The Great Debate UK

Hypocrisy piled on humbug

The row over bankers‘ pay and honours has presented the depressing spectacle of British public life at its nadir, with hypocrisy piled on humbug.

On the one hand, we hear bankers and their apologists arguing that their rewards are required to keep them from running off to sunnier climes, which prompts a number of questions. First, when bankers claim that they have to be paid a fortune in recognition of the size of the organizations they run, we may well ask: how many banks of this scale are there in the world today? How many are so hungry for skills like those of Britain’s bank bosses that they are willing and able to offer these sorts of rewards?

Three or four, maybe, at most – after all, several of the world’s largest banks are now owned by the Chinese Government, so they are unlikely to want a British boss any time soon, and the others do actually have a full management complement anyway. By definition, the number of vacancies at this level is extremely limited, so the danger of an exodus of top British bankers is much exaggerated.

In any case, does it really matter?

After all, even before the crash, there was quite a lot of sniping at high City payoffs and we were told at the time that the outrageous salaries and bonuses were needed to secure the services of people like (Sir) Fred Goodwin et al – and since then we have had ample opportunity to assess the true value of their high-price expertise.

Is it really being suggested now that the banks collapsed because pre-crisis pay rates were insufficient to attract competent CEO’s?

Or is the argument that, if they had paid less astronomic salaries, the banks would have lost even more money than they actually did in 2008-9?

from Global News Journal:

Hope and Fear at the World Bank

It was early March and Kristalina Georgieva, the European Commissioner of International Cooperation Humanitarian Aid and Crisis Response, was traveling in Asia. Her plan was to attend a 7.5 magnitude earthquake simulation that would hit Indonesia and generate a tsunami. A few things, however, changed in her itinerary: The destination turned out to be Japan, the earthquake was 9.0 and it not only generated a huge tsunami, but also a nuclear catastrophe. Plus, it was real.

“Usually our fears are bigger than reality. In this case our reality was worse than our fears,” Georgieva said recently at a World Bank panel on the climate, food and financial crises the world is facing today and the way they all intertwine. Georgieva’s strong Slavic optimism brightened the gloomy panel, but the data she threw in didn’t back up her positive view:

Hold on for a second. How can these disasters have such a devastating impact on us when cutting-edge technology, extensive knowledge and interconnectedness are here to help us mitigate them?

This question left the representatives of Uganda – who followed the event via webcast -- puzzled. So they raised the simplest but toughest question for the panel:

“We seem to know the problem and we also seem to know the answer. The question is then: Why are we not responding?”

No one on the panel disagreed with World Bank’s managing director, Ngozi Okonjo-Iewala, who wasn’t shy to name those she blamed and to evoke “the fear of God” in them:

Will the euro survive Europe’s latest sovereign debt crisis?

Kathleen Brooks is research director at forex.com. The opinions expressed are her own.

Ireland’s banking crisis reached boiling point this week. The Irish authorities are still adamant the country doesn’t need a bailout and are trying to draw a distinction between a sovereign bailout (which Irish Prime Minister Brian Cowen, Finance Minister Brian Lenihan et al claim they don’t need) and banking sector support (which they most definitely do).

Regardless of the semantics, it seems highly likely that Ireland will receive funds from the EU and the IMF possibly by the end of the week. With Ireland likely to be the second member of the Eurozone to require financial assistance in six months, it brings into question the “no bailout” clause in the European Union treaty.

2010 has been the year when Europe’s grand project was fundamentally altered, but where does this leave its most precious commodity – the euro?

Some argue that the precarious financial position of the peripheral nations is evidence that the European project did not work. Interest rates that were too low caused debt bubbles in the fast-growing peripheral nations that eventually burst. Cleaning up the mess is costing billions of euros, the European Financial Stability Fund – which is designed to provide “temporary” financial support to member states in financial difficulties will guarantee 440 billion euros of liabilities. And austerity measures for these nations will crimp growth for many years to come.

While the fund may be able to cope with the claims of Ireland and Greece, it could not cope with those of Spain, another debt-laden southern European economy that is at risk from bond vigilantes once the focus shifts from Ireland’s woes. If Spain was to require financing in the coming months then it would come down to Germany, as the largest economic force in the Euro zone, to cough up more cash. Angela Merkel certainly doesn’t seem to have the political will to “donate” any more money to bail out its Eurozone peers, and if the funds are not there then a situation where Spain is “too big to bail” could break the Eurozone and cause the demise of the Euro.

But we believe this is an extremely unlikely scenario. So what is a more realistic conclusion to the current crisis in Europe? At the moment, it appears that Ireland will receive some form of financial assistance, which will reduce the near-term risks of an Irish default and should calm the markets. But on a more fundamental level, the Irish crisis has shown the political will in Europe to keep the Union afloat. Ireland has been pushed to accept financial assistance from all corners of Europe in an attempt to calm the markets and stop contagion in other fiscally challenged members like Portugal and Spain.

from Breakingviews:

Bush still shows blind eye for financial crisis

By James Ledbetter

During his presidency, George W. Bush was not known as an overly reflective man, or as someone with a powerful thirst for economic knowledge (despite being the only president with a Harvard MBA). It is thus unsurprising that his memoir is not overly reflective about the causes of the financial meltdown that closed out his presidency, nor even very generous with details about what it was like to preside over. Anyone who opens his new memoir, "Decision Points," intent on unearthing Bush's heretofore buried financial insights will be disappointed.

Still, there is some value in glimpsing how Bush perceives the crisis, in part because his economic perspective is so widely shared in the newly resurgent Republican Party. In the chapter devoted to the financial crisis, Bush paints an economic picture using almost exclusively his favorite primary color: tax cuts. Tax cuts, in his view, got America out of the recession that began shortly after he took office. Tax cuts provided another critical boost in 2007. Tax cuts are beautiful because they take money out of the government's hands and place it into citizens' hands; that is all Bush knows, and all he thinks he needs to know, about the economy.

Just about everything else can be delegated, which is to say ignored until it explodes. As he recounts the reasons why the financial system fell apart -- the complexity of Wall Street's mechanics, the booming housing market, overleveraging -- he says the system was "fated to collapse," but admits that he didn't see it at the time. (In another section, he claims he did see the problem of overleveraging at Fannie Mae and Freddie Mac, but that his reform efforts were blocked by Democrats.) His curiosity did not increase very quickly; Bush professes to have been "surprised by the sudden crisis" when Bear Stearns was sold at a forced bargain price in March 2008. He clearly had no idea what caused the problems at American International Group in September of that year.

More telling is his admission that when Federal Reserve Chairman Ben Bernanke told him the crisis could be the worst since the Great Depression his reaction was that he would rather be Franklin D. Roosevelt than Herbert C. Hoover. Yet his refusal to even consider that his administration's, or the Fed's, policies might have contributed to the crisis is distinctly Hooverian. About as close as Bush gets to anything approaching taking responsibility is an admission that "my administration and the regulators underestimated the extent of the risks taken by Wall Street."

As for the height of the crisis, Bush is hardly the first official to say that government intervention -- including the Troubled Asset Relief Program, the rescue of Bear Stearns and bailouts of Fannie Mae, Freddie Mac and AIG -- offends his free market sensibility, but had to be done to prevent bigger disasters. Indeed it is striking, and perhaps a boon, that the former president who writes so repeatedly and weightily about the need to stand up for principles in places like Iraq and Afghanistan could so willingly toss them aside when it came to financial rescue. This only reinforces, however, the impression the book conveys that Bush has few economic principles aside from the belief in lower taxes.

There is one other section of the memoir with economic implications, in which Bush discusses his failed attempt to reform Social Security. It may surprise some that he calls this "one of the greatest disappointments of my presidency." Bush deserves credit for calling attention to the looming insolvency of this entitlement program, as well as the unequal ways that it is administered. Yet he seems unwilling to accept that the bipartisan rejection of his plan stemmed not merely from political pandering -- there was plenty of that -- but from the fact that his proposed cure was quite possibly worse than the disease.

from MacroScope:

The octopus and the economists

What do an eight-legged creature in an aquarium in Germany and 74 economists have in common? The consensus view that Spain would claim the World Cup -- until the economists, as they so often do, changed their minds.

If World Cup 2010 goes down as one of the most unpredictable and exciting competitions in recent history, bringing underdogs Holland and Spain to the final showdown, what was hopelessly routine was watching so-called expert opinion converge around the safest bet. At least among financial professionals, who have done so well of late predicting the future.

When Reuters first surveyed economists and forecasters in May on which team would be kissing the golden grail on July 11, 2010  in South Africa, it made for interesting reading. Spain would take it -- by a narrow margin, it has to be said -- followed by Brazil, Argentina and England. Improbable probability analysis, perhaps, but not boring.

Then as various teams got knocked out of the competition -- former champions Italy, France, and England -- in a miserable and well-deserved defeat to Germany, Reuters re-polled these same economists and a few more for good measure. And that's when they fell flat. Those brave forecasters slipped back to the easy choice, and as a group they picked Brazil. We all know what happened to them.

It's hard enough to accurately predict where GDP growth is headed, where a currency will trade, or where interest rates will go, let alone who's going to win a major sporting tournament. But what the economists should have done was go with their gut and hang on to their convictions instead of revising their views with each little new development, as they so often do.

But for all those last-minute changes, it has to be said the economists were better at it this time around than in 2006. Back then, fewer than 10 percent of them predicted Italy would win -- about the same proportion who managed to predict the biggest financial crisis in generations.

A history lesson for lenders

-Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own.-

Anyone looking for a broader perspective on the events of the last three years could hardly do better than choose for bedtime reading “This Time is Different” by Carmen Reinhart and Kenneth Rogoff.

It is nothing less than a history of financial crises through the ages, starting in late medieval England and continuing via 15th and 16th century Spain and its New World colonies on to the teething problems of Britain’s banks in the industrial revolution and the upheavals of the 20th century, ending in 2008 with the bankruptcy of Lehman Brothers.

The emphasis throughout is on sovereign default. For many politicians, bankers and economists, it ought to read not just as a lesson, but as a severe rebuke, because its basic message is that there is nothing new under the sun and that financial history reads like a long catalogue of facts we have chosen to forget.

So, as the authors show, no country’s history is free of bank collapses, sovereign defaults and currency debasement in one form or another.

Many countries have been serial defaulters, and – surprise, surprise! – the recidivists include some of today’s shakiest sovereigns, notably Greece (which went bust several times in the first decade or two after it gained its independence in 1821, and has never in its history merited a good credit rating) and Spain, which after many defaults in the pre-industrial era seemed until relatively recently to have reformed.

Financial Crisis Part II

- 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. -

Hollywood would never allow a record-breaking disaster movie to go without a sequel. The same seems to be true of the 2008 banking crisis.

In the end, the Greeks are going to get some kind of bailout – of that, we can be absolutely certain, because European policymakers are afraid that Greece could be Europe’s Lehman-AIG.

The resistance of the German Government has been undermined by the dawning realisation that a Greek default would be a major blow to its own banks, which own around 45bn Euros of Greek sovereign debt. Taken on its own, I suspect that would not be enough to persuade Frau Merkel to brave the wrath of her electorate on behalf of the Greeks, but the clincher is the fear that the contagion could spread.

It turns out that, for the last ten years, the German banks have been accumulating a vast stock of the riskiest sovereign debt in Europe – encouraged no doubt by the assurances enshrined in the banking regulatory framework that one Eurozone member country’s debt is as safe as another, so that they may now have nearly a trillion euros of bonds issued by Spain and Portugal alone.

If bailing out Greece can prevent Iberian default, it could be dressed up as a bargain for all concerned.

In short, the so-called sovereign debt crisis is actually a European banking crisis. Germany is unwilling to bail out the Greeks, but it feels it has no choice but to bail out its own banks.

Greenspan and the curse of counterfactual

- 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. -

Suppose that, instead of appeasing Nazi dictator Adolf Hitler at Munich in 1938, Neville Chamberlain had taken Britain to war, what would today’s history books say about the episode?

It is of course impossible to know. Perhaps something along the lines: “the British prime minister’s stubborn refusal to compromise resulted in a war which dragged on for 6 months at a cost of over 300,000 lives…..” Make up your own scenario.

We can never know. But we can be 100 percent certain the history books would NOT now say anything like: “by refusing to appease the dictators, Neville Chamberlain saved more than 30 million lives, prevented the division of Europe and saved the world from 40 years of Cold War”.

In the same way, we can be absolutely sure that, if former Federal Reserve Chairman Alan Greenspan had raised interest rates and tightened credit in 2005 or 2006, putting a stop to the lending boom before it could become a risk to the banking system as a whole, he would not today be feted as the man who saved the world from the worst financial crisis in 60 years.

More likely, opinion would be divided over whether the ensuing recession, with the loss of maybe 1 percent of GDP and 100,000 jobs, was at all necessary.

Critics would have called for Greenspan’s head and possibly even for the Fed to lose its independence, while the defence would have been left lamely quoting the famous dictum of a previous chairman that it is the job of the Fed to take away the punchbowl just as the party gets going.

from Breakingviews:

Rabobank takes lead in bank capital revolution

(Refiles on October 19, 2010 to add disclaimer for author's personal investment. Neil Unmack owned Lloyds CoCos when he wrote this article.)

Ever since the financial crisis struck, regulators have argued for an overhaul of bank capital. Contingent capital, which can absorb losses while the bank remains in business, sounds like the solution. But until last week it had only been used by a few distressed lenders.

So the decision by Rabobank -- one of the world's most highly-rated banks -- to issue contingent capital securities is welcome. The Dutch mutual is the first healthy European lender to sell the securities to investors as a new issue. But investors and regulators will need persuading if the idea is to catch on.

Bankers hope contingent capital can replace other kinds of hybrid debt, which are being phased out by regulators.

Hybrids were popular during the boom years because they counted towards banks' regulatory capital but did not dilute shareholders. But they proved of little use during the crisis because they could not absorb losses while the bank was still in business. Contingent capital solves this problem, by converting into core capital if the bank's regulatory reserves fall below a predetermined trigger point.

Nevertheless, it's still not clear how much of a market there is for this kind of debt. Lloyds Banking Group last year issued bonds that are convertible into shares. However, it did so as part of a debt exchange which gave investors a strong incentive to convert.

Rabobank's securities are different because they don't convert into equity if the trigger is reached. Instead, they are written down to 25 percent of their face value and then repaid. This reduces Rabobank's liabilities, allowing it to book a profit which will boost its Tier 1 capital ratio.

from Breakingviews:

Jamie Dimon needs an even better post-crisis

Jamie Dimon needs an even better post-crisis. The JPMorgan boss runs one of the only major U.S. banks not to post a quarterly loss during the crash. And he has maneuvered his firm into a strong position to grow as the economy rebounds. But investors don't yet seem persuaded.

The shares have been stuck trading around book value, or assets less liabilities, since last summer. Put in perspective, that's not all bad. They had tumbled to less than half that in the depths of the crisis. But to price the bank now at only a fraction more than break-up value seems overly cautious. Another crisis outperformer, Wells Fargo, by comparison, trades at 1.4 times book.

The two lenders are more equal using another measure. Investors value Wells at 14.8 times this year's expected earnings, and JPMorgan at a multiple of 13.9. This still means, however, that Dimon's bank is getting no credit for a faster growth rate. Analysts reckon its net income should jump by a third this year compared with just 8 percent at Wells. Moreover, by 2011 JPMorgan could be earning twice what it did in 2009, and Wells 65 percent more.

At first glance, JPMorgan looks unfairly penalized. After all, both banks are heavily exposed to U.S. consumer loans. JPMorgan expects its credit card unit will lose as much as $2 billion in the first half of this year and that quarterly losses on its mortgage loans may be still higher than last year. Both banks also will lose income from legislation limiting credit card and overdraft charges -- perhaps as much as $1.25 billion for JPMorgan. And Dimon still sees a chance of a double-dip recession.

The difference is that JPMorgan has a much larger investment bank. It accounted for nearly three-fifths of last year's profit as the consumer arm suffered. When equilibrium eventually returns, it should represent less than a third of the bank's earnings. Dimon's fortress balance sheet and solid risk management helped the investment bank solidify its position as a top-tier adviser and underwriter.

The investment bank faces numerous uncertainties. Sure, it generated some $2 billion of revenue from or for JPMorgan's commercial bank and treasury services last year. But the unit requires more capital than any other business -- and has the lowest return on equity target, at 17 percent.

And investment bank trading desks will need to perform without higher leverage as bid-offer spreads narrow further. New regulation looms and only some of the costs can be estimated so far.