The Great Debate UK

Will the Tories come clean on public sector cuts?

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

In the movie “The Untouchables”, the cop played by Sean Connery brushes aside his sidekick’s assertion that he really does want to nail Al Capone with the response: “Yes, but what are you prepared to do?”

We should respond in the same way to the Shadow Chancellor’s public commitment to preserving Britain’s AAA status.

As I have argued before, it is not simply that these promises lack credibility unless they are accompanied by something far more specific than we have had so far from the Tories, it is also a matter of preserving the health of our ailing democracy.

All the indications are that the electorate are more alienated from our politics than ever before in modern times, not just because of the MPs’ expenses scandal, but also because of the near-suppression of debate on a number of hot-button issues: immigration, the war in Afghanistan, EU membership among others.

Now it seems the Conservative front bench agrees with the government that the question of where to cut public sector spending is another subject to be added to the banned list, at least till after the election.

Will they have the nerve to call the next phase QE2?

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

It is hard to be too pessimistic about the economic outlook for the rich countries, and impossible as far as the UK is concerned. With every day that passes, it becomes clearer that, far from being out of the woods, we are once again plunging into recession and possibly crisis.

Wednesday we had news that in Germany, the least-indebted, and apparently best-balanced of the big industrialised countries, one of the largest banks has reported write-downs exceeding forecasts for the final quarter of 2009, and the well-respected IFO Institute is reporting an unexpected fall in business confidence.

In both the UK and the U.S., the index of confidence fell this month – but that is far less surprising, as the penny drops that both are economic basket cases.

There are two ominous sign. In the housing market, where the crisis started, the green shoots of recovery that were spotted by the Prozac-poppers in the equity markets appear to be withering fast. In fact, after an artificial boost due to concessions on stamp duty, the UK’s Council of Mortgage Lenders reckons gross lending in January was 20 percent below its level 12 months ago at what many people thought at the time was the low point of the crisis. Stand by for another fall in house prices.

With one black cloud apparently returning, another is already darkening the horizon. In the post-Lehman panic, investors rushed to buy “safe” government debt, apparently failing to notice that Washington and London are to thrift what Las Vegas is to moral philosophy. In gratitude for this vote of confidence from the bond markets, both the UK and U.S. administrations decided to party as if the world were coming to an end, which in a sense is what now seems likely to happen, as investors wake up to the realisation that 4%+ is a meagre reward for a 20-year loan to Obama, Brown or their likely successors.

The lack of transparency would shame a Chinese or Japanese multinational. In effect, quantitative easing – verbal camouflage for “printing money” – amounts to issuing new Pounds and Dollars so as to buy back the Government’s own debt, which would be an exercise in futility if markets were remotely rational.

Bankers’ bonuses: the fish stinks from the head

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

The awful thing about lynch mobs is they so often hang an innocent man, leaving the guilty totally untouched.  In the case of the banks, the danger is acute.  As I have already argued, hedge funds and private equity are being unfairly targeted, especially in Europe. But there is another, even less popular class which is likely to end up in the firing line, for no good reason and with consequences which could be damaging for all of us.

Broadly speaking, the banks pay 6- and 7-figure bonuses to two quite different sorts of people. First, there is a layer of what we might call technocrats: the striped-shirted traders of legend, with their loud voices and even louder dress codes, along with the managers who try to control them, the quants who invent complex trading strategies and price exotic new instruments, and a variety of others with specialised skills. Since they are rewarded in proportion to the profit they generate for their employer, which can usually be measured with considerable accuracy, their bonuses are often very large indeed. The question is: should we treat these professionals who trade on their expertise and who heavily outnumber senior management in the same way as their bosses? Not as far as I can see.

However unpopular these market professionals might be, I can see no reason whatever for intervening to limit the rewards their expertise earns for them. Arguments about “justice”, “fairness” and “ethics” are irrelevant, especially when they rely on judgements about lifestyles.

Fairness is no criterion for determining pay scales, unless we are also willing to limit the earnings of rock stars, footballers, best-selling novelists…..that is the way to the madhouse (and the collective farm).  The market sets a high price on rare skills, and in a competitive world, any attempt by a single country to restrict that price will result in it losing those skills and the business that goes with them.

No, anger about bank pay levels ought to be directed exclusively at senior management, where the key decisions which brought down the banking system were taken. Merging high street banks with investment banks, securitising mortgages so as to expand balance sheets by borrowing in wholesale markets instead of relying on deposits for funding, leveraging up to and a long way beyond the prudential limit, relentless empire-building that turned Citibank, RBS, HBOS into monsters with balance sheets on the scale of middle-ranking UN member countries – all these catastrophic decisions emanated from the boardroom, not the trading floor. The guilty men were handsomely rewarded for running their banks on to the rocks and, just to add insult to injury, are in most cases now extracting large rewards for salvaging the wreckage! This is the problem, and in my view the only problem, with bank bonuses.

Even before the crisis, it was hard to justify the rewards they earned. Their marketable skills are not always apparent, since they are not always professional bankers themselves –some have spent most of their careers in other industries. It is extremely difficult to measure their contribution to profit, which is precisely why their remuneration packages often involved options with payoff patterns based on highly controversial computations of how well the bank’s shares perform. If their remuneration packages looked over-generous before the crisis, they must be totally indefensible now “après le deluge”.  Can anybody seriously believe that paying more modest salaries would have resulted in even worse mismanagement?

Is a queue forming at the EU’s fiscal soup kitchen?

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Back in the prehistory of the euro zone, I wrote an article in the Times trying to work out how the game currently being played out in Europe would end.

Re-reading it, I think on balance I stand by my 1997 forecast.

Of course, back then it seemed far more likely that the major default threat would come from Italy or Belgium – Greece wasn’t even a member (and seemed unlikely at that stage to be admitted), but otherwise the endgame still looks the same to me.

The situation is as follows. Greece’s national debt is over 110 percent of its GDP, a figure which is growing by 12 percent or more every year (we cannot be sure, because there is widespread suspicion that the government is understating its deficit).

Given that Latin American countries have been often defaulted with far lower levels of debt, the markets are worried – which is hardly surprising, since Eurozone members are in exactly the same situation as third-world countries borrowing in dollars.

It cannot be emphasised enough that, at least in principle, the euro is nobody’s domestic currency, in the sense that no national government or central bank has the right to print it in order to repay its debts. Printing euros is the sole prerogative of the European Central Bank and its governing council, made up of representatives of all the euro zone member countries.

Glass-Steagall Lite, brewed by Volcker, served by Obama

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

Let me say at the outset that I am far from enthusiastic about either of President Barack Obama’s major policy initiatives: healthcare reform and the banking reform plan announced on Thursday.

But both cases are truly momentous, because both are tests of whether America is an imperfect democracy (like all the others) where government by the people eventually works, more or less, or a totally dysfunctional oligarchy.

Each initiative involves a confrontation with powerful vested economic interests whose lobbyists will no doubt fight long and hard in public and even longer and harder behind closed doors to block the changes.

The only difference between the two cases is that, while there may always have been significant popular opposition to the healthcare reforms, the need to “do something” about Wall Street is almost universally accepted on Main Street.

So if Congress blocks bank reform, it will represent a signal triumph of the lobbyists over the popular will.

Why we need a bond market crisis

Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

The spirit of Britain’s Christmas is looking disconsolate this morning. Santa Claus has failed to deliver what our democracy most needed. No, not a deal to let the French have the 2012 Olympics in exchange for a bottle of Beaujolais Nouveau.  Nor the nomination of Tony Blair for the Nobel Peace Prize. Number one on this year’s wish list was something more realistic, and maybe far closer:  a gilt market crisis.

To see the consequences of Santa’s negligence, consider the outlook for 2010. At present, the two main parties have adopted wait-and-see policies for dealing with a budget deficit approaching £200 billion or about an eighth of our GDP.

Neither is proposing to do anything serious until after the election, due no later than May. At most, we have had government promises about what spending would be sacrosanct, leaving us to imagine for ourselves the devastation that will have to be inflicted on whatever is not ring-fenced.

In the face of Labour’s trust-us-till-after-the-election stance, the Tories have felt little pressure to say what they themselves will do if they form the next government.

If no outside force intervenes, the  electorate will be faced with a choice between two parties neither of which is offering any programme for dealing with the biggest economic problem the country has faced since 1945, so that whoever wins the election will have no clear mandate for restoring fiscal balance.

In the unlikely but not impossible event that Labour wins, its supporters will interpret the victory as a vote against substantial cuts, so they are bound to feel aggrieved when the new government proceeds to slaughter their most sacred cattle.

2010: Another year, another crisis

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

If the financial crisis were a theatre production of Hamlet, we would now be at the end of Act III.

But look . . . the audience is already standing up, applauding wildly and putting on their coats. They obviously think it’s all over. Little do they know how much blood remains to be spilled . . . Look at the facts.

The FTSE is up by nearly 50 percent since March, so that it is now more or less back to where it started 2006.  The same is true of gilts, corporate debt, and more or less every other financial asset on both sides of the Atlantic and across the globe. Even the housing market, where it all began, seems to be reviving.

So the crisis must be over, right?

But the jubilation may be premature, because, since Lehman Brothers collapsed in September 2008, policymakers have used every conceivable tool of monetary and fiscal policy so as to restore the status quo ante. Indeed, the success or failure of these policies has largely been judged by the criterion of how far the numbers look normal – where the norm has been redefined to mean “similar to the levels of 2005 and 2006”.

In these terms, the policies, especially quantitative easing, have been extremely successful. In many respects (not just bankers’ bonuses), the clock has indeed been turned back to 2005.

Why Baroness Scotland has to go

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

“Lilies that fester smell far worse than weeds” Shakespeare, Sonnet No. 94

The Bard’s words sum up one of two reasons why the Attorney General, Baroness Scotland, ought to resign in response to being fined 5000 pounds for employing an illegal immigrant in her home. We have a right to expect nothing but the highest standards from any government officer, especially the country’s top legal officer.

However, the lilies-that-fester issue is not the only one involved here. Although this case may not look to most people as serious as many of the scandals of recent years, it has an additional dimension which is absent from run-of-the-mill cases of ministers (or judges or senior policemen) caught exceeding the speed limit or cruising a red-light district.

Just look at the excuses being wheeled out on behalf of the Baroness. They all amount to saying that the law as it currently stands makes demands on prospective employers that are so bureaucratic, time-consuming and complex that nobody should be surprised if even the Attorney-General, with all the resources at her disposal, gets it wrong.

If this is the case, it is an appalling state of affairs, and, far from strengthening the defence, actually makes the case for her departure unanswerable. After all, it may be possible to argue that the average person cannot be expected to conduct a thorough investigation of the residence status of every child-minder, window-cleaner or gardener they employ (though, if this is conceded, 5000 pounds might sound like an unjustly harsh penalty for anyone earning less than the Attorney-General!).

But can the same defence be mounted for the head of the country’s legal profession, given that she is not only a member of the government, and as such ought to take her fair share of the responsibility for creating this bureaucratic nightmare, but that she is also reported to have had a hand in drafting the law?

It’s all over: The banks have won

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

There is so much talk of a new regulatory framework for the financial sector, anyone would think it was an important issue.

Unfortunately, it is almost irrelevant, for the simple reason that, however sophisticated the new regime, experience shows it will be bypassed and/or captured by banks of one kind or another, possibly by novel types of institution invented specially for the purpose.

This is true even in the unlikely event that the whole world – with the possible exception of North Korea – embraces the new regulations and enforces them with vigour.

The only type of intervention which has a hope in hell of success is one based on size. As Mervyn King has said, when a bank is TBTF (Too Big To Fail), it is just too big.

What is needed is breakup along functional (and, where necessary, geographic) lines, separating the boring but essential utility business of deposit-taking and payment-transfer from the exciting risk-taking of investment banking. A once-and-for-all breakup would have to be followed by continual monitoring, to ensure that takeovers and mergers did not breach the size limit and take us back to the TBTF dilemma.

The aim should be straightforward. If banks were cut down to manageable size, the taxpayer’s liability could be limited to deposit insurance alone. Banks could be allowed to fail in the same way as firms in other industries and would no longer be able to hold Governments or central banks to ransom, as they have repeatedly done in the last twenty or thirty years.

Re-entry dilemma for G20 ministers

- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

As the G20 ministers gather for their meeting this week, there should be no doubt about the item at the top of the agenda: the re-entry problem. At what point should the expansionary monetary and fiscal policy of the past year be reversed? And, if the answer is “not yet”, how soon does the re-entry plan need to be announced?

Since nobody is quite sure how much of the current worldwide economic recovery is a direct or indirect result of the various stimulus packages, quantitative easing, cash-for-junk-vehicles and cash-for-junk-bond schemes, it follows that nobody can be sure whether or when it is safe to reverse the fiscal expansion.

But leaving it too late to retrench will hand the decision over to the bond markets. They will be looking for reassurance from the major debtor countries that both versions of the default scenario can be ruled out.

An outright default, probably camouflaged as debt renegotiation rather than repudiation, becomes politically more acceptable than the package of expenditure cuts and tax rises needed to carry on with repayments.

A more likely scenario sees the lenders repaid in devalued currency, as the debtor country achieves the same outcome by printing money so as to generate inflation –- an option always open to any country whose debts are denominated in its own currency (i.e. not to Eurozone members).

So far, the markets have given the United Kingdom and the United States the benefit of the doubt, trusting them to come up with a plan gradually to cut their spending over the next few years.