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Wednesday, 29 July 2009

BA in a pickle over its sandwiches

British Airways has announced that it will scrap all meals, except breakfast, on its short-haul flights. Passengers on flights after 10am, which last less than two-and-half hours, will only be served drinks and snacks, andwill not have the option to buy food. The measure, starting next week, comes as the airline is trying to trim costs, hoping to save £22m a year.

On the other hand, as a passenger I would have hoped that they would have passed the saving on to the passengers. BA clearly prefers to keep the airfare the same and give less value to the customers. Cost cutting is about cutting the costs of producing the end product. It isn’t about cutting the value of the product you offer and hoping that nobody notices.

It seems that the Irish klutz who is running the airline - remember last month’s jackassed idea of asking the staff to work for free – doesn’t realise that the only difference between short haul routes on his airline and Ryanair, is that flights on BA cost four times as much.

Let me explain why this is a big mistake. BA cannot compete with the low cost airlines on domestic routes because it operates from international hubs because it has to connect with its international flights. Heathrow and Gatwick and the other BA airports are more expensive than Stansted , Luton etc because there is more demand for the slots, so anybody travelling say from Glasgow to London has the choice of say Ryanair (via Prestwick & Stansted) or BA (via Paisley & Heathrow/Gatwick). They can either cary their own luggage to the plane and fight for their seats on Ryanair or they can go with BA.

So what sort of service should BA provide? A no-frills but higher cost service than Ryanair, or a service that still caters for its passengers with sme care at a time when airtravel is becoming an ever more painful experience?

Unfortunately Willie Walsh is a former pilot, which is why he never sees things from the passengers or the non-pilot point of view (BA pilots were allowed to negotiate a separate pay deal from the rest of the staff in the last pay round, which caused considerable disgruntlment amongst other cabin crew according to an insider I spoke to recently). It also explains why he doesn't understand that if all we wanted was cheap fares for the experience of sitting for a couple of hours in a cramped seat in a metal tube travelling at 450 mph at 30,000 feet, we wouldn't fly with BA unless there was no other choice.

Getting to grips with electric cars

This looks interesting at first blush, but is it any more than a typical undrgraduate engineering project, albeit that they have a budget the size of a house and a power supply from the on campus ower station at MIT?

Mind you i like the idea that they are getting to grips with high speed charging, although the idea looks quite daunting if we assume that the typical running time between charges is 5 hours then the bateries would have to charge 30 times faster than they discharge. This is not too difficult for the batteries, although I suspect that it shortens the lives of lithium batteries considerably, but let us not be too concerned about that.

The problem is that if we assume the average output of a standard car is around 40kW when running, it would take a 1.2MW supply to charge the battery in 10 minutes. At 240V that would be 5,000 amps, which would be an extraordinary cable. More likely would be 2,400V at 500 amps, but that is not the sort of voltage you would want to be handling, particularly at a petrol filling station. I don't have that sort of power on my domestic supply, and it would be quite a transformer. to get that to work.

Still if they can get it to work they would have my vote. Not for any green issues but because electric cars can be very fast and light, and because the day of the petrol car is largely over. If there is one thing that annoys me about cars, it is not the emissions, but the simple fact that a $90,000 Porsche only costs $22,000 to build, the rest is overheads and marketing. So give me a Tesla or a Wrightspeed X1 any day. Simple cars cost less and go faster.

A £60 billion supertanker with no-one at the helm

According to the FT “Top City of London bankers were stunned” yesterday by the news that John Kingman, chief executive of UK Financial Investments, was stepping down to join the private sector and that Sir David Cooksey would replace Glen Moreno. Apart from the breathtaking incompetence of engaging a chief executive who walks away from the post less than a year later because he fancies a second spell in the private sector, the government was made to look foolish in another way, but more of that later.

Kingman joined the Treasury as a graduate trainee, but left Whitehall four yeas later to go to work at the other pink paper, which explains the oleaginous remarks from his former colleagues. Holding down that job for a only few years, he worked briefly at BP, finding he couldn’t hack a real job (he “found it hard to find a meaningful role and penetrate the corporate culture” according to the FT) he went back to work for the one-eyed son of the manse as a PR merchant at the Treasury. When it turned out that the Treasury had nobody better to deal with Northern Rock when it went bust, following a failure of oversight by the FSA, Kingman was put in charge, and his remit was extended to cover RBS and Lloyds when they went to the government for help.

According to his pals at the FT, when he was appointed:

“Mr Kingman is the ultimate civil servant. Second Treasury permanent secretary at the age of just 38, he has rejected overtures from investment banks anxious to tap his mathematical mind and contacts book. Friends say he has little interest in wealth and thinks the challenge of working in government is more 'fun'.”

Apparently not any more, because Kingman seems to think that he is better suited to the private sector after all. Kingman doesn’t actually have a job to go to in the private sector, which is always a sign that either he could not hack his current job or couldn’t get on with his boss. In Kingman’s case it could be that he couldn’t get on with Cooksey or that he could tell the new Chairman didn’t think he was up to the job, but it is equally possible that while Kingman could kick the heads of the banks when they were bailed out, he knew he didn’t have a clue about how to create value. The idea that Kingman, with precisely zero expertise in managing companies and corporate finance, could turn around and float several companies for a combined £100 billion is laughable.

When he was appointed Kingman was criticised for knowing nothing about banking, although his pink friends say he was quick to learn. Well blow me, the City used to be full of bright young things who know nothing about banking. They were called trainees, but they didn’t get to run £60 billion equity portfolios holding a controlling stake in some of the country’s largest banks. Kingman’s appointment represented a failure by the government to learn from the fact that both Crosby at HBOS and Goodwin at RBS were not experienced bankers and were also appointed to the top jobs while they were still on a learning curve.

So does it look as though the government has learned their lesson? David Cooksey is an engineer, having started at a paper company and later made his name out of Formica, run a successful venture capital firm specialising in technology, but with good establishment connections as a member of the Audit Commission and a director of the Bank of England (not real banking). He might look good from a corporate governance point of view, but how much of do you need in a holding company with shares in a handful of companies? A banking expert, even one as old as the 69 year old Sir David would have been a nice idea.

The prospect of Kingman’s successor is more troubling. The chief executive of UKFI is effectively the shadow chief executive of the banks that it controls. Treasury insiders are reported to expect Mr Kingman to be replaced in the autumn by a senior banker or hedge fund manager. Hedge fund manager? Are these guys serious. Banking is the most heavily regulated industry outside nuclear power. Hedge funds exist because investment managers want to operate unconstrained by regulations. Banks problems started because they began to behave like hedge funds and thought they could take the same sort of risks as the hedge funds. Only they weren’t as smart as the best hedge funds, and we are now picking up the bill.

And now the government that has ruined the City by turning it into casino wants the banks to be managed by a senior croupier? Should we write off the £60 billion now, or should we be more worried about the hundreds of billions worth of assets in those banks that are guaranteed by the Treasury.

Do as I say not as I do

The Independent carries a story here about how accountancy firms have been supplying staff free of charge to the Conservative Party. One might not think there was much wrong with that. All parties accept free support, and the accountants obviously hope to benefit from the estimated £4 billion in consultancy contracts that will be available from the next government.

But wait a minute. What would the position be if the boot was on the other foot and a potential client was giving substantial free gifts to audit firms? Despite a self policing professional body that bends over backwards to clear the Big 4 firms whenever possible, it is hard to see how an audit firm could escape censure if it accepted six-figure gifts. Why does that matter? Because the offer and receipt of gifts or hospitality might be seen to prejudice the judgement of the recipient, thereby protecting the investing public.

One of the firms providing hundreds of thousands pounds worth of free services to the Conservative party has rules for its own staff prohibiting:

  • gifts worth more than £25
  • hospitality from any client or supplier exceeding £500 per annum, or in sensitive case all hospitality

Does the same not apply to political parties? Should they not be constrained by rules to prevent a perception of partiality in the award of contracts paid for by tax payers?

Monday, 27 July 2009

As clear as Mudd

I shall resist the temptation to crop any more puns about the name and position of Daniel Mudd, new chief executive of Fortress Investment and former chief executive of Fannie Mae, I can't help raising an eyebrow at his suggestion that his hedge fund should go into the market to buy a few banks, insurance companies and ... other hedge funds.

OK, Mr Mudd may have his reasons, but hedge fund managers will tell you that their babies are almost all pure α with scarcely a hint of β, pure return and the best you will find. According to the hedge fund market, there is little to be gained from risk diversification? So why would it make sense for me to invest in Mr Mudd's hedge fund?

Because he knows hedge fund managers who can earn more money for their clients than he can? Then why wouldn't I simply place my money with them?

Because he can more money for those clients than the current hedge fund managers? It would be cheaper to advertise to win those clients (or other new business) than it would be to pay a premium to buy the fund.

Still somebody must have thought he knew what he was doing when he was at Fannie Mae. Mudd collected more than $80 million in his time there although he was dismissed as CEO when FHFA stepped in as conservator on September 7, 2008. The US government told him to forget about a severance package, because he was getting Sweet Fannie Adams and his name was Mudd. Oh, I did it.

Safe as houses?

Allco was an Australian leasing company. You may have never heard of them but having been well known as an investment banking boutique renowned for arranging leases or aircraft, ships, railcars and real estate, they decided they could get into the leasing business, if only they ghad a little capital. Which they did. Just like their fellow Australians at Babcock & Brown (who used to be Americans), and just like their compatriots, Allco found that leveraged asseyt finance wasn't always a one way bet, particularly when the owners like to suck out massive paychecks for themselves, and the company went to the wall.

So the Allco receivers held an auction of the assets of the company, primarily a 68 aircraft portfolio encumbered by a large amount of debt, and the winning bidding group was the Chinese HNA Group and a US private-equity firm, Bravia Capital Partners, neither of whom is exactly a well-known name in aviation finance or aircraft remarketing.

Which is sort of important in this business. The aircraft leasing business requires hands-on expertise. Aircraft have a second-hand value but only in the hands of an operator who can use the plane in their fleet. The leading aircraft lessors such as ILFC and GECAS know the needs and plans of all the major airlines. The chances are the Chinese and their American friends don't have a clue. Abbey National made a similar mistake when they ought a mostly similar portfolio from ING in 2001, and we all remember GPA who demonstrated that bulk buying aircraft isn't necessarily a good idea if you can't lease them to your customers.

The problem for HNA, Bravia and the Allco receiver is that any such sale of these assets requires the consent of the lenders, and there are objections outstanding from three banks on the basis that the buyers do not have the relevant experience, those lenders being HBOS, the Military Superannuation Fund of Australia and Alliance & Leicester.

I'll say that again for the benefit of thse who thought their life savings were safe in the hands of a sleepy former building society currently owned by a large Spanish banking group, and not some wideboy bunch of chancers taking a risk on the future residual value of expensive pieces of metal currently located on the other side of the planet:

Alliance & Leicester.

Sunday, 26 July 2009

Another industry under pressure

Yet another example of an industry where decreasing demand from customers and low barriers to entry from new market participants in an undifferentiated market has led to higher competition within the industry with lower average expected returns.

Saturday, 25 July 2009

Hard choices ahead

We are going to hear about some "hard choices" that have to be made in the next year so let us look at the situation in round numbers.

UK annual GDP is £1,400 billion, of which £700 billion is expenditure by the government, which is funded to the extent of £500 billion in taxes.

That means we have a budget deficit (of £200 million) equal to 14% of GDP or 29% of government spending. Let us assume that this is deemed to be foisting the cost of paying for today's benefits onto tomorrow's citizens and is thus unfair. There are other aguments for not running up a large deficit such as the unpredictaility of interest rates, the risk of an inability to refinance or repat the debt etc, so we would like to reduce this number for arguments sake to 0%.

Well the first way would be to raise taxes to cver the shortfall, which would be equivalent to a 40% increase in all forms of taxation. One can run all sorts of arguments about uncompetitiveness, and it might indeed reduce GDP because there would be a lack of incentives and some may emigrate etc. thers might emigrate, but let us ignore those for the moment.

The second way would be to reduce government spending, but we see that when we cut governmen spending we reduce GDP. Let us assume that the tax raised is exactly proportional to GDP, so tax receipts will also drop by 5/14ths of the drop in spending. With more unemployment, benefit costs may also rise but for these purposes, let us ignore that. This means that we have to cut spending by £14/9 to save £1 in deficit (£1 = £14/9 *(1-5/14)), so a deficit equal to 29% of government spending would require a 29% * 14/9 = a ~44% drop in spending.

The third alternative is to run a deficit. To put it into a mathematical formula, we can have

x% of a 14% deficit,

y% of a 44% cut in govenment spending, and

z% of a 40% increase in taxation,

where x+y+z = 100, {x, y, z: >=0, <=100}.

Let us say we go with a third of each, then we have a 15% cut in government spending, a 13% increase in all taxes and we would still have an uncomfortably high deficit of 5% (by way of an example, 3% is the limit for euro convergence, implying a stable economy). That means a higher rate of tax at 45% and a basic rate at 23%, VAT at 20% etc, and the gap would likely be filled by freezing all public sector salary increases until the deficit was reduced to less than 3% of GDP.

When ministers or opposition MPs talk about smaller numbers than these, you know that either they are obfuscating or they do not appreciate the gravity of the situation. 2% of this or 5% of that is never going to bring the economy back to health.

Friday, 24 July 2009

More optimistic spin from the BBC

It wasn't in the blogpost on the website that made up most of her report on the World at One, but on the radio program Stephanie Flanders, apparently an economics editor, can clearly be heard saying the economy did better in 2Q09 than in 1Q09, because in the first quarter it declined by 2.4% whereas in the second it declined by 0.8%.

I don't know if you are reading this Stephanie, but if you are I hope the BBC pays you well because you are going to need all the money because with comments like that you will struggle all through your career.

If GDP declined by 0.8% in 2Q09, that means the economy did worse in the second quarter than in the first .... by 0.8%. Think about it. You'll get there eventually.

Are we there yet?

Apparently not. UK Economic output fell by 0.8 per cent quarter-on-quarter in the three months to June, after a 2.4 per cent decline in the first quarter, according to the Office for National Statistics’ “flash” first estimate of GDP. This was a much bigger drop than economists had expected.

As you will see from the graph below, although lower than the fall last quarter, it is higher than the correspondin figure last year, which means we have now had the biggest year on year drop (5.6%) since records began. So no green shoots yet.

But then I don’t really have much faith in economists who often seem unable to see the wood from the trees, and the same goes for economics journalists, including Sam Brittan of the FT, probably the oldest teenage scribbler in town. In his latest article in the other pink paper, Mr Brittan pours cold water on the size of the budget deficit.

Never mind that the debt ratio was far higher not only after and between the two world wars, but in the supposedly virtuous mid-Victorian period. Never mind the historian Lord Macaulay’s mockery of the debt obsession. This is clearly far from what the Labour government intended when it came to office in 1997 full of talk of “prudence for a purpose”.

Which misses the point. Immediately after the two world wars the country like other world powers was saddled with large debts from the war and had a smaller peacetime economy due to the disruption of the war, but we saw the economy grow rapidly thereafter.

In the mid 19th century Britain (the country, not the man) enjoyed a fast rate of economic growth. Government borrowing was high to fund the development of overseas possessions which was repaid through access to low cost labour and vast natural resources from the Empire.

We are living in a different age now. We are a middle sized power in a post-industrial age with few competitive advantages, having lived through a long period of relative stability. To drive the country so badly into debt and leave our children to pick up the ill is reckless in the extreme. iven the high proportion of state spending, the more apropriate comparison is not with 19th or early 20th century Bitain, but with 1980's Eastern Europe.

To expect the Chinese to keep the salaries of their civil servants low and yet continue to finance the cost of our own, is naive at best.

More value adjustments on own debt

This time from Credit Suisse who booked a loss vecause of narrowin margins on own debt.

Results include net fair value charges of CHF 1.1 billion (before tax) resulting from improving credit spreads on Credit Suisse debt, charges of CHF 0.5 billion (before tax) relating to the settlement with Huntsman Corporation and a discrete tax benefit of CHF 0.4 billion. Excluding these items, after-tax net income would have been CHF 2.5 billion and return on equity 27.4%, both substantially higher vs. 1Q09.

The cute bit is that it was indeed a higher figure than in 1Q09, when Credit Suisse reported a profit of just over CHF 2.0 billion, only that time they were a bit more coy about the fact that that numbe was propped up by CHF 350 million of fair value gains. Like I said, they are more openly dismissive of the loss that then were transparent about the previous corresponding gain.

Liar, liar, pants on fire

“Are our troops under-resourced?”

“We definitely don't have enough helicopters."

“And is it true that more soldiers have died, or will die, because of our lack of helicopters?”

“Yes and no."

Lord Malloch-Brown, Daily Telegraph interview, 17 July 2009

"I actually didn't tell The Daily Telegraph that there weren't enough helicopters in Afghanistan."

Lord Malloch-Brown, BBC interview, 22 July 2009

Well, yes you did. You definitely did. Go straight to jail. Do not pass GO. Do not collect £200.

Thursday, 23 July 2009

Nobody's listening to you any more, Gordon

Gordon Brown yesterday attacked Conservative plans to reverse the nature of City regulation, saying that returning banking supervision to the Bank of England was “unacceptable” and “completely wrong”. Mentioning the failure of BCCI and Barings, Mr Brown said the old system did not work.

Well, that's plain wrong and explains why nobody is listening to Brown any more. The failures at both BCCI and Barings were the result of fraud. A bank regulator is not a policeman. That is the job of the internal and external auditors, the Met and the SFO. The job of the regulator is to regulate the banks' businesses based on the known facts, the published acounts and reported data, allowing the regulator to review and pass judgements on the legitimate business decisions of the banks' management teams.

Of course where fraud is discovered it is the role of the Bank of England to ensure that the position is quickly rectified, and the Bank would have been remiss if BCCI's accounts had not been signed off for years on end, or if Barings had reported years of substantial losses in its Singapore trading activities, but the facts are that BCCI's accounts were signed off by Price Waterhouse (who were later fined a substantial sum for their errors). The auditors in turn claimed that they were unable to report any defict in the acounts because they were unable to access the books of BCP, a Swiss subsidiary subject to banking secrecy laws. UK banking laws permit auditors to make exceptions for such circumstances, so how that can be blamed on the Bank of England rather than the government is a mystery to me

In the case of Barings, Nick Leeson was able to take on massive loss making positions by acting both as the floor manager for Barings' trading on the Singapore International Monetary Exchange and head of settlement operations. Barings had the correct procedures and policies in place by having two positions, but Lesson's line management failed by not implementing them correctly, their internal and external auditors were at fault for not noticing the failure and Leeson was at fault because of his wilful fraud, but it is ridiculous to think that the Bank of England should have been reviewing the org charts of every subsidiary of every financial institution when there were others who were supposed to do exactly that.

Once Leeson's fraud had been discovered the Bank acted to rectify the faults and managers other than Leeson were barred from working in the City. Barings was not found to have deficient policies, but to have failed to implement them, and the Bank was not found to have been warned about these failures and ignored the warnings.

But that is not what the bank supervisor's role is about. That is about monitoring and reviewing the entirely legitimate but potentially misguided decisions of the bank's management, their credit concentrations and their exposure's to different kinds of risk (including their potential exposure to fraud through inappropriate policies).

It was under the FSA that RBS, HBOS, B&B and Northern Rock appointed Managing Directors / Chief Executives of questionable quality, that those banks booked historically large exposures to the property markets and accumulated large positions in structured finance transactions that were poorly understood, relying to a great extent on credit ratings and in many cases incurring very large and ultimately terminal quanta of liquidity risk.

All of which were perfectly legal, but quite wrongheaded and missed by the FSA. But let us not forget about AIGFP, which ran up the most enormous exposure to credit derivatives in its London office but outside the regulatory scope of the FSA because the business was deemed by the FSA to be booked in a internal treasury unit. Now that was a total failure of regulation.

Wednesday, 22 July 2009

Central government funding and other fairy tales

The government has used many ways to persuade us that they are bestowing their magnificent largesse on us, in amounts far beyond our wildest dreams. First of all they the excelled at "re-announcements", where sums of money could be flashed around when a project was first conceived, repeated when the same idea was affirmed, then again when approved, and again when funded etc.

When that began to fall flat, they moved on to the “give with one hand while taking away with the other”. This would often show up in the Budget as a tax giveaway, which was quietly noted elsewhere as being funded by a tax increase. The best example was a much heralded 2% reduction in the rate of corporation tax which was supposed to stimulate business. On closer inspection was entirely funded by a reduction in the standard rate of writing down allowances from 25% to 20%. In other words there was no net saving in taxes paid by companies (because the corporation tax rate cut was funded by the cut in allowances against corporation tax), and in fact the net effect was to shift more of the tax burden to capital intensive industries, precisely the types of industries that would most likely create stable long term employment.

When that began to wear thin, they moved on to the "nebulous announcement". A typical announcement would be the G20 £5 trillion of global stimulus (which is simply a figment of Brown’s imagination), or the other measures listed at the G20 summit in London, which were either announcements of initiatives which had been in place for years (trade finance: i.e. export credits as we have had for decades), amounts already committed, or permissions for multinational agencies to borrow more or to print SDR’s (travellers cheques for central banks), without any commitment to actually make any investment.

As reported ten days ago, they have a new technique in the Butchering Britain’s Future program. The idea is to announce new spending measures, without mentioning that they will be financed by cutting back previously announced projects, thereby reaping the political rewards of announcing two projects while actually only completing and paying for one, usually in a Labour heartland.

When Mr Brown said that £1.5billion would be found to pay for 20,000 new homes for those on low incomes and council house waiting lists, he omitted to mention that nearly £600 million would come from the Department for Communities and Local Government who would take it from housing projects already announced as well as from projects to refurbish council and private rented homes.

So John Healey, the Housing Minister, has written to leaders of 50 councils saying how much of their funding for new homes they will lose next year. The average 42%. Cambridgeshire County Council will see their funding reduced from £13.8million to £7.8million. Greater Norwich will lose more than £2.5million. King’s Lynn is losing £2.7million, Exeter and Devon £3.5million, Teignbridge £2.7million and South Hampshire £4million.

44,000 council houses will also not be refurbished next year because £150million is being taken from the Government’s Decent Homes programme and a further and 8,600 private rented houses will lose £75million of funding for a scheme to upgrade rented homes in the private sector.

Toothless tiger

I forgot to pass comment on an article in HM Telegraph last Saturday by Ambrose Evans-Pritchard.

The article is here. It is all about the unwinding of the welfare state in Ireland due to a lack of money and here is a taster:

“Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland.

Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc.

Coming soon to an economy near you.

Smith Barney or maybe Paine Webber, or some other Wall Street firm used to have a marketing pitch that ran "We make money the old fashioned way. We earn it". Hokum, of course, but a good slogan and a good principle. It isn't possible to run an economy for ever based on consumer demand funded by increasing asset values, just as it isn't possible to drive an economy like that of Ireland just through tax breaks.

Nor is it possible to bribe the electors for ever with a generous helping of state provision of education, health and every other goodie imaginable plus generous pay for public sector workers when the whole operation runs at a staggering deficit.

We will end up bust like the Irish, in the old fashioned way.

Any jobs out there?

Any jobs out there for a graduate trainee (my daughte)? Just left Oxford with a 2:1 (in History), but like 55 of the 60 leavers from her college, no job, no prospect of a job and, in the short term at least, a life on the dole beckons.

Things are getting better so profits may be down (cont.)

As if by clockwork, Morgan Stanley released its 2Q results today, noting that narrowing credit spreads on its long-term debt accounted for "negative revenue" of $2.3 billion. They made less noise about the impact of this accountnig treatment when it reported its 4Q 2008 results last December, when they $2 billion of extra profits because their credit had gone south.

What goes around, comes around.

They must be making this up as they go along

Last week S&P cut its ratings on billions of dollars worth of Collateralized Mortgage Backed Securities issued by Goldman, Credit Suisse, Wachovia and others, as part of its ongoing review of its methodologies. S&P downgraded one class of a Goldman transaction from AAA to BB and five from AAA to BBB-. BB is 2 notches below investment grade which is a long way from AAA (prime risk, practically zero risk of loss etc. etc.)

This gave the banks a problem because it made the bonds ineligible for TALF (the Term Asset-Backed Securities Loan Facility) – they have to be AAA to be in the program.

But surprise, surprise, yesterday the WSJ reported that S&P changed its mind in a “stunning reversal”, because it has “recently updated criteria” for its ratings and has returned all the ratings back to AAA.

Curiously, the same day the Obama administration detailed a plan to overhaul regulation of credit-ratings firms by requiring increased disclosure and stronger oversight, and curbing the practice of "ratings shopping." So S&P held a mid-summer sale while they still could.

According to the WSJ:

S&P spokesman Adam Tempkin said in an email that the firm had received inquiries from market participants on how it applies losses in the AAA category “that prompted us to clarify our approach. In doing so, we are also introducing refinements to the approach.”

Mr. Tempkin said the ratings firm listens “attentively to all feedback from the market at any time,” and makes “changes when we think it makes sense analytically.”

“While we consider all feedback received, we use independent judgement, testing, and analysis in arriving at credit opinions and criteria development/implementation,” he wrote.

Sounds like the guys from Goldman gave S&P more market feedback than their “independent judgement” could take. I have said it before and I’ll say it again: the ratings process is deeply flawed, and I wouldn’t gamble my life savings on the strength of their ratings.

BB is the current rating for Indonesian sovereign debt. Overnight, S&P decids that Indonesia is really Switzerland, Germany and the United States rolled into one.

Have you ever wondered how military coups get started?

"Self-evidently, if I move in an American helicopter, it is because I have not got a British helicopter."

Chief of the General Staff, Sir Richard Dannatt, BBC interview, 15 July 2009

"I have always said that there's no such thing as enough helicopters in an operation campaign."
"In a situation where you have lots of improvised explosive devices, the more you can increase your tactical flexibility by moving people by helicopter, then the more uncertain, more unpredictable your movements become to the enemy.
"Therefore, it is quite patently the case that you could save casualties by doing that."

Chief of the Defence Staff, Sir Jock Stirrup, BBC interview, 16 July 2009

“For troops on the front line this is the last thing they need. They want to know they have the united backing of ministers and politicians from all parties behind their efforts and the huge task they have taken on.”

Lord Mandleson, BBC interview 17 July 2009

“We definitely don’t have enough helicopters. When you have these modern operations and insurgent strikes what you need, above all else, is mobility.”

Lord Malloch-Brown, Daily Telegraph interview, 22 July 2009

" ...while there are without doubt sufficient resources in place for current operations, we should always do what we can to make more available on the frontline."

Lord Malloch-Brown, FCO news release, 22 July 2009

"For the operation we are doing at the moment we have the helicopters that we need."

Gordon Brown, news conference, 22 July 2009.

How to kill an industry

  1. Kill demand for its products
  2. Tax it
  3. Regulate it

Which is exactly what has happened to the British pub. Two years ago pubs were closing at the rate of 2 a week. Last year it was 27 a week and this year it is 52 a week. Given that businesses do not go belly up overnight (although the recession is clearly a factor), this decline has its roots in changes that have happened over the last 5 years.

In that time there has been:

  1. A ban on smoking in enclosed public places (although a pub is a private premises)
  2. A 35% increase in tax on a pint of beer
  3. A new Licensing Act that limits licensed entertainment

You know who to blame if your favourite pub closes.

Things are getting better so profits may be down

Yes, really.

You may have followed previous postings about how banks' reported profits were bolstered by marking to market their liabilities. The logic went as follows: The banks had a lot of crummy loans on their boks so their own creditworthiness took a dive. This meant that the margins required by on the market on securities issued by the banks widened considerably, but without necessarily issing any new securities, accounting rules allowed the banks to mark to market the value of existing liabilities at the higher margin, thereby giving a lower value to those liabilities and booking a profit from the reduction in the value of those liabilities. In many cases the extra profit was what allowed the banks to book a positive number and make a distribution.

Now, for the downside, or should that the upside. It seems that with Lehman and Bear Sterns out of the way, Merrill Lynch effectively disappeared, there is less competition, bid-offer spreads on asset trading are looking fatter and banks are looking more profitable and less likely to default on their debts. So spreads on bank paper have narrowed considerably, unwinding last year's profits.

Many banks will report a loss in the next few weeks. UBS already gave a profits warning last month, but expect others to blame "own debt" credit margins for poor figures in the next few weeks, but in much more loudly than when the same accounting rules boosted their results.

You never had it so good as last year and maybe you never will

According to the BBC, the National Institute of Economic and Social Research (NIESR) sees total UK GDP falling 4.3% in 2009 before growing 1% in 2010 and 1.8% in 2011.

The research body sees income per head - GDP per capita - taking until March 2014 to return to the level it was in the first quarter of 2008.

Except that doesn’t mean you will be as well off. Assume that inflation runs at 2.5% for each of those 6 years and you will be 16% worse off than now.

It would take another 15 years of GDP growth at 1% higher than the rate of inflation to bring us back to the same GDP per capita in real terms, or 2029.

Assuming that this blog is read predominantly by people in the last 55 years of their expected 74 years, nearly 35% of you will die before we get back to the same average prosperity.

Tuesday, 21 July 2009

If only life was as simple as a computer game

Many years ago, when I was a few years out of university zand learning to be a banker, I worked for an American bank who were renowned for their training. Part of their credit training involved a computer based game, which I believe was also played at many leading business schools. Because this was a long time ago, when computers were less ubiquitous, each team would provide a series of numbers to the gamemaster, determining how their company would operate in the next period, giving budgets for manpower, advertising productive capacity and a vast number of details. The inputs for each team would typed into the computer, no doubt by a hidden pipe-smoking technician in a brown coat, and after much whirring of tape machines and flashing of light bulbs, the results would be printed on what was quaintly termed a "line printer" and several hours later returned to the teams to plan the next round.

The whole purpose of the exercise was not really to understand how to run a company so much as to understand how easily things can get out of hand. Ambitious young people trying to win the game would pursue aggressive strategies, and rapidly lose control, having geared up and spent a fortune on advertising and failed to build production capacity, or spent heavily on production capacity and advertising but skimped on wages and failed to meet demand because of a lack of staff. The two lessons that I learnt were first that *everything* is important and nothing should be taken for granted and second that you never know what life is going to thow at you so never think you have all the answers.

I am often reminded of this game when I look at the performance of the government and the economic position of the UK. Yesterday we heard that total outstanding government debt in the UK has risen to 56.6% of UK GDP or £799 billion, which is higher than last month's record and thus the highest it has ever been.

But just when you think that we need to have more tax receipts to service and eventually repay this debt we hear the other shocker, that tax receipts are down 10%, so we have less cash to service the debt. Bear in mind that government spending is still rising (paid for by borrowed money), paying more salaries and NI and putting more cash in the hands of public sector wrkers who will buy things and pay VAT and duties, so for the overall tax take to fall 10%, things must be really bad in the rest of the economy. Like in the North Sea, where BP, the largst producer, says it will be producing 10% less oil in the UK sector than last year.

And that is where this government has gone wrong: by assuming that the private sector (with which very few ministers had any dealings with before their current jobs) would continue to operate as before despite increased taxes, regulations and other costs and in the face of increasing competition from overseas, the government has made the same mistake as the young bankers and their business game. We have some of the highest paid family doctors in the world, lavish salaries for civil servants, and an extravagant schools building programme, yet we have no way of paying our way and our debts are spiralling out of control because the private sector is dying on its feet while nobody wants to invest here.

Monday, 20 July 2009

Here we go round again

Here is a good paper from HBS on structured finance. It is a good summary of how and why the market works and why it went wrong and we ended up with a credit crisis.

What is particularly striking is how the previously rare and highly coveted AAA-rating became a common currency through structuring and securitisation, and what should be plain, though is scarcely stated is/was the way banks structured their deals to fit the valuation models of the rating agencies. I have previously written about the distortion in the market for banking assets caused by ratings based allocations of risk capital, but this paper shows how the demand was satisfied from ratings models based on possibly questionable assumptions about default risks and correlations.

I could go on for hours about the differences between purely quantitative ratings from structured finance based on expectations of default and the more qualitative ratings that were formerly appiled to single counterparty issuers. In the past if a rating agency passed judement on the quality of the manaement of a major company or the political risk or quality of the markets in which it operated by tweaking its rating, it was enerally accepted as a fact of life, but in the ultra quantitative world of structured finance, the focus is entirely on statistical risks, and the quality of the outcomes is as reliable as the quality f the assumptions.

Anyway, that is not what we are writing about today. Suffice it to say that the origins of the credit crisis can be traced to a lot of repackaging of assets of questionable quality into securities that were rated AAA, and that when the wind started to blow in the wrong direction, a lot of those assets were downgraded, meaning first of all that many of the holders lost a lot of value, and secondly that many funds and other investrs who were mandated only to hold AAA paper were left holding a lot of depreciating assets that they had to sell, leaving probably trillions of crummy paper overhanging the market with few buyers.

So it was only a matter of time before some bright spark had the idea of buying up a lot of the devalued paper, and you guessed it, top slicing it to make repackaged AAA paper to sell into the markets. The ratings agencies, seeing a fall in primary and even secondary issuance, are more than happy to slap a AAA ratings sticker on any new issues that give the right numbers on their spreadsheets, and the issuing banks are no doubt making fantastic trading profits, buying in the low value paper in a moribund market and making a spread when they sell the top slice out into the AAA market.

We are seeing the same crummy game played out all over again, and none of the regulators are batting an eyelid because its suits their purposes not to do so. It's like buying in a mouldy fruit cake, scraping away the more obvious bacterial infections and putting the rest back on sale as new fruit cake.

I don't mind if it rains every day until September 20th


I shall lay a claim to my part in the second innings dismissal of Australia by tuning in on the radio. I listened to the start of the innings to hear the first two wickets go down, then went off to do a spot of gardening.

Tuned in again on the way to the station to collect daughter from the train whereupon Ponting was instantly dismissed, more gardening and then took a break for an hour or so before tuning in to hear Hussey and North go, and then went out to tea confident of victory, coming back to find that no wickets had fallen while I was away.

Tuned in at the start of play today to hear the sixth wicket go, but was distracted for an hour, returning an hour later to find no more wickets down, but Clarke went the next ball, so I stayed on for wickets 8,9 &10.

We can all sleep safely knowing that ...

... the official assessment of the threat level of an al-Quaeda terrorist attack on Britain has been lowered from "severe" (where an attack is deemed highly likely) to "substantial" (a strong possibility) ... and spread betters who have previously laid against a bomb attack should look to close out their positions.

You read it here first, #3

News from the Sunday papers that "Dodger" Jenkins is planning to leave Barclays. As often mentioned here, Jenkins Structured Capital Markets Avoidance Schemes'R'Us have long bolstered the Barclays profit and loss statements to the extent that one might have often questioned the viability of the rest of Barclays once the SCM profits were substracted. The Revenue have gradually encroached upon the operations of Barclays and other banks and brokers who peddled such schemes.

One of the more curious pieces of tax legislation bought in by the Labour government was a Tonnage Tax scheme which allowed shipping companies to operate from the UK and opt out of the standard corporation tax on profits, by paying a flat annual fee based on the tonnage of their ships and agreeing to train some cadets, but snce nt all shipping cmpanies always had cadets for training the companies could pay an annual fee instead, known as Payment In Lieu of Training or PILOT. It would be nice to think that the inspiration for this came from Jenkins and his team at Barclays to whom for years the bank made payments in lieu of taxes. Jenkins accumulated hundreds of millions, but this only came about because his team aranged transactions that saved the bank thousands of millions in taxes.

One might have questioned the wisdom of paying so much when the main factor in the deal was the bank's own taxable profits, and the transactions were pretty much well known between tax practitioners, but obviously the bank's directors weren't that smart, or they wanted to keep the tax savings flowing in and though that the cash pai to Jenkins and his team was a price worth paying.

Now it seems that Jenkins no longer considers that the game is worth playing, and is moving out to do business with his new best friends from Qatar. More than likely Barclays realises that it will not be making much more out of the tax man, either for its own account or for its clients. The required level of disclosure is too great to allow such large groups to flourish with a substantial poduct portfolio, and the groups in other banks where the government is a shaelde have been shut down, leaving HMRC free to concentrate on Jenkins' group at Barclays.

No doubt Jenkins has seen the fees earned by Anmanda Stavely and figures that he can do just as well. He should beware the streets of Mayfair are full of brass nameplates of boutiques of boutiques set up by investment bankers who thought they had the inside track, only to find that thse investors made and kept their money by trusting no-one and switching their advisors almst as often as they switch cars.

Jenkins may soon discover that despite his own personal wealth, a thirty year career most of it spent flashing the business cards of a large high street bank and the financial clout and veneer of respectability that implies, is no substitute for living off your wits. Particularly when much of Jenkins' time at Barclays was spent living off other peoples' ideas.

You read it here first, #2

As readers of this blog may have picked up, I have long been an advocate of the removal of the banking supervisory powers of the FSA and the return of the same to the bank of England, and that is due to be announced as Conservative Party policy, with the overblown agency return to its previous job of boxticking and front office compliance and "fit & proper"-ness checking.

The Conservatives have not gone with a full Glass-Steagall approach to the separation of deposit taking from investment banking, for the understndal reason that to do so unlaterally might simply cause the deposit taking/comeercial banking side to be taken over by foreign banks from jurisdictions with less rigorous approaches. That in itself is not necessarily a bad thing, but in harsh economic times there could be a flight of banking risk capital overseas. Why would we want to bank all of our spare cash with institutions that might simply stop lending in the UK to preserve capital back in the US, France, Germany or China?

You read it here first

I couldn't help noticing that a number of blogs picked up the story that I posted here last week that the very high jump in unemployement and the designation of long term sick now means that there will be an extraordinarily high number of unemployed people. It seems increasingly bizarre that with such a high proportion of the working population out of work, they have been so easily swept under the carpet, but with a new Conservative government likely, expect to hear more noise from those quarters who might have been keen to talk about the 5 million or so, possibly more, but who were unwilling to criticise or embarrass a Labour government.

Friday, 17 July 2009

Just keeping the tally

I have been trying to keep track for the last few months of the extra amounts that the government is either spending or putting at risk in order to bail out the financial system.

At the mement I have the following amounts where the government has either invested cash into a bank, bought assets or provided guarantees against third party defaults, in which case their is no cash investment, but there is a contingent liability that should be counted against the national debt, but isn't.

So far I have: Northern Rock: £14.6 billion, Bradford & Bingley: £24 billion, Kaupthing Singer & Friedlander: £3.3 billion, Landsbanki £ 4.5 billion, Heritable £ 0.5 billion, Dunfermline BS £1.6 billion, Recapitalization of RBS, Lloyds/HBOS £ 78.1 billion, Credit Guarantee Scheme £ 250 billion, Working Capital Scheme £11.5 billion, Asset-Backed Securities Guarantee Scheme £50 billion, Asset Protection Scheme £ 465 billion. I make the total amount potentially at risk £903.9 billion, although I suspect that some of the guarantee facilitied have not been drawn

But then we have the cost of providing extra liquidity through Quantative Easing, giving us the Special Liquidity Scheme (SLS) at £185 billion and the Asset Purchase Facility (APF) for £150 billion, so I make that a grand total of £1233.9 billion.

I think that is about 88% of GDP. Trying to work out how that will impact the net debt is unclear. The quantative easing figures do not impact government borrowing because hey are simply a printing of money, but it is not at all clear how much of the other commitments hasve aready been covered by new borrowings. I suspect that only £150 billion has been already been factored into the PSBR, so if all the amounts at risk go bad, the tax payer will have to borrow another £750 billion on top of the forecast £800 billion borrowing requirement ove the next 4 years.

Thursday, 16 July 2009

Do as I say not as I do

“Unless we act now, not some time distant but now, these consequences, disastrous as they are,will be irreversible. So there is nothing more serious, more urgent or more demanding of leadership.”

--- Tony Blair speaking at the launch of the Stern review, 30 October 2006

Interviewer: Have you thought of perhaps not flying to Barbados for a holiday and not using all those air miles?

Tony Blair: I would, frankly, be reluctant to give up my holidays abroad.

Interviewer: It would send out a clear message though wouldn’t it, if we didn’t see that great big air journey off to the sunshine? . . . – a holiday closer to home?

Tony Blair: Yeah – but I personally think these things are a bit impractical actually to expect people to do that. I think that what we need to do is to look at how you make air travel more energy efficient, how you develop the new fuels that will allow us to burn less energy and emit less. How – for example – in the new frames for the aircraft, they are far more energy efficient.
I know everyone always – people probably think the Prime Minister shouldn’t go on holiday at all, but I think if what we do in this area is set people unrealistic targets, you know if we say to people we’re going to cancel all the cheap air travel . . . You know, I’m still waiting for the first politician who’s actually running for office who’s going to come out and say it – and they’re not.

--- interview with Tony Blair, 9 January 2007

Apart from demonstrating his hypocrisy, the comment flagged up Blair's ignorance of energy issues. Aeroplanes are already highly optimised and the potential for further improvements are limited, although anyone flying around in small chartered jets (Learjets and Gulfstreams etc) is probably burning far more fuel per passenger km than is achieved on larger commercial jets.

It seems his successor is no better spending more than £4.6 million of taxpayers’ money on foreign travel over the last year, not once using a scheduled flight for international visits, instead chartering a series of private jets. Brown made several trips to Paris and Brussels on chartered aircraft when he could have traveled far more cheaply and just as fast on the Eurostar, and more importantly at far lower environmental cost.

Low Carbon Transition Plan: Epic Fail

If you want a really depressing perspective of the ineptitude of this govrnment you need go no further than the Low Carbon Transition Plan hub on the DERR website. No comments below please on "Global Warming is a scam", because whether it is or it isn't we have a real problem with future energy supply. North Sea gas is past its peak and you may remembe that we stopped burning coal in our power stations because of the real damage cause by acidic oxide gases in their emissions.

The problem still remains as to how we fund and build the infrastructure to replace our current power stations with new installations powered by other sources, whether they be wind, nuclear, solar, tidal, hydro or biomass. To build a new infrastructue takes time, and in most of these technologies the time scales take longer because they are built in much smaller units than our existing generating infrastructure, so the new but economically less efficient units will have to be built, run and compete with dying but in the short term financially more efficient gas-fired generation. The developers of renewable projects are usually much smaler than th large electricity companies and thus can find it difficult to raise money.

In the rest of the world they know how to handle this - the feed-in tariff. The tariff guarantees a minimum price for electricity and imposes an obligation on an electricty distribution company to connect the renewable project to its network buy the power at that price when offered typically for a term of up to 20 years. depending on the technology and the tariff, this may or may not be a good deal for the electricity company and its customers, but whee it is implemented the cost of wind power in years to come is likely to be the same as the cost of running a power station off Russian gas.

It is a shame that the UK government is unwilling or unable to learn from other countries and persists with its pathetic tradable renewable obligations which don't really work. A project can't secure long term finance if it can only secure short term prices for its exemption certificates, which largely explains the difference between the higher growth of renewable energy in Germany, Italy, France and Spain and the paltry growth in the UK.

But then we have had a Labour government which has often demonstrated its inability to view the facts objectivel. To see how badly they get this wrong we only have to look at Iraqi WMD, the failure of banking regultation, the current budget deficit. Another example was given yesterday when PM Mandelson claimed that thee were 800,000 people working in the low carbon economy, but a quick analysis by The Times showed that this included hundreds of thousands working in the offshoe gas industry. They just don't do obective analysis.

Which is why the White Paper produced yesterday had the feel of something that the Germans wuld have produced fifteen years ago. Except they wouldn't have had the glossy photographs or incorrect or misleading numbers. But the worst aspect of it all is that it is likely to be totally ineffective. It is full of platitudinous statements to the effect that "Britain has the capacity and potential to become a world leader in ...", but of course it won't win the race because the Chinese, the Germans and whoever else you care to name are so far down the track they are over the hill and far away, while the British government is still giving a team talk in the changing room.

For some really thought proviking analysis of where we are and what we need to do to produce sufficient sustainable energy read this. It is written by a Cambridge physics professor and it covers most of the bases regarding what is feasible and what is not. It doesn't discuss global warming much, but starts from the promise that there is undoubtedly an increase in atmospheric CO2 which could have a long term impact on the planet, but moves quickly on to the fact that the fossil fuels that we use for 90% of our energy needs are finite and need to be replaced. It is refreshing to read something as well considered and plainly stated, particlularly when compared with the poorly argued outpourings of eco-nuts and climae change deniers. Well worth reading all of its 383 pages.

Wednesday, 15 July 2009

Unemployment up 13.33% in a month

I don’t know if the guys over at Freakonomics have picked this one up, but maybe the reason that there are a few economics writers who think that we are reaching the end of the downward slope before turning the corner to see the light at the end of the tunnel is because they all have jobs. If you don’t have a job, you don’t get published giving an inherent survivor bias in reporting.

For an alternative point of view they might want to ask one of the 281,000 added to the unemployment statistics last month, making the national total 2.38 million, a rise of 13.33% in a month! Add to that the 2 million who are likely to come of the long term sick list and go on to the unemployed list and the half million or so pre-retirees who are classed as “economically inactive” and the same number of young people on workfare schemes and you have about 20% of the working population who are not gainfully employed. It hasn’t been this bad since the 1930’s.

Fair enough?

The International Accounting Standards Board has proposed a radical shake-up of how banks and insurers report the value of financial instruments. Banks don’t like to report excessively volatile assets and liabilities, particularly when the values don’t move in their favour, so the IASB says that if a bank’s investment produces predictable cash flow, it can be valued in accounts using an accounting treatment that smooths out the blips.

On the other hand, if the asset’s cash flow is unpredictable, like some blow-up-in-your-face derivatives, it should be valued at current fair market values.

But note that the ability to report the asset at “amortised cost” is at the option of the holder and appears to be on an asset-by-asset basis. SO a bank that holds a portfolio of bonds could decide that certain bonds that are trading above their purchase price could be held at fair market value, whereas bonds trading at a discount could be held as long term investments because their fair value is lower than the amortised cost.

The Exposure Draft does not permit reclassification of individual assets, but this is easily circumvented by the following. All assets and liabilities acquired at near par values are initially reported on an amortised cost basis, but when assets trade at a premium over book value they are sold and possibly replaced by similar securities trading at a premium which are held on a mark-to-market basis. All the god news gets booked early while the bad news is deferred.

Tuesday, 14 July 2009

Big Mac and fries to go (offshore)

McDonalds have announced that they are moving their European headquarters from the UK to Switzerland.

The message from the Guardian is that this is being done “to benefit from Switzerland’s advantageous intellectual property tax laws.” Don’t believe a word of it. There are no defects in European intellectual property laws, and no particular reason to think that McDonald;s would be any better protected if its contracts were under Swiss law than any other country that bases its laws on OECD principles. In fact since most of McDonalds intellectual property contracts relate to branding rights which are (a) probably agreed according to local law and (b) typically not up for renewal and (c) could have been written under Swiss law principles at any time if anybody wanted to draw up a contract on that basis, this is the purest of pure hokum.

The real reason is tax, and I will explain the reason why.

McDonalds is a US corporation and the US company is taxed on its worldwide income and the passive income of its subsidiaries located in tax havens, ... OK low tax countries. A lot of McDonalds income derives from its franchises. I don’t know the ins and outs, but as well as selling buns and burgers to the franchisees, the corporation will charge each franchisee a hefty whack for the use of the brand, logos etc., which all count as royalties. It also charges its foreign subsidiaries for the same rights where it operates its own Restaurants. The local McDonalds companies would have paid these royalties away ot an offshore affiliate that held the rights to licence the brand, where the cash accumulated at a low rate of tax. Under US tax rules this income would have been treated as active business income and thus not taxed until remitted to the US.

The problem is the UK link in the corporate structure. Let us assume that all the European subsidiaries and the offshore IP repository were all below the UK in the group structure. Then UK tax rules regarding controlled foreign corporations would also apply. For many years the UK tax man would not have cared two hoots about the offshore IP, but that all changed when HMRC decided that royalties should be treated as passive income ad included in the assessable income of the UK parent.

Which is very inconvenient for a US group like Mcdonalds paying royalties from countries all over Europe to another group company and bringing the cash anywhere near the UK. Particularly when other EU or European countries would not try the same trick. But isn't this just aiding and abetting tax avoidance? Not really. The royalties paid out of high tax EU countries are arms length royalties that reflect the value of the brand and are approved by local tax authorities under their transfer pricing rules, and although it is not taxed immediaely, in order to pay shareholders a dividend the cash has to be brought back to the US where it will be subject to taxation at the Federal tax rate with credit given for foreign taxes paid on the income dividended to the US.

Well, if they get a credit for all foreign taxes, why do they care? Because the US foreign tax credit system is a complicated beast and it imposes some rules. Credits are given on income taxes actually paid on the income of the foreign company only up to the US tax rate on that income as determined under US rules, and subject the fur constraint that different baskets of income are treated separately. Foreign taxes in excess of any limitation in a basket (called excess foreign tax credits) may be carried forward 5 years or back 2, but are lost thereafter. There, I said it was complicated.

The problems for McDonalds would be twofold. First of all they would have a headache over whether for US purposes the new UK tax is a tax on the income of its UK subsidiary, because ostensibly it is a tax on the income of another company that is imposed on the UK company. Next there would be a problem because UK tax is imposed on royalty income which is in a different US tax credit basket to ordinary business income. The royalty income taxable in the UK is far higher than the amount of third party royalty income taken into account at the group level (because all intra-group transactions are netted out when the consolidated income is calculated), which means the limitation in the royalty basket is likely to be exceeded. So McDonalds' worldwide tax bill will be increased considerably.

And that is why McDonalds are moving to Swizerland, but it could have been Ireland, or Luxembourg or the Netherlands. Other companies who have recently done the same include WPP, Shire, United Business Media, Regus, Henderson, Brit Insurance, Hiscox, and Charter.

This will be one of the least successful tax grabs ever, from a headstrong government that won’t appreciate that businesses always have the option to go elsewhere and won’t sit around to be picked apart by the tax man. More importantly for the government, they should realise that in the past 25 years, Britains economic growth was a chieved by pursuing a strategy of low taxes, limited government interference and a business friendly attitude, which gave it advantages ver continental rivals with higher taxes and greater compliance costs. On the ther hand those other countries had better infrastructure and more productive workforces. By undermining the previous policies, the UK is placed in a strategic no man's land, and the private sector will continue to suffer.

Yanks in the UK: Inflation, deflation or just a vacation destination?

Sumer is Icumen in, so the American tourists are heading this way. First up is Mr Tim Geithner, US Treasury secretary, who suggests that, like the Kingdom of God, a recovery is at hand and we don’t need any more fiscal stimulus for the moment. Speaking in London at the start of a European tour (“If today is Tuesday, this must be Belgium”) before heading off to one our two of the friendlier and richer Gulf states, he massacred the English language with: “There is a very good chance for seeing the US economy and the world economy get back to the point when it is growing again over the next few quarters.”

One of his fellow countrymen has taken up a more permanent residence in London. Adam Posen, a US academic, is the latest member of the MPC, and being a newcomer and a foreigner unfamiliar with our ways, he was more direct and confident with MPs at the Treasury committee than is usual for members of the MPC.

In Mr Rosen’s view the UK was behind the US in the economic recovery, but is also better placed to sort out its banks before the fiscal stimulus of the past year runs out of steam.

So rather than being on the verge of maybe turning the corner and seeing the light at the end of the tunnel like the US, we have away to go. Unlike Mr Geithner, Mr Rosen isn’t averse to printing some more money to get the economy going, but since nobody is sure yet how much impact the £125 billion injected so far has had on the economy (isn’t that great, who else could spend that much and not know what had happened to it), he wants to wait a bit.

Unfortunately, if we do see that light it may turn out to be an express train heading in our direction. Mr Rosen says that there is a possible nightmare scenario where that the government fails to fix the banks before creditors refused to finance huge government deficits. This would leave the UK in the same position as Japan in the 1990s.

Mr Posen says he will be undertaking three specific pieces of research to help him think about the UK economy. First, he would evaluate the potential growth rate of the economy, starting from what he described as a puzzle as to why British productivity growth had been so disappointing. Second, he wanted to delve deeper into the lessons from 1990s Japan to ensure countries do not make the same mistakes. Third, Mr Posen said he would begin research on how authorities can develop an exit strategy to loose monetary policy, excessive budget deficits, and support for the financial sector, given the important of ensuring the sequence of these moves does not undermine economic performance.

Well let me save you some time M osen. I can give you answers to points one and three: excessive government regulation, low incentives through the tax system for capital investment giving effective tax rates considerably higher than the headline rate, excessive changes in the tax and corporate legislation and a general unhelpfulness towards business, particularly capital and energy intensive industrial businesses have all contributed to the lack of productivity, and a bloated public sector if you include them in your figures.

The solution is a new, slimmed down government. Don’t look at what Japan got wrong. Look at what Singapore got right.

Tin foil hat time: Dr David Kelly

One for the conspiracy theorists I am afraid, but one of the scientists asking for a proper inquiry into the death of Dr David Kelly raises a very interesting point.

At the time I thought that Dr Kelly was merely an MOD scientist who buckled under the pressure of media scrutiny, although it seems that he had quite a hands-on role in the UN search for chemical and biological weapons, s he was not necessarily the shy, retiring backroom geek that the press made him out to be.

But as a fellow scientist pointed out, Dr Kelly was a very prominent germ and chemical warfare expert. That is relevant because of his knowledge of the biology of death. He had spent 10 years at Porton Down and he knew everything about killing things. So why would he use the uncertain and probably uncertain method of swallowing his wife's co-proxamol tablets and cutting his wrists with a blunt knife?

At the very least he could have used his professional knowledge to better effect.

Here's a confident prediction

UK unemployment will double under the next government.

There are currently 2.1 million unemployed people according to the official statistics based on the claimant count.

There are a further 2.6 million who are claiming long-term disability benefits, but the rules have changed. Applicants for sickness benefits are no longer judged on whether they age sick but n whether they are able to work. The results is that more than two-thirds of applicants for sickness benefits are being rejected under the new regime, casting doubt on the validity of 2.6m existing claimants deemed unfit for work.

According to data seen by several welfare industry figures, up to 90 per cent of applicants are being judged able to work in some regions and placed on unemployment rolls rather than long-term ill-health benefits. A three-year programme starting in 2010 will subject 2.6 million incapacity benefit claimants to the new work capability assessment. If we assume that a more conservative 80% of those will fail the test, then there will be an extra 2.1 million job seekers on the unemployment registers.

The theory is that this will force at least some of them into work. The reality is that with 2.1 million on job seekers allowance and many others "economically inactive", adding the halt and the lame to the ranks of the unemployed won't affect levels of employment.

Monday, 13 July 2009

Cheap is good, free is better

The Telegraph and the FT have made a big fuss today over a report prepared for Morgan Stanley by a 15 year old on a summer work experience. You can read the report here. Morgan Stanley appeared to ave zapped the report of to several f their media clients. His report proved to be “one of the clearest and most thought-provoking insights we have seen. So we published it,” said Edward Hill-Wood.

Either Mr. Hill-Wood gives his kids too much pocket money or he should spend more time at home watching what they do. Kids like technology, or more precisely, the internet, because it gives them a lot of what they want: content (music, videos, communication) in return for very little of that of which they have very little: money. They aren't particularly tech-savvy, but they are usually cash-poor and resourceful enough to learn. These were the people who embraced texting because it was cheaper than talking on their mobile phones. They don't use Twitter because that costs money and they watch little TV and even less advertising and newspapers are completely off their radar.

So for the benefit of all the media moguls who we are told have analysed the report in detail The issue for you is not how to hook into teenagers, it is how to stop them getting everything for free. Sadly for you that doesn't look possible any more. A classic case of how new technology can undermine what used to be a solid business. A 15 year old could have told you that.

Nice work if you can get it

I missed the stories in the papers last week about Alphasteel, David Mills and some Iranians. Alphasteel was a Welsh steel rolling mill which was rescued by an Iranian investor called that Mr Rostami-Safa through his Swiss holding company, Satico. The original purchase seemed kosher enough. The Anglophile Mr Rostami's family had run a large and profitable mill for many years in Saveh and at the time were building another mill in Abu Dhabi, which would no doubt be powered by Qatari gas and Bangladeshi labour, which shows Mr Rostami is no fool.

The purchase of Alphasteel in 2003 though was misguided, and the company folded just before 2007. In that sense it was just another business failure and one that was likely to occur even if Mr Rostami had not bought it for £40 million.

But what caught my eye in the whole deal is the fact that the purchase was partly financed by a loan from Rosbank. Actually only one third of the purchase price, a £13 million credit facility, which might have been for working capital purposes. But the really eye catching part was the £4.7m paid in fees to Summit Development General Trading, a Dubai-registered company, for "counter-guarantees".

The administrators to Alphasteel are trying to reclaim those fees and the courts have frozen the assets of Dr Shahram Shirkhani, a 24.5% shareholder in Summit. They are also trying to recover other "substantial" professional fees from Dr Shirkhani, a lawyer.

Guarantee fees for 36% of the principal? So the net borrowing was only £8.6m with £13 million to repay, plus interest, and lawyers fees on top. No wonder Islamic law forbids usury.

This could get nasty, Part IV

As you were. The US and UBS have agreed to delay their court case for three weeks. That might be enough time to offer Swiss nationality to all US citizens with deposits at UBS.

When I was a young student at one of our more ivy-clad universities I had the pleasure of working for a summer at an international banking institution in Basel (a fine institution whose sports club boasted the finest clay tennis courts I have ever seen, coincidentally little more than a backhand lob away from where Roger Federer now lives).

I had two American bosses who took umbrage at the fact that, while they lived in a low tax country, Uncle Sam wanted to tax them at US rates on their worldwide income. So they wrote to their Senators back home. The Senators both wrote back saying that if the Russians were ever to invade (it was during the Cold War), the US Army would come over and get them out.

"You didn't read our letter", replied the Americans. "We are in Switzerland. We have nuclear shelters. If the Russians invade, we want to stay here."

A step in the right direction

The Centre for Business and Economic Research (CEBR) says the next government will have to deliver a drastic £100 billion programme of tax hikes and spending cuts to repair the ailing public finances.

They say this would be needed to get the UK's budget deficit down to £50 billion by 2014-15. I suspect this would not be enough. With less government spending 6ax recipts would also be down. I figured a while back that 28% cut in government spending would be needed to wipe out the deficit, so a 20% cost cut/tax hike is needed to bring it to £50 bn rather than the 14% proposed by the CEBR.

The CEBR says that if the Conservatives win the next election, the gap will be plugged with £20 billion in tax rises and £80 billion spending cuts. If Labour retains power, it forecasts £40 billion of tax hikes and £60 billion of cuts.

CEBR chief executive Douglas McWilliams said: "It is likely that any government - particularly a new one - will be forced by political necessity to announce its fiscal consolidation programme early while it is still possible to blame the need for it on the previous government. And it will look to achieve most of its results within a parliament."

Sounds like he has written of Gordon Brown's chances of re-election, so there should be fewer shoddy economic forecasts. Alistair Darling said in this year's Budget that he expects the economy to contract by only 3.5% and to grow by 1.25% in 2010 and 3.5% in 2011, or net up by 1.125%.

CEBR says the economy will contract by 4.1% this year - compared with the official 3.5% estimate - before growing by just 0.6% next year and 0.9% in 2011, or net down 2.656%, a 3.8% difference.

Sunday, 12 July 2009

G8 commit $20bn for food security, or maybe not

World leaders have pledged to commit $20bn over three years to develop agriculture in poor countries. The Group of Eight summit of rich countries in L’Aquila, Italy, had aimed to pledge $15bn , but a last whip-round before delegations left came up with an extra $5bn to make a bigger headline figure.

Exactly how much of the promised money was new or how it would be managed was not disclosed, but UK officials candidly admitted that their pledge of $1.8bn had been reallocated to food and agriculture from other aid lines, the same scam that we saw at the London G20 (remember the $5 trillion package) and countless Brown budgets.

Silvio Berlusconi, Italy’s billionaire prime minister, was stung by accusations last week that Italy had cut its aid budget, saying he would rectify the mistake. Despite that assurance, Marcello Fondi, a senior foreign ministry official, later disclosed that his ministry’s aid budget would fall by a further 10 per cent in 2010, according to Save the Children.

Clearly, the key to success in international aid politics is total sincerity. Fake that and youv'e got it made.

Friday, 10 July 2009

If this is success, what do you have to do to fail?

John Meriwether worked as a bond trader at Salomon Brothers. At Salomon, Meriwether rose to become the head of the domestic fixed income arbitrage group in the early 1980s and vice-chairman of the company in 1988, when aged 41. Well it was the days of Liar's Poker and big swinging dicks, and nobody's dick swung bigger than Meriwether's.

Three years later Salomon was caught up in a Treasury securities trading scandal perpetrated by a Salomon employee, and Meriwether was stuck with a $50,000 civil penalty.

Figuring he could make more money elsewhere without such hassle Meriwether decided to leave the Salomon and founded the Long-Term Capital Management hedge fund in Greenwich, Connecticut in 1994. Long-Term Capital Management collapsed in 1998, proving that if you think you are smarter than the market, you probably aren't. LTCM was built on leveraged bond arbitrages. The trouble was that as it got bigger, the number of valuable arbitrages diminishes relative to the capital base. I guess it shows that in a liquid market, arbitrage is a niche business. Anyway, the upshot was that the highly leveraged fund had to be bailed out to the tune of $3.6 billion.

Undismayed Meriwether took a break and then started started JWM artners LLC with initial capital of $250 million with loyal quants and traders. As of April 2008, the company had around $1.6 billion in management. But then it all went horribly wrong. Between September 2007 and February 2009 Meriwether's main fund at JWM Partners underperformed the Masterley Black Sock Fund (stuff cash into a sock and leave it at the back of your draw) by 44%.

It seems there is a never ending supply of mugs who want to give away their money, but what is more astonishing is that after serial failure, Meriwether is seen by some as a doyen of the US financial services industry. It seems that to be real villain you have to be sent down for 150 years.

This could get nasty, Part III

One for the tax geeks. One of the reasons there may be a stand off between the IRS , the Swiss government and UBS is the US-Switzerland tax treaty which has the following paagraph in Article 26 Exchange of Information.

3. In no case shall the provisions of this Article be construed so as to impose upon either of the Contracting States the obligation to carry out administrative measures at variance with the regulations and practice of either Contracting State or which would be contrary to its sovereignty, security or public policy or to supply particulars which are not procurable under its own legislation or that of the State making application.

I guess that means that if and to the extent that Swiss law requires a bank not to disclose any information, then they don't have to under the tax treaty, whatever the US courts or government say. There may be bona fide case to answer for each of the 52,000 names referred to by the IRS, but without all the paperwork suggesting tax fraud for each of those names, the Swiss government is not going to concede.

Thursday, 9 July 2009

What they don't teach you at the Harvard Business School

Takeover battles are usually about share price performance and profits growth but the tussle between the mining giants Xstrata and Anglo American has taken an unusual turn with a crass, sexist attack on Anglo's chief executive, Cynthia Carroll.

One of the few women to head a large UK firm, she has become the target of a tirade from Anglo's former deputy chairman, Graham Boustred, 84, who told South Africa's Business Day: "This woman's hopeless. There's no morale [at Anglo]."

Boustred then suggests that it is difficult finding a female chief executive "because most women are sexually frustrated. Men are not because they can fall back on call girls. If you have a CEO who is sexually frustrated, she can't act properly."

They obviously teach business differently in South Africa. Which is probably why Anglo American have named Sir John Parker, chairman of National Grid since 2002, as its new chairman.

However, this may prove unpopular with the government in South Africa, who were pressing for a black chairman, saying this would be a "positive signal".

Still, better not to have too many "hopeless" people at the top.

This could get nasty, Part II

Alan Gold, the Miami judge who will preside over the UBS hearing next Monday has called on the US authorities to specify how far they would go to force the Swiss bank to comply, if the court rules in their favour. He has asked them to clarify whether they might confiscate assets of the bank’s US operations.

Wednesday, 8 July 2009

This could get nasty

Uncle Sam doesn’t like the fact that UBS has sold its services as a facilitator of tax efficiency to US tax payers. Or to put it another way: it has allowed US citixens to hide behind the cloak of confidentiality provided by the Swiss banking rules.

So the US started investigating UBS and then it litigated, demanding that UBS should hand over the names and addresses of 52,000 US tax payers who held money on deposit at the bank. Normally that would be enough for a bank to hand over the data. Client agreements would normally allow banks to hand over confidential information if required to do so by a court or governmental authority. But in Switzerland it isn't so easy. They have banking laws that protect the identity of investors.

Swiss bank secrecy laws do not give an absolute anonymity. The protection given to depositors under Swiss law is similar to doctor-patient or lawyer-client confidentiality. In practice all bank accounts are linked to an identified individual, and a prosecutor or judge may issue a "lifting order" to access to information relevant to criminal investigations.

However, the Swiss government has now entered the battle by saying it would forbid the bank from handing over confidential client information even if the US courts required it, adding that it would even confiscate the data if necessary.

Now that is an interesting idea. How does a government confiscate the identity of a bank depositor? And if they do, how does the account holder get their money back?

Time for another graph

This is one picture that the government doesn't want you to see. The Prime Minister is apt to spout ststistics regarding GDP as though that was a good thing. The trouble is that GDP is only a good measure when it is fairly priced, and it is probably only a realistic measure of economic activity when applied to the private sector because arms length pricing (usually) applies. Certainly it is the private sector that ultimately pays for all the schools and hospitals and all the other baubles and trinkets doled out by the state.

So let's look at the size of UK private sector activity. We get a figure for that by taking the reported annual GDP and subtracting from that all government expenditure for the year. But in order to measure activity year on year on a meaningful basis we then adjust the economic figure according to an inflation index. I choose to use RPI, but some economists might argue for something else. We find that on this basis private sector activity actually peaked in 2003 and at the end 0f the year it will probably be lower than in 1997 (despite a higher population). So to compare year on year figures on a meaning ful basis we divide by the estimated mid year population, and find that not only is the UK private sector less productive per capita in real terms than it was in 1997, it is more than 30% less than it was 6 years ago.

Click for a larger image

Are we there yet?

The latest economic puff from Halifax reads:

“There was a 0.5% decline in average UK house prices in June. On a quarterly basis, the 1.9% fall in house prices in the second quarter was the smallest since 2008 quarter one. These figures provide evidence that the underlying pace of house price decline is easing."

Did you get that? The pace of decline is easing. In other words the rate of decline in market expectations of future earnings power to pay for houses is declining less rapidly than it was one quarter ago. That doesn't sound like bottoming out. That still sounds like we are still falling but we can see the bottom coming and at least we are not in total free fall.

Tuesday, 7 July 2009

Rover bites PM?

I don't think I was alone at being surprised that a minister should instigate an SFO investigation into the collapse of Rover. After all, BDO Stoy Hayward and a leading QC had been going over the books since 2005, apparently running up £16 million in costs. If there was something untoward, then they would have called in the cops. Only a cynic would have thought they would have delayed so they could max their billings.

But then why would it be left to the Business Secretary to put the call into the SFO? We can only speculate, but the Phoenix 4 think they know. They have accused Gordon Brown of "pulling the plug" on MG Rover in 2005 when he was chancellor of the exchequer, on the advice of Baroness Vadera, at the time a key Treasury adviser. Tony Blair wanted to save the company, the directors claim in a "dossier" issued by Media House, a public relations company.

The document reflects their concern over the fraud investigation into Rover which they bought from BMW for £10 in 2000. They say the SFO enquiry is designed to postpone publication of the investigators' report.

The Phoenix Four submitted 30 separate requests for information to the government about the handling of the company failure, which were all denied. The Department for Business told the media enquirers that disclosing the information could have "prejudiced" official investigations into the collapse.

The dossier implies that Lord Bhattacharryya discouraged the Treasury from supporting MG Rover during last-ditch rescue talks with Shanghai Automotive Industry Corporation (SAIC) in 2005. But the Labour peer and party donor says he was never himself a "key advisor" to government on MG Rover, but the collapse of MG Rover was triggered by advice from Rothschilds to ministers that discussions between MG Rover and SAIC had stalled, and the government withdrew a £120m bridging loan.

The dossier also counters press reports "based on erroneous and mischievous [government] press briefings" that the Phoenix Four extracted £40m from MG Rover. It says that the directors received £8.5m in salary and bonuses over five years and annual pension contributions were made of £730,000 each, or £14.6m in total. The four men received another £10m from a share sale.

New Feature - Muzak

Just to get you in the holiday mood, some sunny French music. Let me have any holiday music requests in the comments.

Monday, 6 July 2009

Let's all Make Money Fast the Goldman way

Ever since there have been exchanges and computers people have tried to figure out how to beat the market using cmputers. One way is to analyse and analyse data looking for trends or market discrepancies, another is to loook for arbitrages across markets, and yet another is to react very fast to changes in data.

The latter is key to Goldman's automated stock and commodities trading business, and being faster than all the ther banks who are hooked up to the same information feeds and exchange links is a key. So their algorithms and their software are prized assets.

So prized in fact that when one of their programmers was lured away for three times his $400,000 Goldman salary, he allegedly tried to take the source code with him. While most Americanss were celebrating the 4th of July, a Russian immigrant living in New Jersey was held on federal charges of stealing secret computer trading codes from Goldman Sachs.

Federal authorities contend the computer codes and related-trading files that Aleynikov uploaded to a German-based website help this major financial institution generate millions of dollars in profits each year. Federal authorities say the software quickly processes market information and using secret mathematical formulae, allows the firm to make automated trades.

This case may be worth watching because it will most likely shed a great deal of light on hw the Goldman department operates and in order to assert that there is any value in the stolen software, Goldman may have to impart some details on the proprietary algorithms - it is easy to see how a good defence lawyer could denigrae the vaue of the black box if Goldman don't eveal its contents.

This is how the criminal complaint describes the Goldman trading platform: “The Financial Institution has devoted substantial resources to developing and maintaining a computer platform that allows the Financial Institution to engage in sophisticated high-speed, and high-volume trades on various stock and commodities markets. Among other things, the platform is capable of quickly obtaining and processing information regarding rapid developments in these markets.”

The complaint did not list the firm, but biographical information for Aleynikov on LinkedIn says he joined Goldman in May 2007 and was vice president for equity strategy. The bio says he was responsible for “development of a distributed real-time co-located high-frequency trading platform.”

Aleynikov apparently had just started a job with another big firm in Chicago after leaving his previous employer in New York in early June, who alerted federal authorities. On July 4, Aleynikov was processed on a “theft of trade secrets charge” in a criminal complaint. As of Sunday morning, he was still being held at the Metropolitan Correction Center in Brooklyn.

The case against Aleynikov may explain why the New York Stock Exchange moved quickly last week to stop reporting program stock trading for its most active firms. Goldman was often at the top of the chart — far ahead of its competitors. Goldman may have asked the NYSE to stop reporting the number after it discovered that someone may have infiltrated the proprietary computer codes it uses.

Federal authorities appear to believe Aleynikov may have had help. The German website that Aleynikov is accused of uploading the stolen information to is registered to a person in London. Not me guv.

For $2.5 billion, I won't take offence

It is refreshing to learn that no money was wasted on branding consultants for the new $2.5 billion joint venture announced between the Russian gas giant Gazprom and the state of Nigeria - Nigaz.

Russian and Nigerian Presidents Dmitry Medvedev and Umaru Yar'Adua agreed last week to build production sites, pipelines and gas fired power stations in the cenrral African country. The name is an amalgamation of Nigeria and Gazprom, pronounced "nye-gaz", but could be read phonetically as a term for people of black African origin, causing consternation in the United States.

One Nigerian in Lagos said: 'White people are making too much of this. As long as the Russians pay us, they can call it what they like.'

Don't you just hate it when

.... the FT goes all "Daily Mail". This morning's target are "Those clever investment bankers". The other pink paper has got itself uptight over securitisation from Barclays and Goldman.

"Barclays Capital has found ways of pooling risky assets on banks’ balance sheets from several clients into “smart” securitisation vehicles that can be rated by a ratings agency. Unlike discredited collateralised debt obligations, however, this is about slicing and dicing existing assets, not new lending."

So shock horror, Barclays is using some the asset securitisation schemes that have been around for years. Like the recession, this started in America, but unlike the recession this started out in the Reagan era with US commercial banks doing exactly the same thing funding pools of customer 's financial assets through off-balance sheet vehicles funded by the commercial paper market.

"Goldman Sachs is working on, in effect, a private sector equivalent to the asset insurance scheme run by the UK government."

You mean a syndicated guarantee? Now I am shocked, shocked that is that the FT pay people to write about this as if it is newsworthy.

"In both cases, this would reduce banks’ capital requirements."

Now the FT could have figurd out that if governments make capital requirements more obnersous, the economics of various arrangements will be impacted and banks will adjust their funding arangements to compensate.

To read the opinions of a wiser financial journalist, readers should turn to this month;s Vanity Fair where they will find a wonderful article by Michael Lewis on the decline and fall of AIG FP, again capturing the key elements of the story ("The Man Who Crashed the World"). I am a little surprised that Lewis has taken so long to get out this article, but it reads to another outsider, to be perfectly pausible. It is a simple story of how well run financial institutions go bad when the wrong people get int power.

I knew AIG FP well in the early 90's when they made the market in long dated swaps. At the time I had a need for long dated cross-currency swaps, and they led the market. Not only did they give the best pricing, they also made the most money, but they soon had competition from the likes of Swiss Re, Gen Re and one or two Japanese institutions. Their problems started when Joe Cassano moved from being head of operations to running the division.

What was previously a geek-led company with a culture of discussion, became a money machine driven by an autocrat, but ultimately failed because while the ungeeky Cassano did not appreciate the risks that wee building, he did understand the massive profit share and pushed AIG's executives to book deals. It might be said that one of the most intelligent houses in the City became the AAA-rated stuffee of choice but of course the level-headed guys at Goldman would never be so rash as to say that.