation rates set to plummet on the back of falling commodity prices the real cost of loans will go through the roof.

Thirdly, bank dividends are very important to pension funds as a source of cash flow out of which to pay current pensioners.  If there is no dividend for up to five years pension funds will be decimated, probably doubly so.  If they keep their bank shares, the rest of their portfolio will have to take the strain at just the worst possible time; similarly if they sell, they do so at the worst possible time and make a massive capital loss.

It looks like Brown has homeowners, businesses and pensioners in his cross hairs for another whopping stealth tax.  And, as we all know, he has form on this; one of his first actions as Chancellor was a stealth tax on pension funds.  That the banks are the proximate target does not change the fact that the ordinary people are the ultimate victims.

Moreover, it turns out that the condition that preference share must be paid back before ordinary dividend payments are resumed was included at the instigation of the EU as confirmed on BBC R4’s ‘World at One’  (audio: the interview begins at approx 10.50 minutes in) today in an interview with Jonathan Todd, spokesman for the EU’s Competition Commissioner.

Apparently the Commission, “wanted to ensure that there was an incentive for the banks to repay the state as quickly as possible and we did not consider that applying a penal interest rate would be sufficient to achieve that“.  The UK government had considered it would be a sufficient incentive. 

This is all wrong - the Competition Commissioner should butt out.  I can concede than the EU has a role in ensuring that member countries don’t provide covert subsidies for national champions (or national basket cases) but it must be clear, even to them, that this is not the context here. This is the worst sort of bureaucracy – powerful, but without any ultimate responsibility or accountability when things screw up as a result of its intervention.

So what should the government do?

I suggest that the bailout: (a) should involve only preference shares (not ordinary shares – see this earlier post for reasons), (b) the interest rate should be as low as possible (e.g. 2% above the government’s own cost of capital),  (c) preference shareholders should get a deferred bonus at redemption of 1% for each year after the first two years that the shares remain outstanding (i.e. 1% on amounts redeemed in the third year, 2% in the fourth year, 3% in the fifth year etc.)  

This would mean that the banks could get healthy again ASAP, in the meantime they could make loans at affordable rates, they could pay dividends to pension funds and others that rely on them (although there seems to be general agreement that, this year at least, there will be no dividends anyway), and last but by no means least it is quite possible that private investors will put up much of the capital if the government gets its numbers right (those I’ve used above are purely illustrative).

After all, it is increasingly obvious that the government needs to keep its powder dry for the firestorm ahead.

Seeds of the next crisis

It is said that the seeds of the next war are sown in the decisions made in at the end of the last one.  As with wars, so it seems with banking crises.

Last week I broadly welcomed the bailout approach adopted by Brown in contrast to the Paulson Plan in the US which was already failing.  Not that Brown can take a credit for inventing the approach; a very similar scheme was used in Sweden in the early 90s and very recently by Warren Buffet, the world’s most successful investor, to rescue Goldman Sachs so the precedents were clear.  Moreover, he had the experience of Northern Rock some months before giving him time to get his head round the concept (with Vince Cable calling it consistently right).  Now most EU countries and, to a limited extent, the US are moving to adopt schemes based on the ‘British Plan’ in some degree.

The background is, of course, an absolutely monumental failure of the banks themselves, the regulators and the government.  (Which is to say that Brown is doubly implicated in that he both heads the government and, as Chancellor, designed the regulatory framework that has failed so catastrophically).

But all that was last week and it seems that even a weekend is a long time in politics.  For the plan that was being discussed last week has mutated over the weekend in ways that are subtle yet important and fill me with foreboding.  Motives matter, and I am not convinced that the government is as pure as driven snow at this point.  It needs to be.

Firstly, the decision to let Lloyds TSB take over HBOS in flagrant breach of competition rules was just about (downhill and with a following wind!) justified when first mooted on the basis that Lloyds could rescue HBOS without recourse to the taxpayer.  But since it has emerged that both Lloyds TSB and HBOS will need taxpayer help this rationale entirely evaporates.  Labour is acting as midwife to the birth of a very dangerous offspring.  Moreover, the loss of an important plc head office to Edinburgh is no small matter.  The UK as a whole would be healthier if more public companies had head offices outside London.  I would like to see this deal stopped or, failing that, a Lib Dem commitment to break up Lloyds/HBOS.  Let it not be said at some later date that Lloyds/HBOS didn’t know the risk.

Secondly, the original rescue plan envisaged that government help would be in the form of preference shares with various conditions attached.  While these were not precisely spelled out it is clear that they would include restrictions on executive pay and bonuses.  What we are actually getting seems to have mutated to a small number of preference shares with most of the money injected in the form or ordinary stock with directors on the board to match.

Now this distinction matters, not so much because of the mechanism per se, but because it seems to herald a shift in government thinking over the weekend.  For, despite the name, ‘preference shares’ are nearer to loans than to ordinary shares.  Under the original proposals the government effectively gives the banks concerned a loan at an interest rate somewhat higher than the government itself pays (so making a profit on the difference), not taking management control as such except via the conditions linked to the purchase of the preference shares.  Under the revised proposals the government is very much involved as a ‘player’ – with ongoing involvement in day-to-day decision making. 

These two approaches are subtly but importantly different.  The first is rather similar to the way the Bank of England operates in setting exchange rate targets – government sets the target at the outset in the full glare of democratic accountability but then stays firmly hands off.  The second is, at first sight, more democratic but in reality it’s classic Labour, hands-on-the-levers-of-power.  However much Brown insists that the government-appointed non-exec directors are just that – not executive – they will have a disproportionate influence in transmitting Brownian wishes into routine management decisions at a level that stays far below any Parliamentary radar.  If Brown says (or even thinks), “jump” the board will have to be exceptionally strong-minded not to ask, “how high?”.  And Parliament will never know, not even that some issue was in play.

Under the preference share approach government has to make its mind up about conditions now then stick to them.  Key decisions are not difficult - the premium over the government’s cost of borrowing, director’s pay and bonus capped at, say, £250,000, until the preference shares are redeemed (Germany has imposed a cap of 500,000 Euros).  This would give directors a powerful interest in giving  taxpayers their money back ASAP so minimising risk.  This giving the money back ASAP is the approach taken with Northern Rock where over half has already been repaid.

Under the ordinary share purchase approach the government will find itself facing a ‘difficult’ election while enjoying massive de facto influence (if not outright control) of a huge pile of assets.  If Brown judges that a quick boom will improve Labour’s chances then a hint here and a nudge there will ensure that there is one by pouring these assets into schemes whose merit may be more political than financial.  And if these schemes can be spun to have wider social benefits then so much the better.  House building would seem to be the obvious way to tick all the boxes.

Already the government is showing its prediliction for political objectives in telling the banks that they must lend to house buyers and small businesses at the same rate as they lent to them in 2007 at near the height of the boom.   Government spokesman have been doing the rounds of the media trying to deflect criticism on this point by saying that they still expect the banks to be prudent lenders.  But that’s not what the government said earlier.  They could just as well have left this to the banks themselves; after all banks make their living my making loans to people and businesses so they can’t and won’t stop just like that.  There are still other banks out there who would be more than happy to pinch their best customers.

Brown needs to get this sorted quickly because, although necessary, this plan is not sufficient to get us out of this mess.  We need to be moving on fast to get ahead of events, and not trailing in their slipstream.

Banking rebooted – keep your fingers crossed

The banking and finance sector has just experienced the financial equivalent of the blue screen of death familiar to users of older versions of Windows. 

What Gordon Brown has done is the financial equivalent of a reboot involving part-nationalizing the major banks.  To give credit where it is due, this is undoubtedly the right approach.  This is a relief; as recently as last week Brown was talking only of liquidity issues (meaning roughly that banks had too much of their assets tied up in long-term loans etc leaving them short of ready cash for day to day operations) even as it was becoming increasingly obvious that (for some banks) there was also a solvency problem (meaning that they had lost so much on bad mortgages that they were bust).  

In such circumstances the only sensible option is to recapitalize the banks but how it is done also matters.  In the USA Paulson’s plan is to do it indirectly by buying bad assets off the banks for more than they are worth (as has the Spanish govt this week).  The banks’ profit on such deals gives them new capital, but the taxpayer gets nothing.  US taxpayers were right to be scandalized and to call this ’socialism for the rich’.  The alternative is to take preference shares (or equivalent) for direct injections of new capital which is what Brown has done.  It has the huge merit of giving taxpayers a big stake in any bank rescued, a big say over policy (including executive remuneration) and the very real possibility of a profit in due course when the govt eventually unwinds its position.

Will it work?  It should provided that global markets aren’t too spooked and panicky (which unfortunately may well be the case).  We will only know in a few days but the evidence will be that UK banks start lending to each other.   Keep praying, keep your fingers crossed or whatever you do; but don’t expect the stock market to recover any time soon – it’s falling in expectation of a pretty severe global recession, probably even depression. 

What if it doesn’t work?  Rinse and repeat, persuade others to do the same where necessary but don’t copy Paulson’s bad plan which already looks to be failing.

But, we should never have started from here.  While I am more than happy to give Brown his due for charting the best route out of this mess, he cannot escape responsibility for getting us into it in the first place.  It is the direct, and ultimately inevitable, result of the ‘market fundamentalist’ policies he and Blair have been following since 1997 and the Tories before that.