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Monday, 31 August 2009

The puritans strike back

The biggest shake-up of the licensing system since the last big shake-up will take effect in Scotland tomorrow when the Licensing (Scotland) Act 2005 comes fully into force.

The main impact is supposed to be the banning of "happy hours".

Who are they kidding? Have they ever been in a Scottish pub? There hasn't been a happy hour in a Scottish pub since the battle of Bannockburn. Not even a happy minute.

Your bill, monsieur

Imagine the following visit to a restaurant. The maître d’hôtel escorts you past the pot plants and assembled diners to your table, seats you with consummate elegance and presents you with the bill.

"But what is this?" you splutter.

"This, monsieur," come the reply "is the bill. As you will remark, it is a little high, but there were eight people and there was the matter of the lobster thermidor, and we must not forget the two bottles of Chateau Yquem."

"But we haven't even ordered yet, and there are only two of us."

"Non, monsieur does not seem to understand. This is the bill for the customers who were at this table here before monsieur."

Absurd? Perhaps, but that is the way that we run our public finances. With a budget deficit running at 15% of GDP we are living way beyond our means. Put another way the government which accounts for 50% of the spending in the UK is only raising 70% of the cost through taxes.

The rest is funded by borrowing. Instead of bribing the electorate with money provided by the richer half, this government bribes the electorate with money to be paid for by their children.

But this is all investment say the government. Not true. The investment such as it is, comes mostly through the PFI, which in theory has nothing to do with government borrowing.

Some spending might validly be called investment and thus might properly be funded by borrowing and paid for over many years. This would include large on balance sheet projects such as Crossrail, West Coast Main Line, sea defences, non-PFI road building or large items of defence expenditure. The rest of expenditure outside the PFI is largely current spending on benefits, education, healthcare, defence, regulation, administration or other services, the cost of which should all be borne by the generation who are supposed to benefit from it and not passed on to the next.

If the government doesn't have the guts to raise taxes to pay for current services, it should cut the services that it can't afford. And that means paying the full cost, including full provision for the pensions, of current public sector workers.

"Ah, monsieur, this is a little, 'ow shall shall we say, delicate, but the people who were at the table before thought that you might care to tip their waiter."

Saturday, 29 August 2009

More BBC economic spin

Two pieces of egregious spin on economics from the BBC:

Economy shrinks less than thought

On last night's news this was spun as indicating that the recession may soon be over. The upward revision was from a 0.8% quarterly decline to a 0.7% decline, so the difference might have been miniscule because of rounding , but of course the BBC did not go into that level of detail. They simply extrapolated from that small detail that our economic woes are over.

Back to reality. Let's put it in perspective. Inflation is over 0.4% per quarter, so a 0.7% decline in GDP is a morge than 1.1% drop in real terms. In how many quarters since 1990 have we seen a 1.1% real terms increase in GDP, which would be more than 1.5% increase in nominal GDP?

According to the BBC: none.

House price rise hits 5-year high

The is little nugget comes from the latest monthly report from the Land Registry that house prices in England and Wales rose by 1.7% in July compared with June, the biggest monthly leap in value since July 2004.

At first blush this might look encouraging, although it is only monthly figures, and based on substantially lower sales figures and thus a more volatile market where house prices are still 11.7% lower than a year ago. The methodology looks sound because the Land Registry compares the value of houses actually sold against known previous sales to compute an index.

The House Price Index is based on values of houses that were actually bought and sold in the relevant month compared with last known sales of the same property. The Land Registry database contains 15 million entries of which about 5 million are matched pairs giving 2.5 million price ratios between sales which can give a reasonable input to a regression analysis, but there are a number of problems with the method.

First of all the data excludes forced house sales from divorce settlements and reposessions. The latter might be sensible in a fair market, but it creates a material upward bias in the Land Registry report when repossessions are more frequent.

It also excludes new builds by definition, which will constitute a large part of the market at any time and where prices may become very depressed in a recession as developers try to clear their books to repay lenders, which would tend to bias the HPI higher than the real average price when developers are having a bad time.

Third, the index assumes that it is comparing a homogeneous distribution of house sales, but if we look at the price points where sales are ocurring we see that this is not the case. Sales at the upper end of the market are about a half of where they were a year ago. On the other hand sales of properties below £50,000 were very much in demand with numbers of sales up by 50% and no doubt higher prices being paid.

A 1% increase in the value of low cost housing stock would be given equal weight in the computation as a 1% increase in the price of high cost housing stock. It looks suspiciously as though the Land Registry methodology has pushed up the House Price Index simply because of a substantial increase in demand for properties right at the bottom end of the market, notably in Wales and the North of England, whilst the price of higher priced housing stock where the number of sales has actually decreased could well be static or declining, but because fewer of those houses have sold they have less impact on the results.

Not that the BBC would ever want to go into that level of analysis.

Friday, 28 August 2009

Cheap, nasty, smelly

That is the choice of housing that you get when you are poor, unemployed and living on benefits. It also describes the government's treatment of some of the very poorest in society.

At the moment people on Local Housing Allowance who cannot make ends meet are able to trade down to find accommodation that costs less than the maximum allowance available to them and keep the savings, up to a maximum of £15 a week. Believe me, this is not something that anyone does lightly. LHA is means tested so if anyone is claiming it, they are in a bad way. Many families cannot cope with the levels of income that are available to them and are forced to move to lower quality housing simply to take advantage of the extra £15.

Essentially this policy has cost the tax payer nothing because the families would have claimed the more expensive housing if they had no choice.

Now we hear that the Treasury says that the policy costs too much and that the ability to pocket any surplus should be scrapped from April 1. Someone living on £65-a-week jobseeker’s allowance would lose 18.75% of their income. The press and the government both kept quiet about it at the time and the measure was not a feature of the Finance Act. Details were hidden away in the text of press notices:

Local Housing Allowance

The Government is reforming the Local Housing Allowance (LHA) so that it is more equitable and promotes work incentives. From April 2010, households will no longer be able to keep any of the surplus if the LHA they receive is higher than their rent. For those already receiving LHA, this reduction will not apply until the anniversary of their claim. It is essential that the LHA represents good value for money for the taxpayer and as this measure will only affect surpluses, it will not produce rent shortfalls.

The truth is this will not save the government a penny because if the cash is taken away, families will simply move into more expensive accomodation to take up their full housing allowance, but will lose valuable cash.

So all I can do is suggest that you write to your MP, not that it will do any good and support your local food bank. If you really need convincing how tough life can be at the sharp end, pop round to see their "clients". Requests for help at the food bank in our nearest town have risen 40% over the last year. The situation is probably the same where you live and will be much worse if this measure goes through.

Crime of the Week: Multi-colored Swap Shop

UK readers may remember the style crime that was Noel Edmonds TV show, but they have probably never heard of Edward H. Okun, the former owner of The 1031 Tax Group LLP. The name of the company derives from a section of the US tax code, section 1031 as it happens, from which a minor industry peculiar to the US has evolved.

Under Section 1031, recognition of gains or losses arising on the alienation of property may be deferred on the exchange of certain types of property. Or in plain English, if a US tax payer buys a building for 100 which they decide to sell many years later for its market value of 200, they would pay tax on the profit of 100, but if they exchanged it for another property also worth 200, they would not recognise any gain, but they would carry over a "basis" of 100 in the new property.

In terms of tax policy, there is nothing particularly unusual about this as many countries operate what might broadly be termed reinvestment relief where the proceeds of the sale of movable or immovable property are reinvested in similar property. The US system is unique in that it requires the exchange of the old property for the new to qualify for the tax relief. There is no other mechanism under the US tax code for the vendor to achieve the same relief.

This creates a number of problems. First of all if you are selling one building and buying another, the buyer of the old proerty and the seller of the new property are almost certainly not the same person. Since those two other counterparties do not want to be involved in your tax affairs, it is necessary to introduce a third party accomodator who will enter into the buying and selling contracts with the other counter parties and exchange the properties with you to give you the desired tax effects.

Now the real estate market being what it is, the chances of being able to line up all your ducks in a row and contract a simultaneous sale and unconnected purchase are about as remote as Bernie Madoff chances of beatification. The solution was to amend the law to permit deferred exchanges, where you would enter into one half of the exchange with the intermediary who would sell the property and hang on to the proceeds, giving you 45 days to indentify and 180 days to complete on the purchase leg of the exchange. In order to make this work the accommodating party, called a Qualified Intermediary, had to be completely unconnected.

But in most cases, there were no requirements that the Qualified Intermediary should have any qualifications at all. Extraordinarily, the only place they have to be licensed is in Nevada, although that state does not require permits for unconcealed handguns. Elsewhere anybody who is fit to run a US company can set up as a 1031 intermediary.

Okun's business grew when the times were good, so that at any time his company would hold several hundreds of millions of dollars, but when the market peaked, volumes dropped and the group ran into a "liquidity problem", specifically because Okun had helped himself to $126 million of client monies, which is why he is going away until 2109.

Nice work if you can be bothered

There hasn't been a more abortive return from retirement since Michael Schumacher decided that driving in Formula 1 can be a bit of a pain in the neck, but Robert Benmosche, the new chief executive of bailed-out insurer American International Group Inc has told Reuters that he's getting a lot of work done from his massive villa in Croatia.

Robert Benmosche working hard at his Croation villa

In fact, the former head of MetLife says he agreed to come out of retirement one week earlier than planned, although anyone with their wits about them would have figured that this was simply to start work before he took his three week vacation in Croatia, so that the holiday would take place while he was employed. After all, his predecessor only lasted 11 months on his $1 a year contract, so with a contract for $3m in cash plus $4m in stocks and a bonus package that could be worth $3.5m, Mr Benmosche's service up to the end of his vacation would have earned him a pro-rata $600k for one week at the office.

Apparently it is not all sunshine and sand in Dubrovnik. Oh no, Mr Benmosche takes an average of 3 conference calls a day, which is not bad for a guy running a company that is trying to make disposals left, right and centre and which has been bailed out by the US government to the tune of $85 billion. And clearly he has the best interests of the US tax payer at heart:

"Some of us need to come out of retirement, who have done this before, to help deal with the crisis," says Mr Benmosche. "If I sit here, I just felt that there are going to be continuing problems. I felt I had some of the skills necessary to fix the problems of AIG in particular and it made sense to come back."

Or rather to disappear to his villa 5,000 miles away.

UK economy contracts by 0.7%

The UK economy shrank by 0.7 per cent in the second quarter, according to the ONS. Let's get this right before all the media jump on the story. This isn't better than the 2.4 per cent decline seen in the first quarter of the year, it is 0.7 per cent worse, and it is worse than many of the pundits had forecast.

This is a 5.5% decline year on year, which once again is the largest such decline since records began.

While France, Germany, Japan and Hong Kong, countries who have largely shunned the ideas of fiscal stimulus, cash for clunkers and quantitative easing have broken out of recession and are now showing economic growth, the UK and the US are still on a downward trend, with a lack of investment and ballooning government debt suggesting that situation will continue.

Bank debt buybacks à la mode

Shares in Crédit Agricole rose by 7% on Thursday after it reported better-than-expected Q2 net profits, helped by resilient sales in its retail and asset management businesses and lower asset writedowns. France’s third-largest bank said it made net profit of €201m ($286m), flat on the first quarter but well ahead of analysts’ expectations. First-half revenues at €8.62bn rose 17% from a year ago.

But wait a minute, because at the beginning of the second quarter Crédit Agricole announced the result of its offer to repurchase up to £750 million of its outstanding £1,050 million Upper Tier 2 Notes. Crédit Agricole received valid tenders of £545,211,000 principal amount of the Notes, and agreed to pay £392,551,920 for those notes plus accrued interest.

Call me naive, but I make that a profit on the repurchase of those notes of £152,659,080, or about €175 million. So we can put 85% of the banks net profits down to the fact that it is doing so badly that it could buy its sub debt at a discount, and this is enough to cause the share price to rise by 7%.

Which is probably why CA repeated the same stunt in the third quarter booking a gain of C$63.6 million on a repurchase of C$212 million of Undated Deeply Subordinated Fixed to Floating Rate Notes.

Why make money out of risky lending when you can profit from your own crappiness? No doubt the directors will point to these profits as a reason to preserve their year end bonuses.

Thursday, 27 August 2009

Saving the planet with a 100% tolerance

Engineers. I can't help admire what they do but of all the intelligent people in the world those with the lowest social skills tend to be engineers. And the lowest members of that particular gene pool are invariably mechanical engineers. You probably remember them from your university days. The mechanical engineers were the ones who spent their vacations stripping down and rebuilding a car, a job that you could have told them would soon be replaced by robots. They wore college scarves and sweatshirts, grew beards and you just knew that they were destined to spend a career in one of the less exciting metal-bashing industries.

But they were usually competent at what they did which is why it was interesting to see that they had published a report setting out a range of potential geo-engineering options to cool the planet, the foremost being:

  1. Artificial trees - machines that can remove CO2 from the atmosphere like trees for sequestration
  2. Algae-coated buildings - letting the slime grow on buildings and using it as a biofuel.
  3. Reflective buildings - increasing the albedo and reflectivity of the built environment.
Nothing particularly innovative, but the slimy buildings does have an element of impracticality and the sort of aesthetics-free behaviour that you would expect from engineers.

So I decided to download the 1.8Mb PDF to find out what they were upto, only to discover that even in my relatively powerful computer the obese code that is the latest version of Adobe Reader keels over and grinds to a halt when confronted with the engineer's relatively modestly sized report. Even a little tweaking to switch off all the images leaves the text of the file dripping onto the screen before it seizes up completely. I don't think my copy of Adobe Reader is any different to anybody else's, so heaven knows what happened to IMechE's Total Quality Manegement or ISO 9001 doodads.

Sorry guys, I might have been interested, but if you can't learn to present your case in a form that can be read by your audience, don't be surprised if we dismiss you as a bunch of socially autistic geeks.

Quantitative easing is not working.

Mortgage approvals are up according to the media. Up to a point. Mortgage approvals always rise in July because that is the time that people buy and sell houses. It is a seasonal business that kicks off in the spring and slows down in the autumn. Taking into account redemptions and repayments mortgage lending is actually down on last year, according to figures from the BBA.

OK, how about bank lending to non-financial companies, the booster for the economy. If times are tough and cash flows are drying up, then we could expect the banks to be lending more to their customers. After all we know that the Bank of England has a £175 billion programme to buy gilts and other securities from the banks to give them liquidity and capital to lend to business and thereby fund growth. Well, no, loans to non-financial companies are down 3% on last year, despite the £160bn of bank money sitting on deposit at the BoE.

So let's look at capital spending by businesses. It has just fallen by 10.4% quarter on quarter, according to the Office of National Statistics, 18.4% lower than a year ago and the sharpest decline since records began in 1966. Fair enough. Perhaps we would expect capital expenditure to fall in a recession, but we should bear in mind that a substantial part of that expenditure is on government programmes through the PFI, but which count as private investment. A further considerable part of business capex is on office equipment. This is often contracted expenditure and is so recurrent it is more like an operating than capital expenditure, an unavoidable periodic cost of employing staff.

Then when we take into account equipment with limited lives such as transport and food processing where an ongoing purchase of equipment is required to continue in business or large value items such as aeroplanes and ships which are typically contracted to be purchased years in advance of delivery, we see that the nearly 20% annual fall is substantial, and the substantial fall is blamed in part on the banks' collective refusal to lend.

So what are the banks doing with all the extra capital? Well it looks like they are using it on interbank transactions, derivative trades and a whole lot of hoopla that makes money for the banks but doesn't actually involve lending money to companies, according to Adair Turner. His prescription is to tax the banks, but this is probably the dumbest solution possible, particularly coming from a bank regulator.

One of the reasons the banks don't want to to lend or companies don't want to borrow to invest is the increasing cost of doing business in the UK, regulation and taxation, so adding more burdens and costs to business is not going to help.

If Mr Turner doesn't like what the banks are doing because he doesn't think they are doing the sort of things banks should be doing with tax payer support, then he should do what he is paid to do which is to apply banking regulations. He isn't paid to decide which activities are of a social value (whatever that means), nor to propose tax measures. If he thinks the government should not be supporting finance for speculations on CDS's or the gold market, he should say so and stop banks from taking those risks. If he thinks deposits should be backstopped by a government guarantee because that is the way that business is financed, he should shape the regulations to make it happen.

The problem with his idea of a "Tobin tax" is that it puts up the costs to the banks of doing business, and reduces their likelihood of earning the sort of returns required by the stock market, which means they are less likely to enter into capital-intensive plain vanilla lending to business, and more likely to go after the low capital securitisation and derivatives trading that Turner is trying to limit.

Wednesday, 26 August 2009

Compassion fatigue

One of the most important lessons to learn on Wall Street is to survive by adapting to changing circumstances. Another is to be able to re-engineer the competior's product offerings. It may not bring in much money because you are second out of the starting gate, but it stops your competitors taking your customers. Most products can be re-engineered in days or weeks.

So it is no surprise to hear the latest news about Bernie Madoff. Mr Madoff will by now have realised that he is no longer in the finance business. He is in the business of finding ways to arbitrage his expected lifetime against his prison sentance. At the moment is he is trading in deeply negative territory, and it seems he may be aware of a relevant product from the UK successfully sold by Abdul Baset Ali Al Megrahi and known as "Compassionate Release".

The New York Post broke the news yesterday that Madoff is dying of cancer. The Wall Street Journal later confirmed the news with a source familiar with the situation. According to the Post, quoting an inmate at Madoff's new home Butner, N.C., Madoff is taking about 20 pills a day for his cancer. “He talks about it all the time,” said the inmate. “He’s not doing very well.”

However, the Bureau of Prisons is not impressed, because yesterday afternoon they released the following statement on Bernie Madoff’s condition:

"While the NY Post story is full of inaccuracies, and we can’t specifically address all of them, we can tell you that Bernie Madoff is not terminally ill, and has not been diagnosed with cancer."

Oh well, nice try. At least we can enjoy some of the other possibly inaccurate tidbits from the NY Post:

  • When he first arrived Madoff was assigned to the prison’s engraving section, but last month he was transferred to painting fences. No indication whether this was a promotion.
  • That “a bare-chested Bernie has been killing time at the prison participating in Native American religious purification ceremonies” involving “praying, using heated rocks to induce sweat and smoking from a ceremonial pipe.”
  • Various gangs are trying to recruit Bernie to their crews. They cook sandwich wraps for him back at their cells, which is nice.
  • Madoff hangs out with a homosexual posse although it is all reportedly platonic. Just don't pick up the soap in the shower, Bernie.

Geek post: Bloatware

Software bloat is a term used to describe the tendency of newer computer programs to have a larger installation footprint, or just generally use more system resources than necessary, while offering little or no benefit to its users, and the latest example comes from the criminal case involving Sergey Aleynikov, formnerly a VP at Goldman Sachs. He left Goldman on June 5. In the days before he left, he transferred code to a server in Germany that offers free data hosting.

At Aleynikov’s bail hearing, Joseph Facciponti, the assistant United States attorney prosecuting the case, said that Goldman discovered the transfer in late June. On July 1, the company told the government about the suspected theft. Two days later, agents arrested Mr. Aleynikov at Newark.

In his defence, Aleynikov said that he had inadvertently downloaded a portion of Goldman’s proprietary code while trying to take files of open source software — programs that are not proprietary and can be used freely by anyone. He said he had not used the Goldman code at his new job or distributed it to anyone else, and the criminal complaint offers no evidence that he has.

Aleynikov has not explained why he downloaded the open source software from Goldman, rather than getting it elsewhere, and how he could at the same time have inadvertently downloaded some of the firm’s most confidential software. Sabrina Shroff, a public defender representing Aleynikov, says he had transferred less than 32 megabytes of Goldman proprietary code, a small fraction of the overall program, which is at least 1,224 megabytes.

1.224 Gigabytes!? What the hell are Goldman doing? The whole point of high frequency trading is that it is supposed to be fast and nimble, receiving data, processing it and reacting in milliseconds, or better still microseconds. That should equate to a software path running to thousands of instructions, perhaps millions at the most. How does that require 1,224,000,000 bytes of code? Must have been written by Microsoft.

Tuesday, 25 August 2009

Sterling: Euro trash

If you are returning to the UK from abroad this weekend after spending all of August on the continent, it isn't all bad news. Sterling is at a 10 week low against the euro after falling consistently through the month of August, so any remaining euros that you have in your pocket will buy you more pounds than you spent to buy the euros at the start of the month.

The rest of the news is bad.

There have been some positive signals in the economy, and we are no longer in the la-la green shoot spotting land of improving second derivatives, but into the world of upward slopes of financial measures. The trouble is that those upwardly trending indicators are not hard figures but straw polls amongst chartered surveyors (read property salemen) and purchasing managers. There is a naturally optimistic survivor bias amongst purchasing managers. Those working for companies that are doing badly are morely to be sacked if there is less to purchase, so there will inevitably be more purchasing at companies that are surviving.

The reality of secong quarter UK GDP is that it fell by another 0.8%. If on the other hand you stayed on the continent you might have noticed the economies growing at a 0.3 per cent quarterly rate. That is a difference of 4.5% over a year.

The pound headed south at the beginning of the month when the Bank of England increased its quantitative easing programme because the economy was not growing. It wasn't helped when the tax receipts for the month of July came in much lower than last year, putting the deficit higher than UK government plans and the level anticipated by the markets, which is why the British currency is faring badly against the euro.

On the other side of the channel, Ms Merkel says she has ruled out tax rises to close Germany's budget deficit, which although much smaller than UK's deficit, will be 6% next year. I like that. None of this "no plans to raise taxes" nonsense. You know where you stand. No wonder their economy is doing so much better.

Swimming in gas

UK natural gas contracts fell 59 per cent yesterday because of low seasonal demand and excess flows of liquefied gas. Wholesale gas for same-day delivery dropped to 9 pence a therm. Demand in the 24 hours up to 6 a.m.today was 173 million cubic meters, about 37 million below normal for this time of year due to the recession and warm weather.

LNG cargoes are arriving at Britain’s new import terminals from Qatar, Oman and Nigeria, and gas supplies from Norway through the Langeled pipeline are supplementing flows from the North Sea. It also didn't help that the reversible gas interconnector from Bacton to Zeebrugge was switched into reverse flow, bringing gas from Belgium to Britain rather than exporting it to Belgium.

Running out of gas? Not this week.

Warning: May contain embedded options

The deal to sell RBS' Asian businesses to Standard Chartered is looking a little shaky, and to be honest, I wouldn't buy either business on principle because of their willingness to fleece the naive Asians through what they call dual currency deposits, supposedly a source of high returns to investors, but in reality a scam from the derivatives trading floor.

I have never been a fan of retail structured products from UK banks. A typical scheme of 10 years ago was a share based investment with a guaranteed return of capital. 70% of your investment went back on deposit to secure the capital while the rest went in a tracker, and you were charged a fee on the whole amount.

The DCD which has been around for a while goes to another level of deviousness by offering suspiciously high rates of interest whilst embedding a currency option effectively written by the depsitor to the bank. The way it works is as follows: You deposit say $50,000 in one currency with the bank and nominate an alternate currency, usually quite weakly correlated, such as NZ$ and EUR. The deposit earns what appears to be a high rate of interest over a month, but at the end of the term the principal and accrued interest may be repaid in the original or the alternate currency, at the bank's option.

And guess what, at maturity the bank always chooses the currency that costs them the least, or in other words earns you the least. If you stop and think about it, the extra loss probably wipes out the extra interest earned on the deposit. In fact if you think a litle bit harder, you will realise that the bank is only doing this because on average, even after all the cost of the added complexity, it is making more money on the DCD than on conventional deposits.

In Europe the DCD is rarely seen, but in Asia it is surprisingly popular, but then so is gambling. Contrary to what Standard Chartered, RBS, HSBC, Citibank and all the other banks between the Gulf and Australia who push these things may say, they aren't sold to sophisticated investors.

Almost by definition, they are sold to people who don't understand the risks, or if they do, can't quantify them. They might be able to tell that 8% is a better rate of interest than 6%, but they probably have no idea whether over one month that interest differential is an adequate premium for a one month currency option. If a sophisticated investor really wanted exposure to the currency risks, they would probably have bought a different product.

Monday, 24 August 2009

Santander tweaking its liabilities

Earlier this month I explained how Barclays booked a £1.1 billion profit at the expense of future interest costs by repurchasing libilities trading at a discount to par, and how RBS did the same to the tune of over £3 billion.

Now it looks as though Santander are doing the same. Six weeks ago Santander offered to swap a nominal €9.1 billion of securities for new issues, and today they are offering to buy back €16.5 bn of bonds, which the bank says will improve its capital structure and strengthen the balance sheet of Grupo Santander.

Discounts on par values this time range between 4.5 and 39 per cent, meaning the bank will book extraordinary profits on any repurchased bonds. Some of the retired bonds formed part of the Tier 2 capital structure of the bank, but the profits will go to the bottom line and boost Tier 1 capital, at the expense of future interest costs. Does it make the bank a stronger bank if there is more senior debt and less subordinated? Not really but tell that to the regulators and accountants.

BBC on spin cycle

The BBC is desperately spinning for the government telling the world that the Recession in Britain is 'at an end'. A little closer reading shows that they are actually reporting a survey from the ICAEW that says many private sector companies are upbeat about their prospects, and extrapolates from that a 0.5% increase in activity. How that works is not explained, but this is a guesstimate about future business that hasn't happened yet.

But that doesn't stop the BBC from reporting it as a fact.

Tailender fighting a rearguard action

Gordon Brown outraged Scotsmen everywhere when he congratulated England's cricket team on their first Test win against Australia at Lord's in 75 years.

"The prime minister has been following the cricket," said his spokesman, adding "This was clearly a good win for England today and he looks forward to the rest of the series."

But obviously not that much, because nearly 24 hours after the winning the Ashes, the England team has yet to hear from the Prime Minister. The silence is in marked contrast to his words of praise for the England women's team after they won the Twenty20 World Cup this spring.

His diffidence is clearly because he knows that if he sticks his head out of the 10 Downing Street bunker, he will be shot down by a salvo of questions about trade agreements with Libya. No doubt he will intite the victorious team to pee on his roses at a later date.

We may get back to 2007 by 4Q2010

Many years ago I worked for a few months at a bank in Switzerland. Not any bank, but the Bank for International Settlements, where I developed a computer system for econometric analysis. In fact this was so long ago that this predated personal computers and was written to run on mainframes, but it did most of the sort of things that a statisticsal system for time series might do today, pulling data out of a database, running various statistivcal tests and producing fancy tests, and though I say it myself, it was a rather nifty program, albeit fairly clunky by today's standards, and no doubt it was consigned to the scrap heap when a PC came along with enough computing power to do the same arithmetic.

The only reason that I mention it, is because of a report presented at the Kansas City Federal Reserve Bank's annual conference last week by 3 economists from the same department of the BIS. According to their analysis, damage from financial crises is generally long-lasting and deep, and the U.S. and UK economies are not likely to regain their pre-crisis levels of activity until the second half of 2010.

In a study of how long it takes nations to recover from banking crises, the economists from the Bank for International Settlements said that a third of the 40 crises they studied led to contractions that lasted for three years or more and a quarter of the crises resulted in cumulative losses in economic output of more than 25% of pre-crisis gross domestic product.

The trouble with using such such a simple measure as nominal GDP is that even if the nominal values get back to where they were before the slump, in real terms activity will be 6-10% lower, and then when measuring individual prosperity we have to take into account that the population will have grown. So figuring GDP growth at say 3% and inflation at 2%, it may be way over a decade before we get beck to where we were in 2007.

Counting the cost of plugging the gap

One of the great myths surrounding black Wednesday is that the Conservative government lost tens of billions of pounds in the affair. Sure enough they sold tens of billions of foreign currency reserves, buying back sterling in an effort to support the currency to keep it within ERM limits. The government lossed money as the value of the sterling fell a few percent through the ERM limits, but the amounts actually lost were a few per cent on tens of billions, which puts the losses into the range of hundreds of millions. Arguably, most of the losses were made up in the next few weeks, although it depends at what point in time you start to measure the loss.

Compare that with the more recent performance of governments taking stakes in banks. We shall ignore the total privatisations of the likes of Bradford & Bingley and Northern Rock and look at where governments have taken less than 100% stakes to stabilise the banks.

In these cases, the banks were not necessarily at imminent risk of insolvency, but governments had stipulated that the banks needed to raise more Tier 1 equity to operate within prudential banking limits complying with Basel capital adequacy criteria, particularly in the light of expected write-offs, changes in accounting rules to bring securtised assets back on balance sheet and changes to Basel II criteria that would allocate higher risk to highly rated and structured assets.

All in all, buying bank equity in these circumstances would look like a favourable thing for governments. After all as regulator, they hold many of the cards and should have a good understanding of the remaining risks in the banks. And so it turned out in the main.

First of all we have the Swiss government, which sold its 9 per cent UBS stake for a SFr1.2 billion profit last week, no doubt helped by the resolution of UBS' dispute with the US government over the bank's assistance of US tax evasion, in which the Swiss government took a very active role.

In the same vein, the US government holds an unrealised profit of nearly $11 billion on a 34% interest in Citigroup.

In July the US government converted $25bn of preferred stock into 7 billion shares of common equity at $3.25 a share. The share price has increased by $1.55.

Elsewhere, total losses in the UK, Germany, Belgium, Luxembourg and France offset the US and Swiss gains. Germany is sitting on only a small loss on its stake in Commerzbank, and a much larger loss on its stake in Hypo Real Estate, while the Belgian, Luxembourg and French governments are sharing a $3.2 billion loss on their joint $9 billion investment in Dexia, which looks bad, but as most of the bank's borrowers are municipal entities in those countries, the loss is perhaps inevitable.

But the biggest losses, $5.5 billion, relate to the UK government’s 43% stake in Lloyds and 70% stake in RBS respectively, despite the rrecent rises in the stock market. At the end of June, the the government was sitting on a paper loss of $11 billion. That figure was the difference between the market price at the time and the lowest price that the government could extract six months earlier from the banks on behalf of the taxpayer, notwithstanding that the UK government held all the cards with a gun pointed at the heads of the bankers.

The $11 billion loss far outstrips anything that occurred on Black Wednesday, and if that doesn't sound incompetent, just remember that the US government managed to make a 50% profit on their stake in Citigroup in a few weeks.

Saturday, 22 August 2009

Rough estimates

I have the greatest of admiration for people who "know how to use an envelope". Not for the usual purpose of sending letters and parcels by post, but for the real use of working out numbers, particularly costs. It is a skill that second nature to anybody in aposition of autthority in business or in government, and for the most adept, no envelope is actually necessary.

In the past I have commented on the Blair government's inexcusable exaggeration of possible UK deaths on 9/11? 700 (as estimated by Straw and Blair)? Try 48.

Now we have a new example from Ed Balls, then a special adviser to the chancellor of the day Gordon Brown, now a minister prepared a report saying that the “central estimate” for the cost of “preparation, deployment and return” of UK troops from Iraq was £2.5bn, about the same as the cost of UK participation in the 1991 Gulf war.

Now I am not an expert on military warfare or its cost, nor of MOD budgetting, but I do know that counter invasion of Kuwait and the removal of the Iraqi army was a relatively simple affair, and I also know that when the Iraqis had been pushed back into Iraq, the earlier present Bush and the rest of his admninistration resisted the idea of moving on Baghdad because of the cost and extra effort of doing so.

Ten years later, obviously to the issues that were clear to the elder Bush and perhaps willfully ignoring the lessons of history, the Labour government foolishly thinks that ten years later a more complex exercise, including occupying a defeated nation would actually cost less in real terms.

Balls and Brown deserve their own envelopes, filled with P45s.

Friday, 21 August 2009

We do things differently in the public sector

I have long pointed out the differences between public and private sector behaviour in relation to the marking of on balance sheet and off balance sheet items.

For example we have the PFI schemes, which the government insists are contracts for the provision of services related to assets such as hospitals, schools and military equipment and not finance leases of the assets themselves with some services attached, although individual departments take a different view and capitalise the assets oin their balance sheets, although they are removed on consolifation because the government prefers it that way.

The fact that if the risks are transferred they must either be passed to the project equity or debt providers. The fact that these include both government owned equity holders and the 70% government owned RBS does not seem to make the assets any more on balance sheet.

But that was not what I came to talk about as Arlo Guthrie would say half way through his song, I came to talk about independence, specifically the "independence" of the Bank of England and its monetary policy committee. We might say that it is impossible to achieve independence when the employees are all civil servants and on the government payroll, but perhaps there are new issues.

The private sector, particularly the financial sector, has rules about independence. They show up most in the dealings of auditors. The rules are extensive, but not particularly complicated. For example, if a firm audits a listed company, no partner or employee may own any shares issued by that company. It doesn't matter if the staff member lives at the other end of the country from the firm in question, or if the firm is so large that the staff member has never met and will never meet any of the audit team. The rules apply even if the audit client is a large international company that would make up a part of any reasonably sized share portfolio. The rule is simple: no exposure.

In the US the rules can be even stricter and partners may be kicked out of partnerships when a close relation is promoted toa senior position in an audit client. It really happens. The rationale is that the authorities require that the auditor is seen to be totally independent of the audit client.

Now apply the same rationale to the Bank of England. The Bank has always participated in the money markets through repos of gilts, but those short tterm loans were overcollateralised and the primary risk was always that the bank would redeem the collateral, with a second way out being the ability to sell the gilts pledged as collateral if necessary (although in practice this was rarely required).

Now we have something very different. The Bank of England is purchasing and holding gilts in massive amounts. One might say that their actions have been vital both to the banks and to the government in allowing the banks to preserve capital and the government to issue debt. Not to the extent of an auditor's paltry shareholding but to the tune of hundreds of billions of pounds.

No doubt government apologists will say that this does nothing to impair the Governor's independent view from the government of the state of the economy. Maybe, mabe not, but by the private sector's usual measure of independence the government and the Bank of England and the government are in each other's pockets.

But then the public sector always sees these things differently.

Thursday, 20 August 2009

Trawling through the log

Looking back through the last few hundred entries in the logger for the site there is an impressive roster of financial institutions dropping by: JPMorgan Chase & Co., CIBC World Markets, Goldman Sachs, PricewaterhouseCoopers, Barclays Capital /Barclays Bank plc., Phibro/Citigroup, Morgan Stanley Group, Janus Capital, National Australia Bank, Allied Irish Bank, Deutsche Bank, London Scottish Bank, Alchemy Venture Partners, Wells Fargo Bank and Lehman Brothers.

Woah! What was that? Lehman Brothers? Sure enough there is an entry from 13:15 last Sunday recording a page access from a Lehman Brothers IP address in London. But you probably thought there was nothing left at Lehman. Well not quite. Barclays bought a lot of the US businesses, and Nomura took the Asian businesses and bought the European staff for $2, but passed on the assets and liabilities which are being run off by PricewaterhouseCoopers.

Among the remaining assets of Lehman Brothers is a stockpile of 450,000 lb of uranium "yellowcake", a solid form of unenriched uranium and a hangover from a commodities trading contract.

So what was the no doubt lonely administrator doing on a Sunday lunchtime in the Lehman offices? Answer: looking at the Google search results for "PCP capital partners Amanda Staveley".

Looking for yellow cake buyers in the Gulf? Forget it pal. From what little I know of export controls, that's one sale that's never going to complete.

Borrowing Soars on Low Tax Receipts

While Germany, France, Japan and Hong Kong say they ae out of recession, it continues to take a major toll on the UK public finances, with a huge decline in corporate tax receipts in July and higher welfare costs leading to a net £8 billion deficit, according to the Office for National Statistics.

The nation's overall debt, at £800.8 billion, now accounts for 56.8% of gross domestic product, its highest since the measure started in 1974.

So much for the £7.6 billion net surplus consensus from a Dow Jones Newswires survey of leading-economists-who-need-to-get-out-into-the-real-world-a-bit-more.

Hang on, you say, an £8 billion deficit for the month doesn't sound so bad, because that is only £100 billion per year which is a lot less than the budget. In the financial year to date, which started in April, public sector net borrowing was £49.8 billion against £15.9 billion for the year-earlier period, so £8 billion is a lot better than the £16.6 billion average of the previous three months.

Well, no, actually it is worse because July is normally a month for enormous net receipts because it is one of months when corporation tax receipts are at their highest. Last year there was a surplus of £5.2 billion in July and this is the first July with a deficit since 1996, when there was a different corporation tax payment regime and calendar year end companies paid all their corporation tax in one go on 1 October.

Central government current tax receipts were down 15.3% in July from a year earlier, with corporation tax falling 38%, down to £6.2 billion from £9.9 billion in July last year, the biggest annual tax revenue decline since records began in 1998. Accrued income tax for the month was down 13%, while VAT takings were reduced 18% from last year.

Central government current spending was up 7.5% in July from a year earlier, with net social benefits, including unemployment payments, up 10.4% on a yearly basis.

Wednesday, 19 August 2009

The dumbest fool on Wall Street

Government is almost always the most stupid player in the financial markets. One reason is because it doesn't have a profit motive, and thinks that some intangible public god can justify its actions. The other reason is that unlike other dumb players, it won't get wiped out, and will keep coming back for more abuse.

Twenty years ago a swaps dealer told me about a niche market where he would profit from the EIB. The EIB would raise fixed rate funding through bond issuance and would offer funding to potential borrowers that would be held at a fixed rate over the funding tranche. When bond yields moved upwards the swaps dealer would chase down potential borrowers and get them into EIB deals which he would swap into sub-LIBOR floating rate funding, but because the EIB hadn't moved their orrefered fixed rates in line with market rates, the swap margins were humungous.

So it was no surprise yesterday when Wall Street were reported as heaving a sigh of releif when the Fed and the US Treasury announced on Monday that they were extending the $200bn TALF which was supposed to revive the securitisation market.

First of all we had TARP (the Troubled Asset Relief Program) where the US government was supposed to buy impaired assets from the market. This was less than successful because it meant that the banks would have to sell assets at a discounted value, which meant getting a valuation and maybe booking a loss, and worse still losing out on any upside. On the other hand, if there was a far value in the market the banks would have sold there and didn't need the government, so it is safe to assume that where the US government did buy assets it got a raw deal.

Better than TARP for the banks was TALF, which came about when the ABS market came to a standstill in late 2008. Getting banks assets off their books and into the capital markets had become such an integral part of the US credit markets that the government decided it needed to unlock the jam, and it did this by having the Federal Reserve Bank of New York lend up to $1 trillion on a non-recourse basis to holders of certain AAA-rated ABS backed by recent consumer and small business loans. The deal didn't require approval from Congress because it came from the Federal Reserve and not the Treasury. This was a great deal for the banks, giving them assured and cheap funding, and best of all because the loans were non-recourse to the banks, the Fed took all the risk on the securitised assets.

So imagine the squealing when bankers saw that the deal was coming to an end, and sure enough the Fed decided that its friends on Wall Street needed more stimulus.

But in case you think that is as good as it gets, there is more, because as was recently reported Wall Street banks are earning enormous profits by trading with the Federal Reserve. The Fed has become one of Wall Street’s biggest customers during the financial crisis, buying securities to stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed is the biggest buyer in the market.

Well, good for Wall Street you might think. The US government is buying securities so traders are bound to make some money, but the game is more loaded in favour of the banks, because in the name of open government and transparency, the Fed announces in advance its intention to buy particular securities, which is about as dumb as it gets. In other markets there are specific rules about trading ahead of customers or "front running", but when dealing with the US government this doesn't apply because they have signalled their intentions in advance.

The big Wall Street banks have the financial muscle to buy up securities that the Fed says it wants to buy, which they turn around to sell to the Fed when they see it open its cheque book, a big factor in the higher profits from fixed income trading reported by banks in the last 6 months.

A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”

William Dudley, president of the New York Fed, has defended the approach to securities purchases, saying “We believe that opting for transparency is a greater good,” he said. “If we didn’t have transparency, we’d be criticised on other grounds.”

If I was a US tax payer, I think there are times when I would rather have some secrecy.

Tuesday, 18 August 2009

Australian news

Two recent items from the energy sector. First on renewable energy:

The Australian government has moved to ensure the passing of renewable energy legislation in the Senate by decoupling a 20 percent renewables target by 2020 from its more controversial carbon emissions trading bill. The contentious legislation was rejected in the Senate earlier in the week where the government has insufficient numbers to ensure the bill's passage.

and in the carbon sector:

A decades-long windfall for Australia's natural gas sector looks assured with up to $100 billion of fresh investment over 12 to 18 months expected across a range of projects after China promised last night to buy $50bn worth of natural gas from the proposed North West Shelf Gorgon development. The Gorgon venture promises to be Australia's biggest resources project, pumping $40bn into the federal government's tax coffers over the next 20 to 30 years.

So while the Australians struggle to agree on a bill on carbon emissions in their own country they are quite happy to sell fossil fuels to the Chinese without batting an eyelid over the envionmental impact, besides which it brings in taxes. Actually the "Australian natural gas sector" comprises such great Antipodean names as Exxon, Shell and Chevron, but still it is a boost to their economy.

On the other hand they want to commit to 20% power generation from renewable sources. Since Australia doesn't have a lot of hydro, it looks like they will have to rely on unpredictable wind power or the currently expensive solar. If they go for the latter option they will need the $40 billion tax revenues from Chinese gas sales to pay for the solar subsidies.

And where would they buy their solar panels? From China, of course. So net net, Australia gets to sell vast dollops of energy to China and uses the cash to buy back and operate solar panels that will produce a fraction of the energy sold.

Britains train system is leading the way in Europe

... according to the FT.

Monday, 17 August 2009

Fairly priced pay

J.P. Morgan have asked the FSA to review a multi-million pound compensation package being offered to entice Todd Edgar, a proprietary trader, to join Barclays Capital with his team. The five man team are reportedly being offered £30m in cash and stock to join Barcap.

What does Edgar and his team do to merit this amount of pay? At J.P.Morgan he headed the bank’s London-based commodities proprietary trading desk and ran a $2 billion portfolio. He took a bullish view on gld in 2006 when gold was languishing in the doldrums, buying physical gold and gold futures and options, making a $250 million profit in 2007.

I make that about a 12.5% return on his $2 billion, which is not that fantastic, but it is pretty god going for a gold trader because the market is not at all volatile.

On the other side of the Atlantic Citigroup is in a compensation tussle with Andrew J. Hall, the British head of Phibro, the commodity trading arm that Citi acquired with Salomon. Hall has earned way over a quarter of a billion dollars in the last 5 years, mostly by betting correctly that demand from China and India would drive up the price of oil. Now that the US government owns a large stake in Citigroup, they have baulked at the idea of paying a trader many times more than the chief executive.

Hall has pointed out that his division makes spectacular amounts of money and that he has long had a profit-sharing contract with Citigroup and its predecessor banks entitling him and his small team of traders to a large percentage of Phibro's gains. The percentage under the contract terms currently stands at below 30%.

On the other hand critics say that Hall's busines is only viable because it has received funding from the Citi treasury that it would not be able to attract as an independent entity, and there appear to be no suitors trying to poach Hall and his team.

My guess is that J.P. Morgan's protestations aout Todd Edgar will be to no avail despite some froth in the UK media, and Hall will lose out to the US government. The difference: Barclays are paying an arms length price for Edgar and his team, Citi's deal with Phibro and Hall is an intenal affair and only continues because management alows it to do so - Phibro's funding could be cut in an instant and I bet that isn't covered by Hall's contract.

The issue is not whether Edgar or Hall are paid vast amounts of money for winning trades. The issue is whether tax payers in the US or in the UK, want to guarantee the deposits placed with Citibank or Barcays when there is a run on the bank because of losing trades. People like Edgar and Hall make the case for a Glass-Steagall style separation of traders from deposit takers.

Japan out of recession

Like France and Germany, Japan has broken out of recession after the economy returned to growth in the second quarter. Gross domestic product grew 0.9 per cent quarter on quarter, which would be a health 3.7 per cent on an annualised basis.

Some of that was provided by Japanese government expenditure, because public investment expanded 8.1 per cent in the quarter, but exports were also robust, growing 6.3 per cent in the period and Japanese domestic consumption grew by 0.8 per cent.

So where were those exports going? Certainly not to the UK, where despite rolling the printing presses to the tune of 11% of GDP through quantitative easing, the economy remains in decline.

Should we expect a redefinition of recession or GDP growth?

Sunday, 16 August 2009

You read it here first

The Sunday Telegraph runs a story that illustrates the catastrophic collapse in Britain's non-public sector economy under Labour. The economic output of the private sector next fiscal year will be around £706.1bn – lower than the inflation-adjusted £708.9bn it amounted to in 1998/99, the first full fiscal year of the Blair government. The figures, calculated by the Policy Exchange think tank, show that in that same period the size of the public sector ballooned by some 63pc.

Keen readers will remember a story here on the same theme from 6 weeks ago. The figures are even worse if you work out private sector activity per capita.

Click for a larger image

Even more soundbites

Mr Darling says the government is ready to tighten laws to curb City bonuses in a bid to prevent bankers from taking excessive risks. The chancellor says he thinks large rewards for bankers had encouraged risk-taking and contributed to the current crisis.

He said he understood public anger over the issue and if tougher legislation was required ministers would act. Under Treasury plans, the banking regulator, the Financial Services Authority (FSA), would be given powers to control bonuses in all banks, a move which is likely to require new legislation.

So Mandelson's attacks would have us believe George Osborne's statement that he would control City bonuses is opportunistic populism, but Darling's reaction to public anger is really a matter of prudent bank supervision?

That is scarcely credible coming from a government which has shown itself to be incapable of bank supervision.

Saturday, 15 August 2009

More soundbites

George Osborne has spoken out about to say that the Conservatives would seek to control large bonuses paid t bankers. As I said, this is an area where the government is trying to draw a line between Labour and Conservatives, so Osborne's move upset Mandelson as muchasit upset Conservative supporters.

We know that because Lord Mandelson has come out with the following criticis of the shadow chancellor.

"George Osborne is a crowd pleaser. He and the Tories had nothing to say on the subject of bonuses to FSA during their consultation on the subject but because he was being interviewed by the Guardian, he says what he thinks Guardian readers want to hear.
"The rewards (for bankers) need to be linked to risks. The problem is when excessive rewards start driving excessive risk taking."

Say that again.

"The rewards (for bankers) need to be linked to risks."

That was what I thought you said, but I didn't realise you were that stupid. Actually the rwards for bankers need to be linked to profits, and the risks taken to earn those profits should be linked to the amount of capital available in the bank. Which is how Basel II works.. Except that as we know it doesn't work well because banks are required to set regulatory capital against assets according to the condition of the assets from time to time rather than the worst case possible, which means that banks have to start scrabbling for extra capital when their assets turn bad.

But that has nothing to do with salaries. Two steps that I would advocate for banks that are in receipt of government support (shareholdings, asset protection and maybe even normal deposit protection):

1. No bonuses paid to any emplyees or directors if and to the extent that the bank would make a loss.

2. All guaranteed/contracted but unpaid bonuses would be deducted from Tier 1 capital on the date that they ae guaranteed rather than the date that they are paid. It is ridiculous to think that a bank can agree to pay a bonus irrespective of future results and still treat that amount of part of the capital it can put at risk. If an amount is agreed to be paid as bonus at some point in the future it can't be used as capital to absorb any future losses.

A tight squeeze

A story in HM Telegraph caught my eye of a young man who will go far, first to court and maybe onto detention, but thereafter who knows:

Residents raised the alarm when the teenager woke them at 1.10am on Tuesday with screams of "let me out". Police officers found the teenager trapped on the car roof with his left hand stuck between the driver's door and the bodywork.
They believe he bent the door of the Vauxhall Cavalier out of shape to get his arm in then slipped causing the door to slam shut.
Janet Hooley, 68, whose car it was, said: "It's an old car and he had managed to get his fingers in the door and prise it open.
"The kid must have been laid on top and got his arm in to pull up the button.
"When we heard a noise I went to the window and then outside. I said to him: 'What are you doing with your arm in my car?'

At which point the young man replied, and I don't know whether this was brazen gall or unsurpassable stupidity:

'It wasn't me.'

Friday, 14 August 2009

Soundbite City

Hector Sants, the former investment banker who is chief executive of the FSA, hit back at “politicians looking for soundbites” on Thursday, insisting it was up to lawmakers to decide whether to cap bankers’ bonuses. “We are not mandated by government to limit individual pay for social reasons,” he said in a BBC interview. Mr Sants also denied the FSA had watered down its code, saying the new rules were in some ways “tougher” than what had been previously proposed.

A number of ministers, including Lord Mandelson, the business secretary, are understood to be unhappy with the FSA's position on bankers' pay. Lord Mandelson thinks the guidelines do not reflect public concerns that the City is returning to “business as usual” after receiving "billions in state support".

Ordinary businesses are paying the price,” he said in an interview. “We have not heard the last word on this subject.

The Treasury says it is still “pursuing all options” to clamp down on "excessive and risky bonuses" and may introduce legislation in the next financial services bill.

Of course none of it will happen, but it will fill up parliamentary time and newspaper columns before the next election. Mandelson knows that capping or taxing pay will simply mean that many bankers and traders will switch countries just as easily as they move jobs, but it is a vote-winning tactic, much like the Hunting Bill. The idea is not to pass the Bill into law, although if that does happen it will most likely affect a Consevative government, but to draw a line between the political parties and force the opposition to support the electorally indefensible.

We live in stupid times

You may neve have heard of Ketech, but they are a profitable UK business with turnover of £16m and they make all sorts of electronic devices, such as CCTV systems, explosives and drug detectors and all manner of gizmo for the modern world. Exactly the sort of company that should be encouraged, but when they went to their bank (HBOS) for a loan to finance the fulfillment of orders they had on their books, they were turned down.

It seems that while one part of the government (DTI/BERR or whatever it is called this week) is telling banks to lend as much as possible, and another part (the Bank of England) is buying up banks' assets so they have plenty of cash to lend, a third (the FSA) is telling banks that they need to improve their capital ratios, which implies either a rights issue, which the government is resisting or curbing lending, and a fourth (UKFI) is telling them to maximise the value of their shares in the short term.

Into all of this government made mayhem rides Lord Mandelsonwith his £75m Capital for Enterprise Fund.

"Here peasants", cries the smarmy Lord, "gratefully accept this £2m cheque while I pose for these cameras over here. Right. I'm off. I have to do more of these visits before the next General Election. We announced in April we announced we had 300 applications for these photo-opportunities and four months later we have identified um... 4 companies for funding."

I have no idea whether the £2m, which amounts to around 45 days turnover for the company, is enough for their purposes, but I have the following tip for the directors:

Take some of your government-provided £2m cheque down to the government-owned HBOS (or any other cash you have lying around) and offer it as a fee for a loan for 10 times as much. The fee goes straight to the bank's profits and with no tax to pay for years, is added to the bank's Tier 1 capital. This will allow them to lend you without lowering the banks' government-regulated capital ratios.

If the government is willing to put taxpayer's cash at risk by injecting equity capital into your company, why would a government-owned bank turn you down for a loan?

Then again, we live in stupid times.

Thursday, 13 August 2009

International results service

Results coming in from around in Europe:

France and Germany both up 0.3% GDP in the period April to June.

UK nowhere. The Bank of England warned on Wednesday that UK recovery was likely to be “slow and protracted”. The Bank’s quarterly inflation report underlined that interest rates are set to stay low for a longer period than expected by the market and that its £175bn programme of cash injections into the economy was unlikely to be unwound any time soon.

“The world economy remains in a deep recession,” said Mervyn King, governor of the Bank.

Yeah, go and tell that to the Germans. They like the occasional bit of schadenfreude.

Wednesday, 12 August 2009

Quiz: Why is BA so poor?

BA is the national airline, but to understand why it is so bad try the following quiz (answers below):

1 Name all the cities that BA flies to from
a) Glasgow, Edinburgh, Newcastle, Manchester?
b) Belfast, Bimingham, Southampton, Bristol, Leeds-Bradford?
c) Newquay, Guernsey, Exeter, Isle of Man?

2 How many flights a day does BA operate to Ireland?

3 From how many airports does BA operate to/from in:
a) London?
b) Rest of England?
c) Scotland?
d) Wales?
e) Northern Ireland?

1 a. London, b. Nowhere, c. Nowhere
2 None
3 a. 3, b. 2, c. 3, d. 0, e. 0

Blowing up your customers

The Bankruptcy Estate of Terra Securities ASA and the Norwegian municipalities of Bremanger, Hattfjelldal, Hemnes, Kvinesdal, Narvik, Rana and Vik have started an action in New York seeking over $200 million from Citigroup for violations of the United States securities laws. The lawsuit contends that Citigroup misled Terra and the municipalities in 2007 and thereby induced the municipalities into purchasing notes linked to a "tender option bond," or TOB, fund purportedly managed by Citigroup. TOB funds involve leveraged investments in United States municipal bonds. Ultimately, the municipalities lost approximately $90 million to Citigroup, and Terra, a Norwegian securities firm, suffered additional losses when it was forced into bankruptcy.

The lawsuit contends that Citigroup misled Terra and the municipalities in 2007 and thereby induced themunicipalities into purchasing notes linked to a "tender option bond," or TOB, fund purportedly managed by Citigroup. TOB funds involve leveraged investments in United States municipal bonds. Ultimately, the municipalities lost approximately $90 million to Citigroup, and Terra, a Norwegian securities firm, suffered additional losses when it was forced into bankruptcy. According to the lawsuit, Citigroup, through Terra, marketed and sold to the municipalities over $115 million in notes linked to the TOB fund in May and June 2007.

By way of background, a tender option bond fund is a fund that raises money through senior short-term borrowings secured on long-term municipal bonds to fund the purchase of those bonds. It looks like Citigroup sold the Norwegians a bunch of subordinated notes issued by the fund, essentially a leveraged investment in US municipal bonds. US muni bonds typically trade at a yield slightly below treasuries but are tax exempt to US holders which is why the yield is lower than treasuries. Many muni bonds are guaranteed by bond insurers, such as FGIC Corp., Ambac Financial Group and MBIA Inc. and were rated AAA when issued.

The bet is that the fund will earn a profit between the rate they have to pay senior lenders and what they earn on the long-term bond. This might be enhanced if the tax exempt nature of the muni-bonds can be passed through to the senior lenders - tricky but it can be done. TOB funds are little like some of the mortgage backed SIVs except that the underlying credit of the municipal bond issuer will still be investment grade even if the guarantor falls apart, and unlike sub-prime mortgagees the risk of a tax raising municipality defaulting is vey low indeed.

Sounds easy but it isn't. When times were good 40% of all municipal issues were insured by monolines. But now those AAA ratings are imperilled or gone. This has caused the municipal bond market to decouple from the taxable bond market. Whereas historically municipals tend to trade just below Treasury rates, when trouble hit muni yields shot up and bond prices went down.

This means two things for TOBs. First, money market funds are increasingly unwilling to hold the short term senior TOB debt. Second, the TOB fund's hedging stopped working, which meant many TOB funds made losses, which meant withdrawls, which meant funds had to liquidate their positions, selling into a relatively illiquid munical bond market, forcing muni bond prices even lower.

Whatever the rights and wrongs of the case, I have little sympathy for either side.

Have the Norwegians not read Liars Poker? The boys from Salomon took every S&L from Hicksville, NY to Greasy Ridge, OH for a ride and picked their pockets on the way. The difference is that 25 years later, the country boys have come from inside the Arctic Circle.

As for the bankers, what the hell were they playing at? Whatever their case about how they presented the deal, what did they think they were offering? They take a perfectly safe investment instrument (a muni-bond) , wrapped in a guarantee, and instead of selling and trading that, they leveraged it and then sold the junior portion as a long term investment reliant on their ability to manage the liquidity and basis risk they have added to the deal. This wasn't an investment in municipal paper but a bet against Citi's risk management capabilities in return for the no doubt substantial management fees that Citi earned.

If there was ever a case that both sides deserve to lose, this is it.

Unemployment up 10% in the last quarter

The number of unemployed people has risen to 2.4 million, up by 220,000 in a month. I won't fall into the trap of saying that it is better than the 13.33% increase last month, because it is 10% worse. The fact is that the number of unemployed people has risen by nearly a quarter in 2 months, with a general expectation that it will hit 3 million that before it will get better.

In addition, the number of people actually employed fell by a record 271,000 in the three months to June. So that's 51,000 people who have emigrated, died or just disappeared.

In fact economists say that the rate of unemployment will not decline until the economy starts to fgrow at more than the long term inflation rate of 2.5%. But that is hardly likely to happen some time soon with government spending (currently making up 50% of the economy) likely to be held flat or cut. the rest of the economy would have to grow at Chinese rates to break 2.5%.

Ah but say the teenage scribblers, average earnings went up by 2.5% year on year, which is a hopeful sign for consumer spending. Not when the number of people in work is decreasing by more than 2.5% year on year. That means total spending power is decreasing.

Much was made yesterday of George Osborne's use of a quotation from a past speech by Gordon Brown, but he should have use this one from the same speech:

"When literally millions of people with talent and energy are denied the chance to realise their potential to the full, no minister can walk by on the other side. It makes me angry when I meet young people at 16 or 17, their life's chances crippled by unemployment and poverty.
Any fair-minded citizen moved to anger, would also be moved to action. A root-and-branch modernisation of the economy, with a new and reformed welfare state was the only way to achieve what we have always sought and what I affirm as our goal today: employment opportunity for all in every part of Britain. Full employment for the 21st century. The ambition of decent-minded people everywhere."

Tuesday, 11 August 2009

Issuing debt in the doldrums

A big bonjour to our seasonally increased readership in the south of France, particularly those in Provence who currently make up 5% of page hits at the moment. Not joining you at the moment is the bond issuance team at Barclays who have just issued their second long dated deal in the last 10 days.

August is usually a quiet month for bond issuance as Europeans in particular take off most of the month, which is why it might seem a litle odd that Barclays (LON:BARC) have followed up last week’s €2bn ($2.8bn) 10-year senior unsecured deal with yesterday’s £750m of 12-year senior issue. On the other hand there was no shortage of demand for long dated sterling bank paper.

But this should be no surprise when we remember that more than one third of Barclays' interim profits announced last week came from the early redemption of long dated debt. Having cashed in the maket discount on their outstanding low coupon debt by buying it back, Barclays are now stocking up on higher coupon long term debt that will reverse those gains over the next ten years.

In the long term it won't make the shareholders any richer, but it made the directors look good and fooled the market last week.

Child exploitation in the 21st century

It wasn't so long ago that firms were willing to pay young graduates to work for them. Sure they had to turn up every day and do something useful, but in general they were treated like employees. Some firms were even so munificient that they provided training courses in such esoteric subjects as management, or how to do your job.

Of course these graduates didn't all come to the workplace as raw recruits. Many students had worked in commercial companies during their student vacations. The author of this blog spent his summers before graduation working in Paris in the European headquarters of a very large US corporation (twice) and several months working in a bank in Switzerland, and he was paid handsomely for his efforts, thereby funding a relatively lavish lifestyle at his Oxbridge college.

Things are somewhat different now. Many firms require their recruits to have experience in their industy and the route to that is not the paid summer job, but the internship. What's the difference? In most cases the salary, or at least most of it. That has been the price of obtaining a start in a big firm.

But things have become a lot worse in the recession. With paying jobs hard to come by, a lot of college graduates would gladly accept a nonpaying internship. But the trouble is they are competing with laid-off employees with far more experience.

In America, an increasing number of graduates, or their parents, are paying thousands of dollars to services that help them land internships. These are paid internships, but not paid by the company, but by the student or parents, to the tune of several thousand dollars.

In many cases US companies offer internships by auction with the auction proceeds going to a charity nominated by the company. In many cases, companies say that the internship is reated simply to raise money for the charity.

Hey kids, a word of advice from your uncle Alex. If somebody offers to let you pay them to work for them for free, just walk away. If you are smart enough to do that you are smart enough to run your own business, and you don't need to exploit young people to make money.

Liechtenstein: Trust me

Splashed all over the media with such consistency that it has the hallmarks of a big press campaign, we hear that the UK government will announce a deal with Liechtenstein today that, according to HMRC, effectively ends secrecy for Britons who hold accounts in the tax haven. The media say that up to 5,000 British investors have an estimated £3 billion stashed away in secret accounts in the country. In other words, it could be a lost less and they don't really know how many investors there are.

UK tax payers who are Liechtenstein account holders will be asked to settle unpaid tax going back 10 years, and pay interest and a penalty of 10 per cent of the tax. They are being offered better terms from the UK government than investors in other offshore jurisdictions, who in September will be offered an amnesty, or “new disclosure opportunity”, under which they will have to settle unpaid tax going back up to 20 years, along with interest and penalties of 10 per cent, or in some cases 20 per cent.

There is also talk of a "tacit assurance" that investors who come forward will not be prosecuted, but there is no official guarantee of immunity because HMRC can't do that.

The Liechtenstein authorities will be asked to close the accounts of those who do not take up the amnesty. Banks will then be independently audited to verify the undeclared accounts have been purged. So the UK tax man goes home happy knowing that there are no UK bank accounts in Liechtenstein without any breaches of confidentiality.

Or not quite. Liechtenstein is the only civil law jurisdiction that has taken up the largely Anglo-Saxon trust, although, unlike the common law trust, there is no bar against accumulation of income, nor against perpetuities. How convenient for all those Anglo-Saxons out there who can let their income roll up in the trust. And the trusts may be set up under foreign laws, which is also convenient for Anglo-Saxon lawyers who understand these things.

A Liechtenstein Trust is set up by a deed between the settlor and trustees. The trust deed does not have to name the beneficiaries. If the trust deed is deposited with the Liechtenstein Registrar of Trusts, it will not be publicly available, and later instruments, which might, for example, name beneficiaries, who might just happen to be Anglo Saxon, do not have to be disclosed. So if the trust is established with Liechtenstein trustees, there is no reason why the details of UK resident beneficiaries should show up in an audit.

And, trust me, they won't.


Just watched the reporters on the TV channel of anothr pink paper dribbling their ignorance all over a report on this. First of all to the young tyke interviewer, this does not affect Britons living in Liechtenstein - this is about people resident in the UK who do not declare their worldwide interest income.

Secondly, to the FT woman interviewee who thinks that money laundering regulations will cause problems because payments will have to be reported (because that is what HMRC told her), there is no reason to believe that any deposits that are moved from foreign country A to foreign country B outside the UK will ever have to be reported to the UK authorities, let alone HMRC, particularly when moved from one offshore trust to another.

Monday, 10 August 2009

Too big to fail?

Click to view larger image

Short people aren't gonna get you every time

Hats off to Xiaoxia Lou of the University of Delaware and Jonathan M. Karpoff of the Michael G. Foster School of Business at the University of Washington, who have just published a report on short selling that you can download here.

It seems that according to the authors, short sellers are not the villains that politicians and regulators would have us believe. They say that listed companies are often inclined to inflate their reported profits with accounting mischief, and I would concur with that. Look at the accounting tricks posted by RBS and Barclays reported here last week for evidence, and in corporate America the practice is not restricted to the likes of Enron and Worldcom.

The authors identified firms that misrepresented their financial statements, the spotting of that overstatement of profits and share price declines until the time when the accounting treatment is widely known. According to the authors, uninformed investors who trade during the average firm’s violation period benefit from lower prices to the extent of ranges between 0.19% to 1.53% of the firm’s equity value.

They say that their research indicates that short sellers anticipate the eventual discovery and severity of financial misconduct. Short selling also conveys external benefits to uninformed investors, by helping to uncover financial misconduct and by keeping prices closer to fundamental values when firms provide incorrect financial information.

Somehow, I don't think financial regulators will be congratulating the authors on their report.

The Emmentaler Agreement

If you thought that Swiss cheese was full of holes, that is nothing compared to the agreement between the US and Switzerland over UBS and its upcoming court case.

The IRS and the Swiss authorities announced that they have a deal that the Swiss will hand over several thousand names and other details of US citizens. But there appears to be a delay, and as reported in the English speaking press, widely copying from Bloomberg reports, there appears to be some ongoing discussion about how the detais will be passed across.

That doesn't sound right. A floppy disk, CD-ROM or memory stick would appear to be enough to hndle all the data, so a quick skim of the Swiss press gives us the real answer. The Swiss Federal Assembly is meeting today to discuss how the matter may be handled under the current Swiss banking laws.

Not easy. Under current laws, the bank has to ask the permission of every deposit holder whose name it wants to disclose.

The Masterley solution? Send the 52,000 requests by post in marked envelopes that can be identified and tracked by the automatic sorting machines of the US Postal Service, or sent by a bulk mailing organisation in the US designated by the IRS.

Beijing Confidential

When is information in the public domain not public any more? When it relates to Chinese economic or social development.

Rio Tinto have been accused by the Chinese government of engaging in industrial espionage, probably the greatest example ever of black pots and kettles, and 4 RT employees have been arrested.

However, it appears that the issue may be complicated by China’s laws on the protection of state secrets, which as one would expect from a totalitarian state, give maximum flexibility to state officials and very little to private or corporate citizens.

It seems that the law has empowered Chinese state officials to classify public information as “secret” if it is related to economic and social development or “other issues”.

You have been warned

The United States has finished constructing a huge physics experiment aimed at recreating conditions at the heart of the Sun.

The US National Ignition Facility is designed to demonstrate the feasibility of nuclear fusion, a process that could offer abundant clean energy.

The lab will kick-start the reaction by focusing 192 giant laser beams on a tiny pellet of hydrogen fuel. To work, it must show that more energy can be extracted from the process than is required to initiate it.

So like a hydrogen bomb. Isn't that dangerous? Professor Mike Dunne, who leads a European venture that is also pursuing nuclear fusion with lasers, says that if NIF was successful, it would be a "seismic event".

I hope that was just an unfortunate turn of phrase.

Saturday, 8 August 2009

News that will gladden the hearts of all true socialists

The Labour government is currently running the country from the Corfu holiday villa of a hedge fund managing member of the Rothschild family.

Friday, 7 August 2009

When the revolution comes

The first lamppost is reserved for any politician who says that the turnaround is starting because US unemployment is dropping.

The American economy lost 247,000 jobs in July, and slightly surprisingly, the unemployment rate fell slightly, to 9.4%.

The only reason that the unemployment rate declined is 400,000 people (in my estimation that is one in 500 working age Americans) gave up looking for work.

The employment-to-population ratio gives amore accurate picture of the slack in the labour market and the hidden secret in today’s report was that this measure slid to a 25-year low of 59.4% from 59.5% in June and 61.0% at the turn of the year.


It looks like we have our first candidate (from various news sources):

The White House immediately hailed the unexpected data.

"This morning we received additional signs that the worst may be behind us," said President Barack Obama in remarks after the report was released. "We have pulled the financial system back from the brink."


There was a euphoric rise on the release of the numbers because analysts didn't spot that the fall in unemploment was due to the sheer number of people just giving up. But now it seems that there is a growing numbe of analysts subscribing to the more down beat view, according to another pink paper.

For more on US social destitution see Louis Theroux's programme on crystal meth in Fresno.

RBS : again not what it seems

Why is it that as soon as governments get involved with banks they start lying about their results?

That was a rhetorical question. I know the answer. At the moment, politicians like to talk down the profits of the banks they do not control and talk up the profits of the ones that they do. Earlier this week Lloyds (LON:LLOY) were telling the world, or the government and the BBC were telling the world on their behalf, that the 43% government owned bank had lost £4 billion on a pro-forma basis, when Lloyds' statutory accounts actually showed a £7 billion profit.

Now we see the 70% government owned RBS (LON:RBS) telling the world that it made a £15 million profit, when its statutory accounts clearly show that the profit attributable to the RBS shareholders after stripping out all the dividends due to the minority shareholders who are caught up in the ABN/Fortis mess is not actually a profit at all but a £1 billion loss.

But that £1 billion loss includes a £3.79 billion gain from the early redemption of large chunks of RBS debt at a discount to par. Smart move you might think, even though it is only possible because the RBS asset book is reducing and there is cash available to repurchase debts (just like Barclays reported earlier this week). But just like Barclays this is largely illusory, because if RBS want to grow their balance sheet in the future, they are going to have to issue debt at the future prevailing yields rather than the lower yield on the debt they have just retired.

To understand this scam, imagine that 5 years ago a bank issued £100 of 15 years securities at par paying a coupon of 5%, but 5 years later the yield on that banks debt has risen to 6%. That implies that the securities could be repurchased in the market at a discounted price of £92.64, giving a profit of £7.36. Independently, but not completely independently because it has to pay for the bonds it retires, the bank goes back to the market to raise some funds. It might be weeks or months before or after the bond repurchase, but let us assume market condittions are similar, and the bank borrows £100 for 10 years at the market rate of 6%, which means that they will pay a total of 10 more in interest than they would have had to pay if they had not retired the 5% original bonds.

This week we have seen both Barclays and RBS book substantial profits on the retirement of their own debt. More than likely, this upfront gain will result in a larger increase in funding costs spread over many years. So figure that the realistic result for RBS for the last six months is closer to a £5 billion loss than it is to the reported £15 million profit.

Wall Street's indulgences

The US financial system apears to have revived a practice of the Catholic church, namely the sale of indulgences. Witness the extraordinary settlements with the SEC this week by GE (NYSE:GE) and Maurice Greenberg, former chairman of AIG (NYSE:AIG) who prefers to be known as "Hank".

It seems that after absolution of the guilty from their sins and payment of alms to the SEC pardoner, $50 million in the case of GE, $15 million from Mr Greenberg, the soul is restored to its former godliness and the matter is laid to rest.

A complaint filed by the SEC said Greenberg and former chief financial officer Howard Smith were involved in "numerous improper accounting transactions" that inflated AIG's reported financial results between 2000 and 2005. Mr Smith agreed to pay $1.5 million to settle the charges.

Robert Khuzami, director of the SEC's Division of Enforcement, read Mr Greenberg a sermon to the effect that "Corporate leaders cannot avoid the truth and consequences of their companies' performance by using improper accounting gimmicks and signing off on distorted financial reports."

But the the law firm representing Mr Greenberg stressed that its client was not charged with fraud. Rather, they tell us that the SEC charges arose solely as by virture of the fact that Greenberg was running AIG when the suspect accounting took place: "Mr. Greenberg appreciates the SEC's recognition that he personally should not be charged with any fraud and the settlement is recognition of his lack of responsibility, even as a control person, for the vast majority of accounting issues."

That may be the trouble with corporate America. With so many company directors trousering hundreds of millions, it must be tough to find enough hours in the day to spend all that money and still run the company.

Time for a Reformation perhaps?

Quantitative Easing: waste of effort

More on the RBS Interim Results when I have had the time to look thrugh the several hundred pages, but it is clear from reading that the description of the business that Quantitative Easing is just a mental exercise for economists because in the real world it has no impact on the UK economy (see yesterday's post about bank's cash piling up at the Bank of England rather than being lent to UK companies).

RBS's balance sheet has dropped in size quite considerably as it unwinds some of its derivative positions, exits foreign businesses and receives repayments from its customers. It has made new lendings which it mentions in its reprts but overall lending is down for reasons described in the following extract:

In business markets, RBS has achieved gross new lending of £28.6 billion. However, demand has been comparatively muted, with companies cutting inventories and expansion plans and reducing their bank borrowing requirements. Additionally, the anticipated withdrawal of non-UK and wholesale-funded lenders which has characterised the mortgage market has not occurred in corporate markets, and the anticipated “gap” in the market for creditworthy corporate borrowers has not emerged. After taking account of loan repayments and overdraft movements, RBS’s UK business lending, including Ulster, at 30 June 2009 totalled £155.1 billion, a decrease of 1% from 30 June 2008 and a decline of 4% since the end of 2008.

In the SME segment of business markets, gross lending in the first half totalled £17 billion notwithstanding weaker demand. However, repayments have been accelerating since the third quarter of 2008, leaving balances at the end of June of £66.6 billion, up 2% from June 2008. As a result of RBS’s price pledge, 94% of customers who renewed their overdrafts in the second quarter of 2009 did so at the same margin or lower and in June, the average interest rate paid by customers on term loans was half its level a year earlier. Total credit applications in the first half were down 22% on the same period of 2008. While there has been some recovery in recent months in the number of applications for term loans, the average size of each application has fallen, reflecting, among other factors, falling property values. As a result, term loan applications by value were 37% lower. The acceptance rate across all categories of SME credit remains stable at 85%.

In other words, it doesn't ake any difference how much cash is pushed into the banks, there is very little real demand from companies to brrow to invest.

That is not surprising. After all, who would want to invest in a country that is running a government budget deficit of 14% of GDP? That way lies massively higher taxation. If the government wants to make a difference it should stop pretending that pumping money into the financial system is making any difference and start making the country more attractive for investment. That means smaller government and less red tape for businesses.