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from Breakingviews:

Mervyn King’s mini mea culpa is missed opportunity

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

“Don’t blame me, blame the banks.” That, in a nutshell, is Mervyn King’s assessment of Britain’s most severe recession for seventy years. The Bank of England governor admitted in his radio lecture to not shouting loudly enough about financial risks. Yet his retrospective largely ignored the many criticisms of central bank policy, after as well as before the crisis. That’s a missed opportunity.

Anyone who tuned in expecting new insights about the financial crisis will have been disappointed. King offered a conventional - and partial - explanation of what went wrong: banks became risky, interconnected and too big to fail. When the financial system wobbled, taxpayers and central banks were able to avert a total collapse, but not a severe recession. Even King’s mea culpa came with an excuse: because the central bank was stripped of responsibility for regulating banks in 1997, it could not intervene directly.

King’s praise of pre-crisis monetary policy was especially baffling. The governor insisted that the central bank had got it about right, because there was “a bust without a boom”. That totally ignores the giant debt-fuelled property bubble that helped bring about Britain’s subsequent economic woes. And if the Bank of England was broadly correct before, why has it set up a Financial Policy Committee, chaired by the governor, which is seeking far-reaching powers to prevent future bubbles?

King may have felt that a radio broadcast, the first such peacetime address since 1939, was not the best forum in which to explore such contradictions. Besides, Federal Reserve Chairman Ben Bernanke and former European Central Bank President Jean-Claude Trichet have hardly been more apologetic. And lack of contrition has so far proved a successful strategy. The Bank of England has emerged from the crisis more powerful than ever, while the Financial Services Authority, which has completed several painful self-examinations, has been dismembered.

Such stubbornness may yet backfire. The Bank of England is under intense pressure for its expanded responsibilities to be combined with greater transparency and accountability. King’s self-congratulatory revisionism will only embolden his growing band of critics. The governor’s successor, who is due to take over in July 2013, may face greater restraints.

from Breakingviews:

The Bank of England needs a home-grown governor

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Must the governor of the Bank of England be English? That’s the intriguing question raised by a report that Mark Carney, the governor of the Bank of Canada, has been sounded out as a possible replacement for Mervyn King, who is due to retire next year.

In most other developed countries, the question would not even arise. It’s inconceivable that, say, an American could be head of the European Central Bank, or that the Federal Reserve would choose a German or Chinese chairman.

The UK is different. It has long shown an admirable willingness to install foreigners into senior positions. Almost half the chief executives of the constituents of the FTSE 100 index aren’t British. Quintessentially English sporting events like Wimbledon and the Oxford-Cambridge boat race are dominated by foreign contestants. Even England’s national football team was, until recently, managed by an Italian.

But such internationalism has its limits. The governor of the Bank of England is no faceless technocrat; he is the most powerful non-elected official in the country. The job has become more powerful, and more political, since the financial crisis. The central bank has embarked on a controversial bond-buying spree and is set to receive sweeping new powers for regulating banks and pricking future financial bubbles.

The governor will be at the very heart of economic and social policy. King has been rightly criticised for the Bank of England’s lack of transparency and accountability. The last thing his successor will need is a row over nationality.

from Global Investing:

Three snapshots for Wednesday

Spanish house prices fell 7.2 percent in the first quarter from a year earlier while Spanish banks' bad loans rose to their highest level since October 1994 (see chart).

The Bank of England is poised to turn off its money-printing press next month. Minutes of the Bank's April meeting, combined with a stark warning on inflation from deputy governor Paul Tucker on the same day, signalled a sharp change in tone that could bring forward expectations for interest rate rises.

Does the E in PE need a reality check too?

from MacroScope:

Central bank balance sheets: Battle of the bulge

Central banks across the industrialized world responded aggressively to the global financial crisis that began in mid-2007 and in many ways remains with us today. Now, faced with sluggish recoveries, policymakers are reticent to embark on further unconventional monetary easing, fearing both internal criticism and political blowback. They are being forced to rely more on verbal guidance than actual stimulus to prevent markets from pricing in higher rates.

How do the world’s most prominent central banks stack up against each other? The Federal Reserve was extremely aggressive, more than tripling the size of its balance sheet from around $700-$800 billion pre-crisis to nearly 3 trillion today. Still, the ECB’s total asset holdings are actually larger than the Fed’s – it started from a higher base.

The Bank of England, for its part, went even deeper into uncharted territory, with its assets as a percentage of GDP surpassing the Fed’s. By the same measure, the ECB has overtaken the Bank of Japan, which has been grappling with deflation for some two decades and started from a much higher level.

Taken together, the expansion in reserves is impressive – and speaks to just how deep the global recession proved to be.

from MacroScope:

Who’d be a central banker?

The focus is already on the euro zone finance ministers meeting in Copenhagen, starting on Friday, which is likely to agree to some form of extra funds for the currency bloc's future bailout fund. What they come up with will go a long way to determining whether markets scent any faltering commitment on the part of Europe's leaders.

In the meantime, top billing goes to Bundesbank chief Jens Weidmann speaking in London later. He is heading an increasingly vocal group within the European Central bank who are fretting about the future inflationary and other consequences of the creation of  more than a trillion euros of three-year money. There is no chance of the ECB hitting the policy reverse button yet but the debate looks set to intensify. A combination of German inflation and euro zone money supply numbers today (which include a breakdown on bank lending) will give some guide to the pressures on the ECB.

Central bankers face a very mixed picture with U.S. recovery and high oil vying with the unresolved euro zone debt crisis and signs of slowdown in China.

Bank of England Governor Mervyn King was sitting firmly on the fence yesterday, saying he did not know whether more QE would be required in Britain or not. Tellingly, he also did not know whether euro zone policymakers will take advantage of the window of opportunity offered them by the ECB or not. King illuminated a common theme coming from central bankers, saying the onus was firmly on the politicians now, while his colleague Adam Posen noted that the reason Britain’s recovery has lagged America’s is because of the former’s tough austerity measures. That’s another debate that is echoing around the euro zone. In the States, Bernanke said it is too soon to declare victory in the U.S. economic recovery.

Back to the euro zone and Spanish media was alive with reports that the EU was pressing Madrid to take a bailout to recapitalize its wobbly banks. The denials from both centres were so emphatic that it seems not to be true. It seems  EU Competition Commissioner Joaquin Almunia spelled out three options to clean up Spain's banking sector: using Spanish public funds, finding private investment or applying for European aid.  Journalists present leapt on the latter. That may well become true in the end ... but not yet.

Spain faces a general strike on Thursday while Prime Minister Mariano Rajoy is promising Friday's 2012 budget will deliver eye-watering austerity for a country already sinking back into recession.

from Breakingviews:

UK’s bubble-prickers seek iron grip on banks

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Britain’s bubble-prickers are aiming high. The Bank of England’s new Financial Policy Committee, which is charged with averting future crises, has asked the government for sweeping powers to rein in banks, insurers and fund managers. Even if it doesn’t get everything it wants, the FPC will clearly have muscle. The snag is that it has few ideas for solving the most pressing current problem: excessive risk aversion.

Most of the FPC’s wish list is pretty sensible. It wants to set and vary banks’ counter-cyclical capital buffers - the tool specifically designed to allow regulators to “lean against the wind” of excessive exuberance or caution. It also wants to control the size of banks’ balance sheets by setting the leverage ratio, which measures equity as a proportion of total assets. And it wants to be able to apply its powers to any regulated entity, including insurers and investment funds. That should allow it to quickly whack risk-taking that shifts from banks to other parts of the system.

More troublesome is the FPC’s desire to vary capital ratios for lending to different sectors. Such micro-management could undermine investors’ already-fragile confidence in the accuracy of banks’ ratios. It is also hard to reconcile with the European Commission’s efforts to ensure that new capital rules are applied consistently across the European Union.

True, the proposed tool would have allowed regulators to rein in banks’ property lending during the last bubble. However, the same aim could be achieved more easily by capping loans as a proportion of the value of a property, or a multiple of the borrower’s income. Sadly, the FPC appears to have concluded that demanding such powers is a political non-starter.

A more pressing problem, however, is that the FPC’s proposed powers are asymmetric: they are much better suited to tackling exaggerated optimism than in countering the undue caution currently gripping Britain’s economy. This tension is evident from the minutes of FPC’s latest meeting: it concluded that UK banks should raise capital to further strengthen their buffers, even as the government attempts to stimulate the flow of credit to small businesses and housebuyers. Even if the FPC gets the tools it wants, it could be years before they are used.

from MacroScope:

A Very British Budget

Today we get the what could possibly be the most pre-spun British budget ever, though don’t rule out the traditional “rabbit from the hat” surprise so beloved of British finance ministers.

The important stuff for the markets is that with ratings agencies still threatening to rob Britain of its AAA status, it will be pretty much fiscally neutral – i.e. no serious economic stimulus on offer – borrowing will have come in  a little lower than expected this year and the government’s independent forecasting body will predict the economy will eke out just enough growth this year to avoid a new recession.

In other words, don’t expect much market reaction, though the fact the slightly lower borrowing may allow slightly lower debt issuance in the coming year could give gilts a small fillip.

With precious little in the coffers this will be a deeply political budget, balancing the twin needs of a centre-right/centre-left coalition, despite U.S. Treasury Secretary Geithner’s warning this week about the futility of austerity for austerity’s sake.

So what does a chancellor of the exchequer do with little or nothing to spend? In economic terms, he tinkers. That is not to say that tinkering might not be politically explosive.

We’re told George Osborne will cut the 50 percent top rate of income tax, although maybe not immediately, balancing that by lifting more poor people out of the tax net altogether, slapping a higher purchase tax on houses worth more than 2 million pounds and pledging to crack down on the wealthy who avoid tax. Will the latter measures be enough to neuter the accusation that the Conservative party – the dominant one in the government – is not merely helping out its core constituency? I’d be amazed if that isn’t the tack taken by the opposition Labour party and even by some Liberal Democrats, the minority coalition partners.

Osborne’s gamble is presumably that with Labour not making much headway with its argument that austerity is wrecking the economy, now is the time to make bold decisions on tax which will delight his party’s base. The LibDems, already eviscerated in the polls, are probably in the most uncomfortable position; in a government cutting taxes at the top end, something many of their supporters will despair of. They’ll put a brave face on it. The last thing they need is to collapse the coalition and force an early election at which they could be all but wiped out in parliamentary terms.

from MacroScope:

There be feudin’ at the BoE

The once-good relationship between Bank of England Governor Mervyn King and his most likely successor, Deputy Governor Paul Tucker, is coming  under increasing strain, according to a new book by former Daily Telegraph journalist Dan Conaghan.  It  alleges   King’s management style and and alleged disdain for the financial markets is to blame.

While the Bank of England’s Monetary Policy Committee remains reasonably collegiate, on other matters King more than lives up to the description from former chancellor Alistair Darling that he is ‘incredibly stubborn’, says Conaghan, who now worksas an asset manager.

“The governor can be particularly dogmatic,” he told Reuters. “One of the key things … is the attitude to the capital markets. One of my sources described Sir

Mervyn’s attitude as one of disdain. I’ve heard that repeatedly. Paul is much more pragmatic.”

One tangible upshot of this came at the launch of the Bank’s quantitative easing programme in March 2009, which Conaghan said led to an upsurge in failed trades on the British government bond market, until the central bank found a mechanism to lend back some of the gilts it had bought.

More broadly, Conaghan’s book The Bank: Inside the Bank of England describes something approaching a feud growing out of a philosophical split between King – who champions a purist, economics-driven approach – and Tucker, who is closer to financial market participants.

“It is widely acknowledged within the Bank’s upper echelons and elsewhere that the relationship between King and Paul Tucker … has deteriorated over the past few years. One very senior figure at the Bank describes it as being, at times, ‘a battle-ground,’ where the battles over policy, direction and structure are common. Another senior official at the Treasury concedes that they ‘do not get on, to put it mildly’.”

from Global Investing:

Financial repression revisited

At a monetary policy event hosted by Fathom Consulting at the Reuters London office today, former Bank of England policymakers were discussing the pros and cons of "financial repression".

Financial repression is a concept first introduced in the 1970s in the United States and is becoming a talking point again after the financial crisis, especially with a NBER paper last year written by economists Reinhart and Sbrancia reviving the debate.

In the paper, authors define financial repression as follows:

Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression”.

Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.

Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real

from Breakingviews:

UK banks need government to solve funding squeeze

By George Hay The author is a Reuters Breakingviews columnist. The opinions expressed are his own.The Bank of England is tooling itself up. The UK central bank announced on Dec. 6 a new facility to help domestic lenders if the euro zone crisis causes a fully-fledged freeze in short-term funding markets. But banks may still need more help.

The BoE already has two ways to combat liquidity squeezes. It allows banks to borrow against liquid collateral for three or six months through its Indexed Long-Term Repo (ILTR) auctions. And it allows desperate banks to swap illiquid collateral for gilts for up to a year via its Discount Window Facility (DWF) – in return for a fat fee and big haircuts.

In some senses, the new Extended Collateral Term Repo facility (ECTR) is a halfway house. It uses a similar auction structure to the ILTR but allows banks to pledge DWF-style collateral for a minimum fee of 125 basis points over the BoE’s base rate. As such it goes some way to filling the gap left by the now-defunct Special Liquidity Scheme (SLS), the crisis facility which allowed UK banks to swap illiquid mortgage-backed securities for liquid Treasury Bills for a period of up to three years.

However, the ECTR will only last for thirty days at a time. That may help avoid a collapse, but won’t provide much long-term reassurance. Contrast the BoE’s approach with the European Central Bank, which is currently being pressured to offer facilities that last for two or even three years. Even though the UK is not in the euro zone, its banks are suffering from the same long-term funding drought as their rivals on the continent. That’s worrying because, according to the BoE’s own figures, UK lenders have to roll over 140 billion pounds of term funding next year.

But the central bank has rightly judged that providing long-term bank funding is not its job. That is a task for the UK government, which could re-open its Credit Guarantee Scheme, a 250 billion pound programme that allowed banks to weather the 2008 crisis by issuing new long-term debt insured by the state.

Unlike many European countries, a UK sovereign guarantee still carries credibility – 10-year gilts are currently yielding just 2.3 percent. Now that the BoE has donned its fire-fighting kit, HM Treasury should tool up as well.