What a difference a day makes

Yesterday I woke up to hear BBC Radio 4 telling me that a UK consortium had won a vital contract to supply rolling stock for the East Coast Main Line and this was going to create or sustain 12,500 jobs, according to Geoff Hoon. By the end of the day, all this had been rubbished and it turns out that no more than 500 new jobs will be created and that this UK consortium is really Hitachi supplying the rolling stock, John Laing building a few sheds and Barclays supplying some finance.

Some of the assembly will be done in the UK, but you can bet your bottom dollar that this is to reduce the impact of EU import duties – the rate duty on the components will be smaller than that on the finished product and there is no duty at all on the component of the final sales price represented by the final assembly if that takes place inside the EU.

Undaunted, last night Geoff Hoon was spinning a new line. This was no longer a UK consortium but welcome inbound investment by Hitachi. Wrong again Mr Hoon. Inbound investment is when a foreign company makes an investment in plant and machinery in the UK to build up a business and make sales. What is happening here is sale first, capital spend later. If the government didn’t agree to buy the Hitachi imported train sets, there would be no money spent on building the maintenance depots. That money will come from Barclays and the bank market, not Hitachi.

Two untruthful spins on the same story from the same minister in one day. Is this a record?

Factors stopping UK growth according to the World Economic Forum

http://www.weforum.org/documents/gcr0809/index.html

Tax regulations ..........................13.3
Inefficient government bureaucracy........11.5
Tax rates ................................11.4
Inadequately educated workforce............9.9
Access to financing........................9.2
Inflation .................................9.2
Restrictive labor regulations..............8.0
Poor work ethic in national labor force ...6.7
Inadequate supply of infrastructure .......6.0
Policy instability.........................4.8
Foreign currency regulations...............2.8
Crime and theft ...........................2.2
Poor public health.........................1.8
Corruption.................................1.7
Government instability/coups ..............1.4

SFO goes after AIG

Various press reports this afternoon along the following lines:

The Serious Fraud Office has launched a preliminary inquiry into the UK operations of US insurance giant American International Group's finance arm. The inquiry relates to overseas finance deals made by AIG Financial Products Corporation. The SFO is working with US authorities who are already conducting separate, independent investigations involving conduct at the firm.
SFO director Richard Alderman said: "It is right for us to look into the UK operations of AIG Financial Products Corporation to determine if there has been criminal conduct. "We will use our full range of powers to seek information and to speak to those with an inside knowledge of the company's operations." The SFO said both AIG and the subsidiary in question are cooperating with its inquiries.
City watchdog the Financial Services Authority is also involved in the investigation.

OK stop right there! The SFO should be looking at the FSA's failure to regulate AIG. AIG was writing credit default swaps in a UK subsidiary that was neither regulated as an insurance company nor as a financial trader. Size of the book? Several hundred billion. The SFO should pin this one on AIG, the FSA, the Bank of England and PwC (auditors). Since AIG’s collapse in September 2008, insurance regulators in various jurisdictions have played pass the parcel, all trying to distance themselves from the firm’s London business.

Adair Turner, the FSA’s chairman, has declined to answer questions about AIG’s London operation, AIG Financial Products (AIG FP), because he says it falls outside the FSA's jurisdiction. The FSA considers AIG FP to be an “internal treasury operation” and, like the internal treasury operations of other companies, is not regulated. The FSA does have regulatory oversight responsibility for a number of AIG units in London, including a company called AIG FP Capital Management registered at 1 Curzon Street.

There is no doubt that the US authorities consider London to be the cause of the AIG disaster. It was staffed by executives from Drexel Burnham Lambert. Remember them? Drexel’s junk bond king, Michael Milken, was investigated for insider trading in the 1980s and pleaded guilty to six charges. By the end of 2007 AIG had $562bn of CDS contracts on its books, and in their October 7, 2008 testimony before the House Oversight Committee company executives acknowledged that this business was based at 1 Curzon Street. In contrast to market practice, however, AIG FP did not hedge its exposure to a possible fall in the CDS market. In a footnote to AIG’s 2007 accounts, the company declared: “In most cases AIG FP does not hedge its exposures to credit default swaps it has written.”

In November 2007, when PwC asked the insurer to change the way it valued CDS’s, the world suddenly saw how little capital AIG FP used to build a mountain of business. The mortgage deals it was supporting with its CDS's looked shaky. The market took fright. AIG was downgraded from AAA to AA, and AIG's counterparties on the CDS's made cash calls (as they were entitled to do). AIG ran short of cash and the rest (including AIG's independence) was history.

How long did PwC fail to correct AIG's accounting?

Why did the FSA treat AIG FP as an internal treasury unit when it was clearly booking the unhedged risk on third party trades, and why didn't PwC point out this anomalous behaviour to the FSA?

How long will it be before the FSA turn round and say, "If only we had known about this"?

The world's favourite downgrade

Now that Moodys has decided that BA is no longer investment grade (down to BA1 from BAA1) should I be buying a CDS to hedge the risk on my 6-figure accumulation of BA Miles?

Pro-government spin on the BBC

This morning I heard the BBC this morning desperately spinning that a UK consortium had won a £7.5 billion order for trains for the East Coast mainline.

It turns out that the UK consortium members are Barclays (finance)and Laing (building the depots) but the trains come from Hitachi and are as Japanese as sake.

The losing bidder was a combination of, amongst others, Siemens and Bombardier, who run the only UK train factory at Derby (the old BREL works, later ABB, then Adtranz).

The FT puts a different gloss on the story.

Memorandum from Paul Moore, Ex-head of Group Regulatory Risk, HBOS Plc

1.My background and credentials

1.1I was Head of Group Regulatory Risk (GRR) at HBOS between 2002 and 2005. I reported to the CFO, Mike Ellis. I had formal responsibility for the bank’s policy and oversight of executive management’s compliance with FSA regulation.

... and so it goes on. I'd like to be nice about the guy, but he sounds like a police,an. You would never guess that he used to be a KPMG partner.

Crosby, Steals, Cash & Runs?

I never understood why James Crosby was made the MD at HBOS but here is how it happened:

He studied maths at Oxford. Now who studies maths at Oxford, although apolgies to all my friends who did, and Frances K who is a Maths prof. at Balliol?

Being of a mathematical bent he thought thet actuarial qualifications would be a good idea, so he started his career at Scottish Amicable, a pension fund, then moved to Rothschild's where he worked in fund management. He was clearly so good at picking stocks he got put in charge of IT.

From there he fluked the job in 1999 of MD at Halifax. Perhaps this wasn't so surprising because Halifax was not known for the calibre of its staff, so to get an Oxford graduate from the admin side of Rothschilds probably sounded like a good idea - but have you ever bnoticed how Rothschilds bankers always end up in soft jobs or government jobs, hey never seem to end up cutting it in the really top banks. But Crosby seemed good enough for a plain vanilla mortgage bank.

By a stroke of good luck, Halifax and Bank of Scotland decided to merge, with the chiefe executive at BOS, Peter Burt, deciding to switch to a Deputy Chairman role, amanging the merger, leaving Crosby to manage the bank on a day-to-day basis.

So after two years experience in banking in 2000 Crosby was running abank with a market cap of about £30 billion, which in those days was big bananas. The securitisation salesmen in all the investment banks in the City and on Wall Street must have seen a real patsy, because he then went on a property splurge funded by securitisation.

He buit the HBOS/Halifax mortgage business through TV advertising and funded it by issuing paper rather than attacting deposits, a risky strategy because there is always a risk that the wholesale markets will dry up, although the bond and commercial paper orginators will says that is a remote, very remote, highly remote possibility. About as remote as the M25.

Crosby and the other HBOS directors were warned in 2004 that the risks were becoming extensive and dangerous. He didn't like to hear this, so he sacked the messenger and gagged him with a confidentiality clause. Then realising that the game was going to be up pretty soon, he stood down, took a knighthood and made a hospital pass to Andy Hornby. He to a nice little earner with Downing Street on how to push ID cards on an uncompliant populace and for his troubles the Prime Minister makes him Deputy Chairman of the Financial Services Authority.

Having fluked it to the top of the UK banking industry without ever having to sign off on a loan (boards are not credit committees), he suddenly gets to be the de facto head of bank regulation, having a few banks on his CV, which is at least a step up from Adair "Executive Hair" Turner, the chairman of the FSA, management consultant and lobby group chairman, with as much experience in banking as a spotty graduate.

When the former Head of Risk Management at HBOS can tell the whole story under parliamentary privilege, it seems that not only did he tell the HBOS board that they were doomed, but he also blew the whistle at the FSA, who ignored him.

When Andy Hornby and Denis Stevenson met the House of Commons Treasury Committee, Mr Hornby told them that he had tried to undo the damage caused by Mr Crosby, reducing the HBOS share of the mortgage market and increasing the average term of their capital market liabilities, but to no avail because the Labour Party and the BBC contrived to kill the HBOS share price, cause a run on funding and and force HBOS to merge with Lloyds. Would it not be surprising if Brown hadn't been made aware of the problems at HBOs by Crosby, his financial advisor and until today, Deputy Watchdawg.

In all Crosby spent about 6 years in banking, but all of that at board level and away from the day to day banking decisions, so why he was ever appointed to the FSA or as Gordon Brown's advisor is a mystery, or rather a question of the blind leading the blind. But now he is caught like a rabbit in the headlights of an oncoming truck, and he has done what all rabbits would do in a similar situation, he has bolted down his barrow.

The Great and Good are now small and ugly

The Times has compiled a list of the ten people it holds most responsible for the New Depression. Remarkably for lists of ten people the list contains eleven names, but we won’t hold that against them. A fair list and hard to disagree with most of the names, although perhaps Fred Goodwin’s I would always hesitate to ascribe too much prominence to RBS. Fred “the shred” Goodwin’s stupidity in buying ABN was matched by equally appalling fecklessness at HBOS, Bradford & Bingley and Northern Rock. It is hard to understand why anybody would think that the administration of BCCI was good preparation for running a successful bank. As it was Goodwin took RBS to the verge of insolvency, where he would have been at home.

1. Dick Fuld


2. Hank Paulson


3. Alan Greenspan


4. John Tiner/Hector Sants


5. Fred “the shred” Goodwin


6. Gordon Brown


7. George Bush


8. Kathleen Corbet


9. "Hank" Greenberg


10. Angelo Mozilo

But the name I would put at the top of the list, without a doubt, and not something I would blame him for, is Bill Gates. Without Mr Gates and the IBM PC we wouldn’t have thousands of traders sitting in front of computerised trading desks designing, trading and hedging ever more exotic financial; projects. Computers would have been used for offline accounting, order entry and processing, but option pricing models would have stayed in theory books rather than on trading floors, skewness and kurtosis would have remained statistical concepts unfamiliar to financial analysts. For all the productivity of the personal computer, the New Depression may have wiped out many of the earlier economic gains.

A second opinion

It is good to know that Lloyd Blankfein shares my opinion on many matters related to the New Depression. For those who need to be reminded is the chief executive of an investment bank on Wall Street by the name of Goldman Sachs.

He has made clear some of our shared opinions in an article in the FT. For those too lazy to read the FT, here is my summary of his points:

• He says

  “Risk management should not be entirely predicated on historical data.“

  I go further and say “Don’t rely entirely on mathematical risk models.” Those models are predicated on the assumption that markets and prices operate so similarly to the models that the models can be used a s a measure of value and risk. They can for most of the time, but sometimes markets break down and the models don’t work. It is better to have a risk management systems that work, perhaps imprecisely but all of the time than to have a system that is perfectly accurate for only 95% of the time and is completely useless the rest of the time. He says the industry needs to do more to stress test models. I say banking just needs more seat of the pants risk-averse common-sense decision makers.


• He says
  

  “too many financial institutions and investors simply outsourced their risk management”

  which is true enough but in a sense they always did. Unlike for example the lead bank in a syndicated loan or a bond underwriter, the rating agencies have no money at risk, but this is not the biggest issue. What is different now is that so much of the creditworthiness (and now, in the particular case of banks, the capital allocation) depends on the say-so of the rating agencies. In the past agencies would have rated a few well known companies, but nowadays they opinr on the structure and documentation of deals rather than company performance. It was relatively simple to take a view on the value of say a big oil company and its likelihood of defaulting in its debts. Can a rating agency really show the same certainty about the risks on the assets and documentation of a special purpose funding vehicle?
  
• He cites the

  “over-dependence on credit ratings coincided with the dilution of the coveted triple A rating”,

  which I mentioned a few weeks ago, but although he mentions that there were 64,000 AAA-rated structured deals but only 12 AAA corporates in 2008, he does not mention that this added to the pro-cyclicality effect of Basel II. When Basel II was first conceived there were very few AAA ratings and banks did very little business with AAA counterparties, so that there would be very little need for extra capital on a ratings downgrade of a AAA counterparty. The situation now is very different.


• He says that

  “size matters”,

  or that it is easy to forget that although the risk of loss on $5bn of high quality debt is the same as the risk on $50bn, the consequences of loss are far greater on the latter. Well blow me! He doesn’t miss a trick this guy. Some prudent banks have always set limits on types of asset they hold, counterparties and other risks. It seems some did not. Perhaps this is really an Enron-type problem, more connected with off-balance sheet items and the assumption that what you don’t see is not really there.


• He says that

  “many risk models incorrectly assumed that positions could be fully hedged”,

  which is the corollary of the assumption that risk models operate correctly at all times. The trouble is that hedging markets can breakdown just as easily as the market for the assets being traded, and there is no guarantee that the liquidity in the hedging market will be the same as the liquidity in the primary asset market.


• He says

  “risk models failed to capture the risk inherent in off-balance sheet activities, such as structured investment vehicles”,

  but I would put it differently. If there is any exposure to risk in an asset or liability then perhaps it shouldn’t be off-balance sheet. This is the Enron effect. A bank or a company does a trade, perhaps the sale of an asset that isn’t quite a full sale, although maybe we can convince the auditors it is close enough to a sale to warrant sale accounting treatment. Remember the Enron Nigerian barges? Maybe not, but that is what banks do all the time to remove assets from their balance sheet and perhaps to book gains on a sale. Only the problem is there are some residual risks associated with those assets, but if we speak nicely to the auditor he won’t mind them being there, and after all it’s only one deal. Except that single deal is repeated and gets the same sign off as before and then after a few more repetitions the auditor can’t change his opinion. In fact he probably goes to the accounting standards board to get his treatment approved, and then the business really takes off.


• He says there was

  "too much complexity",

  which made it hard to manage the growth of new instruments. I would turn the point around and say that there was too little regulation of new instruments which places some of the fault at the door of the regulators, but I would also put some fault at the door of the bankers who were profiting from the complexity knowing that there was inadequate regulatory understanding of the instruments being created.


• His last point is that

  “financial institutions did not account for asset values accurately enough”.

  I would differ saying that some of the instruments were not capable of sensible valuation and that even if some valuations were perfectly accurate at the time they were made, they should not have been relied on immediately thereafter. A balance sheet might measure the risk in some straightforward instruments, but it doesn't come close to articulating the risk in some instruments.

One area that he misses completely is the "we never saw it coming" line that is coming from so many mouths today. What they are really saying is "yeah, we knew about it but we shut it out of our minds". The bankers of today's modern finance rely heavily on trading and securitisation, and by and large they have the trader's mentality. An asset is a risk until it is hedged or sold (albeit that there might be some ongoing risk in the asset). A liquidity exposure is a risk until some funding is put in place, although the risk doesn't go away completely. It all happens on an item by item basis and the "market" is often assumed to be almost infinite, or at least to the exnt that putting another trade into the market doesn't absorb all liquidity.

When risk assessments were made in banks the one question that was not asked was "What happens if X market goes away?" because the likely answer was "it ain't gonna happen, but if it does we all go to hell in handcart, you, me, the Governor of the Bank of England and the whole economy". The risk was put in the very low risk category, not factored into any pricing models and generally ignored. On a deal by deal basis that made perfect sense because the loss on that deal was limited to the values related to that particular deal. On an aggregate basis the numbers were so huge that no bank would contemplate the losses resulting from any individual deal, so deals got done and the market consensus was that these sorts of things did not and would not happen. Which meant that the market grew and grew and the issues that were ignored were precisely those that occurred because nobody was worrying abut them.

That apart, Blankfein has some good points and should go far.

More tax payer funded bonuses at Barclays?

Not so obvious because Barclays has not gone to the government for cash, but the Quakers at Barclays Bank were always quick off the mark when it came to making a fast buck of the tax man (see the activities of Roger Jenkins, Ian Abrahams and Michael Keeley mentioned elsewhere on this blog).

Today, Barclays announced a £6.1 billion profit, which sounds impressive in the circumstances, only a tad down on last year. But wait a mo. A quick look at the accounts shows that £2.6 billion of this came from a gain on acquisition of certain assets and liabilities of Lehman Bros. Fair enough, and it looks like they got it at a good price because Barclays decided that they could mark up the fair value of the assets.

Note 11 to the accounts says “The excess of the fair value of net assets acquired over consideration paid resulted in £2,262m of gains on acquisition”, which translated into English reads, “This was a steal!”.

To which one might well respond, “Well if that is the price you paid, and nobody else matched you, how can you be so sure you can sell those assets for £2.2 billion more?”. So this £2.2 billion of profit is just an accounting valuation adjustment and nothing to do with business profits. Best of all Note 11 states:

“The initial accounting for the acquisition has been determined only provisionally. Any revisions to fair values that result from the conclusion of the acquisition process with respect to assets not yet received by the Group will be recognised as an adjustment to the initial accounting. Any such revisions must be effected within 12 months of the acquisition date and would result in a restatement of the 2008 income statement and balance sheet.”

In other words:

"We don’t really know what this is worth. We will tell you later, but for
argument’s sake, let’s say we are up by £2.2 billion"

The next bit of good news for the directors (who didn’t want to be bailed out by the government because they might have lost a bonus or two) is that the acquisition results in a recognition of a £400m deferred tax asset previously unrecognised that can be set against deferred tax liabilities acquired with Lehman Brothers resulting in a tax credit for the year. In simple English, Barclays previously had some losses which they couldn’t use to reduce their tax bill, but by buying Lehmans means that they will have some future income on which they will pay no tax because of the old losses.

Or to put it another way, that is £400 million of tax the taxman (which particular taxman is not quite clear) will never collect. Not as big as an equity injection or a loan, but you don’t have to pay this one back. Best of all, although there is no £400 million of cash paid to the company (a bit like the £2.2 billion of unrealised gain on the Lehmans assets) the £400 million number goes straight to the bottom line and is available to pay directors’ bonuses.

Do as I say not as I do?

What chance is there that the UKFI, the group responsible for managing the banks funded by the tax payer, will insist that government funded banks will pay no bonuses? It appears that their employees ... will be on a bonus scheme. So, practically none.

Bankers are hardly likely to take much heed of what the politicians say. Listeners to the Today Programme this morning will have heard Yvette Cooper saying that bankers should refuse their bonuses, even if they had a contractual entitlement to them. Oh how we laughed when John Humphreys questioned Ms Cooper about the fact that she and her husband Ed Balls both claimed their maximum entitlement in respect of their their home in London as a second home, even though it appears that this is their main residence and their second, rarely used home is in Yorkshire near their constituencies.

Mr Humphreys also questioned her about Jacqui Smith's claim that her main residence was as a lodger in her sister's small terraced house in South London, where she apparently spends only 3 nights a week and has no legal interest in the property, and that her second home is a large house in the Midlands which she owns jointly with her husband, where he lives with their children and where the children go to school. Mrs Balls defended herself by saying they were all only claiming what they were entitled to claim.

And so of course would the bankers.

Sound thinking from the WSJ

The following from the Wall Street Journal sounds like the first piece of economic common sense since we first started hearing about fiscal stimulus.

"A dollar doled out in jobless benefits may well be spent by the worker who receives it. That $1 of spending will count as economic activity and add to GDP. But that same dollar can't be conjured out of thin air. The government has to take that dollar away from someone else -- either in higher taxes, or by issuing new debt in the form of a bond. The person who is taxed or buys the bond will have $1 less to spend. If the beneficiary of that $1 spends it on something less productive than the taxed American or the lender would have, then the net impact on growth will be negative.”

Unfortunately, we still have the one-eyed Scottish idiot with his GDP fetish. As said before GDP is supposed to be a measure of the value of goods and services provided by the economy, assuming that they are fairly priced. This government has always been eager to boost GDP by taxing Paul to pay an inflated salary to Peter, on which he pays more tax etc, etc, etc. irrespective of the value of the services provided. This boosts GDP, which means that in the wacky world of New Labour economics, we are less indebted, because they measure government borrowing as a percentage of GDP.

But hang on, I hear you say, we really do owe that money and the actual amount the government has borrowed in our name has gone up. Yes, I reply and that is only half the story because of all the off-balance sheet shenanigams, but the real problem is that so much of this government-funded GDP (NHS staff paid twice as much for the same output, civil service salaries higher than the private sector, dievrsity co-ordinators, NHS computer systems nobody wanted, ID cards, the Olympics, extraordinarily expensive PFI schemes and the rest) represents little or no real value, but gets included in GDP because real hard cash was spent on them, far in excess of the true value. The short term injection of cash is like a junkie's fix, and like a fix, it is killing the junkie.

So what is the alternative? The answer lies in true wealth generation. Businesses with long-term competitive advantages that will produce sustainable wealth. London had one such in the financial services industry but overdid it with funny paper, and this was missed by the government. The rest of the economy needs less government interference, not just because that interference creates costs and slows down existing businesses, but because the world moves quickly and the businesses of the future will arrive sooner than we know it. But where will those industries set up? In a country riddled with debt and government interference, or in a business friendly country with reasonable regulation and a light tax burden.

Go figure.

Malus payouts

The Treasury has ordered an investigation inro how banks are run. They control the FSA so one might properly ask what they have been doing for the last 11 years.

Time to go shopping

We all know that when times get tough, the tough.... go shopping. But what happens when the times get so tough all the shops shut? Baugur has just applied for protection from its creditors in the Icelandic courts, but that only lasts for 3 weeks. Expect some bargains in the folloing shops in the next few weeks:

· House of Fraser

· Iceland

· Hamleys

· Goldsmiths

· Mappin & Webb

· Watches of Switzerland

· Wyevale Garden Centres

· Whistles

· All Saints

· Jane Norman

· Mosaic Fashions

· Karen Millen

· Coast

· Oasis

· Nine West

· Pied a Terre

I told you so

I have been telling anyone who would listen for the last year that this is the only solution, and finally the idiots running the country are waking up.

From the FT:
Darling revives option of 'bad bank'

Alistair Darling admitted UK taxpayers may have to buy toxic assets from Britain's banks to help stimulate lending, adding a "bad bank" scheme to the government's existing plans to insure banks against unexpected losses.

The UK chancellor said the bad bank approach might be necessary with "one or two institutions" in order to remove problematic old loans from banks' balance sheets rather than simply insuring them, to give them confidence to start lending again.

Mr Darling announced on January 19 the government favoured a "back stop" insurance scheme, where the taxpayer charges a fee to banks to guarantee against heavy future losses on certain loans, over a bad bank that would buy the loans outright.
He said at the time that the insurance approach was quicker and more straightforward, but on Tuesday said: "It could be that in some cases it could be easier to do a good/bad bank split."

The government and its advisers are working hard to draw up an insurance scheme for Royal Bank of Scotland, the state-controlled lender.

The agreement, due to be unveiled by the end of the month, is expected to act as a template for negotiations with other banks, including Lloyds Banking Group, the other part-nationalised institution, which includes HBOS.

Mr Darling's comments took banker by surprise because they believed the government still favoured the insurance scheme. This approach has the benefit of allowing the government to insure banks against future losses without immediately increasing the national debt.

It also avoids the government being forced to assign a value to loans for which there is no market price, potentially triggering further losses for the banks.

Mr Darling is looking at a hybrid scheme where some assets are insured by the government, while some are bought outright by the taxpayer and put into a "bad bank". The approach is similar to the one being drawn up by the authorities in the US.
Mr Darling told the House of Lords economic affairs committee:"I've always preferred an approach where you have a menu to choose from and you decide what's appropriate".

The purchase of toxic assets will be controversial, as the state will have to take full ownership of assets rather than being responsible for losses. Fixing a price with the banks is also likely to be highly complicated.

Mr Darling's team argues there has to be some valuation of the assets in any insurance scheme and that it may be more appropriate to buy some asset classes outright – particulary those which tie up capital over many years.

George Osborne, shadow chancellor, said a bad bank solution might be the best approach, but claimed Mr Darling was retreating on his earlier insurance scheme.

He said: "This confusion over such a sensitive area of policy gives the impession that the government doesn't know what it is doing and risks further undermining confidence".

Meanwhile the Tories won an amendment in the Lords to require a quarterly Treasury report to parliament on the extent of taxpayer liabilities in the banking sector.

Montez votre bicyclette, pal

Mandy, Lord Fondlebum of Boys, the Marrakesh Mincer, has issued a proclamation from a Swiss ski-resort where he is hobnobbing with the great and the good of the New World Order ((c) G. Brown). If the British horny-handed sons of toil don't like their jobs being taken by wops, spigs, dagos and eyeties, they can do a Norman Tebbit and get a job on the continong.

That's what we expect to hear from Herbert Morrison's grandson!

The two great lessons of the twentieth century

Gordon Brown's latest speech really takes the biscuit:

"This is the first financial crisis of the global age. And there is no clear map that has been set out from past experience to deal with it."

Not so this is straight out of the 1930's. An over-extended and over sophisticated banking system.

"I'm reminded of the story of Titian, who's the great painter, who reached the age of 90, finished the last of his nearly 100 brilliant paintings, and he said at the end of it, 'I'm finally beginning to learn how to paint', and that is where we are."

So the great and good at Davos really want to hear Brown's views on the painter's skill? I doubt it very much.

"We're learning all the time about how to deal with what are real problems for which we have no historical analogies to fall back on, because when the 1930s problems hit them, they did not have the global financial markets that we have today."

The facts are that nothing you have done so far has reversed the economic decline. The precedent in the 1930's is exactly the one you should be following. An over-extension of the banking system led to a general failure of banking and commerce, and was corrected by building up the banking system and keeping its business simple.

The two lessons of the twentieth century are that collective ownership leads to economic stagnation and that whenever regulated banks are allowed to trade with other people's money with low allocations of risk capital, central banks invariably end up bailing them out.

Stories we missed: Fridge magnate jailed

A Chinese tycoon was today sentenced to 12 years in prison following his conviction for falsifying and withholding information and embezzlement.

Gu Chujun, former chairman of Chinese refrigerator maker Guangdong Kelon Electrical Holdings Co., was also fined $636,000.

Gu plans to appeal the sentence.

Some new financial terms you may need to learn

The FT has reported that Morgan Stanley have ventured to suggest that
hyperinflation is a possibility, although this depends on a number of
factors, including the willingness of governments to pump up the money
supply and run the printing presses. We shall not speculate on the
correctness of their analysis, but if we assume for the moment that they are
correct, here is some terminology that may be useful.

We are used to the terms million, billion and even trillion, but thereafter
we may be less familiar with the commonly used terms for large numbers. In
fact, the system used in scientific circles and widely adopted in America
and hence in world financial circles is quite simple once we realise that
the prefixes after one million are sort of Latin: bi-, tri-, quadri-,
quinti- etc.

Or each each name represents 10^(3*(n+1)), where n is the number usually represented by the prefix in the name.

Hence one billion (bi-: 2) = 10^(3*3) = 10^9

One quintillion (quinti-: 5) = 10^(3*6) = 10^18

This has been a public service announcement.

Madoff victims sue Santander

From the FT:
Victims of the alleged $50bn fraud by US broker Bernard Madoff have filed the first lawsuit against Santander of Spain, the eurozone's biggest bank, claiming damages and accusing the bank and other defendants of gross negligence.
The civil class action suit, filed on Monday in Miami, names Banco Santander — along with Santander International, Optimal Investment Services, the bank's Swiss-based hedge fund arm, and three Optimal managers — as defendants.
PwC, the auditors, and two HSBC units in Ireland are also named for their administration and custodianship of the investments.
Plaintiffs in the case include Inversiones Mar Octava, a Chilean company that lost $300,000 and "paid substantial advisory fees for illusory services", and Marcelo Guillermo Testa, an Argentinian.
Santander has said that its clients around the world may have lost €2.33bn ($3bn) with Mr Madoff, but declined to make any comments on Tuesday about the lawsuit. Only US money managers Fairfield Greenwich and Tremont have said their customers lost more. At least 19 civil lawsuits seeking to recover Madoff-related losses have been filed in four countries since the broker's December 11 arrest.
The Santander suit accuses all the defendants of violating US securities regulations, of gross negligence, of negligent misrepresentation and of unjustly enriching themselves.
"Despite the considerable fees charged to investors and the repeated representations that Optimal Investment would carefully select the managers, all of the Plaintiffs' and the Class' funds were stolen through the Madoff Ponzi scheme," the plaintiffs claim in a complaint filed in federal court in Miami.
"Defendants paid themselves tens of millions of dollars in fees, and perhaps hundreds of millions of dollars, predicated on phoney profits," the claim asserts.
Javier Cremades, senior partner of Cremades & Calvo-Sotelo, the Spanish law firm that announced the lawsuit on Tuesday, said the action related to clients who had invested in the funds through Miami.
The firm is hoping to negotiate for a global settlement with Santander executives in Madrid, according to Mr Cremades.
"They are very willing to talk. We still hope a settlement is going to be possible," he said.
He has estimated that there are around 3,000 investors in Spain — individual and institutional — affected by the collapse of Mr Madoff's scheme.
Meanwhile, a group of French private investors plans to file the first lawsuit there against UBS Zurich, the parent of the Luxembourg arm which ran Madoff feeder funds.
Veronique Lartigue, a lawyer representing roughly 10 people who invested in these funds, told the Financial Times that her clients were demanding €7m in compensation and would file on Wednesday in France. The investors are claiming reimbursement and interest from the parent bank, which they say is ultimately responsible. "In the prospectus the name UBS . . . was the determining element for investor confidence," she said.
UBS has said that these funds were established at the request of clients.

More Famous Quotes

"When I'm shaving in the morning, I often look in the mirror and think if I were a young man I would emigrate" - James Callaghan, 1979.

Famous quotes

“A weak currency arises from a weak economy which in turn is the result of a weak Government” - Gordon Brown, 1995.

Is the BBC acting like Pravda?

There appears to be widespread civil unrest, particularly in Northern
Europe, caused by the financial crisis as reported by the world's press:

Iceland
Demonstrations outside the Icelandic parliament have caused Social
Democratic Alliance chief Ingibjorg Gisladottir to hold talks with her party
on Saturday to consider Prime Minister Geir Haarde's call for a May 9
election. Iceland had its worst street riots in 50 years when 2,000
protesters took to the streets of Reykjavik on Thursday, hurling paving
stones at Iceland's parliament building, over the economic crisis. The day
before, protesters threw eggs and soft drinks at Iceland's prime minister.

Bulgaria
Dozens of people, including 14 police, injured during riots in Sofia last
week.

Latvia
Centre-right government likely to call elections after riots over harsh
conditions following IMF bail-out.

Lithuania
Street clashes and 86 arrests after 7,000 people attended a Vilnius rally
called by trade unions to protest at public sector pay cuts, reduced social
security payments, an increase in VAT and an end to tax breaks on medicine
and home heating.

None of this is reported by the BBC (Europe headlines below):

Fatal storms hit Spain and France
Migrants escape on Italian island
EU gives boost to dairy exports
Britons 'bored but happy' - study
Dane guilty of genital mutilation
Belgian creche suspect questioned
France's Dati to quit government
UK in recession as economy slides
Pope launches Vatican on YouTube
S Ossetia 'war crimes' condemned
Norway school shooting kills two
Gerrard denies nightclub assault
Fans clash after Djokovic victory
Spain's jobless rate hits 13.9%
Spanish police seize 'fake' Dalis
EU threat to retained fire crews
Europeans 'seized in Sahara'

North Korea anyone?

Did I hear that right?

Did I hear the dulcet tones of Mr Brown this morning saying that the government had regulated the banks correctly. OK, he admitted, they may have made some mistakes over liquidity, but they got the rest right. Which is a little like a dam builder saying they got the steel reinforcement right but they may have made some mistakes with the concrete. It only takes one mistake for the dam to burst.

Unfortunately that is not the only mistake, although the mistake is common to many jurisdictions and their regulators. The Basel II capital adequacy rules are procyclical, meaning that when things are going bad they are exacerbated by the bank capital requirements and things are going well the burden eases, leaving banks with free capital to support extra lendeing.

Why is this? Because the amount of capital required by banks to be set against an asset is linked to the rating of the debtor. Under the old rules the weighting for a particular asset was determined by whether the debtor was a government, bank or corporation, and to be frank, this was very unlikely to change during the life of an asset. Under the new rules the risk weighting of an asset also depended on the rating of the borrower.

On its face this didn't seem unreasonable. Why should a standby credit facility to AAA rated multinational be treated the same as the subordinated of a leveraged buy out. AAA borrowers from banks were rare because they could get the money from the bond markets at better rates, so it seemed that these rare diamonds were relatively harmless. It was recognised that the rating of the borrower could decline, but AAA borrowers never went bust overnight (if we conveniently forget about Confederation Life) so the bank could always reduce its position by trading it away if it really had to, but in reality it would probably have the extra capital to support the position and a AA or A credit was still very bankable.

The problem was that neither the bankers nor the regulators saw what would happen next. Instead of being a rare jewel the AAA credit rating became a prized commodity that could be used to wrap around inferior credits. Fannie Mae, Freddie Mac and AIG became important not just because their sprinkling of fairy dust over an otherwise dubious asset gave it a higher credit rating, but also the assets became attractive to banks looking to maximise their returns to shareholders. The paper may have had a lowish yield, but it paid at a higher than normal paper with a similar credit rating because of complexity, and jo oy joys because of the high rating banks could hold much more of it per dollar of capital than they could hold of loans to corporates.

The demand for credit wrapped mortgage paper went through the roof until it became clear that there was little underlying credit in some of the assets and the high ratings for the guarantors were looking a little shaky to say the least. Now the regulators were looking at a different problem to the one they envisaged. Instead of looking at rare instances of AAA lending that might have been envisaged, the entire financial market was overhung by vast amounts of structured mortgage assets with likely ratings downgrades and capital requirements that could not be met.

Not all Mr. Brown's fault, but as the Cooke Committee was largely driven out of London, the UK government cannot avoid a lot of the blame, and as the financial regulator for one of the most significant markets for these transaction, the FSA has a lot of egg on its face.

And then there are all the credit default swaps written by AIG in London in an unregulated vehicle...

Hear no evil, see no evil, speak no evil

According to a report in the FT, the FSA is holding talks with top auditors to "try to ensure banks are not destabilised by accountants making a qualified judgement in annual accounts on their capacity to continue as a going concern".

So what is an honest accountant to do if he spots a big hole in a bank’s accounts? Pretend that it’s not there and be sued 2 months later by the bank’s shareholders when it goes to the wall?

It looks as though the FSA, having failed to supervise the banks, is trying to get the auditors to ignore the problems that the FSA has already overlooked.

Probably the worst deal ever - worse than the Conservatives' Black Wednesday

At close of business last Friday, the UK government held £5 billion in preference shares and a 50% of the ordinary shares of RBS. I calculate the market cap of all of the company’s ordinary shares at £8.33 billion, so the total government holding of prefs and ordinaries would have been worth about £9.16 billion.

At the weekend the government cut what it thought was a good deal to exchange the prefs for ordinaries at a price 8.25% below the Friday closing price, giving the government a 70% interest in the ordinaries. With the discount on the ordinaries, the government would have thought they held about £9.56 billion of shares at the start of business on Monday. Unfortunately the share price fell 67% on the day leaving the market cap of RBS at £4.58 billion, and the UK government’s 70% share at £3.2 billion. So instead of getting a benefit of a £400m discount on the conversion price, the government took a £5.96 billion loss on the day, or rather the tax payer took that loss.

If the rating of UK government debt is downgraded as has just happened to Spain, then the banks will still be short of capital and the whole exercise will have been in vain.

RBS shares fall 70%

Just thought I would mention it.

Gordon Brown is a bit upset

It appears that he has found out that 80% of the assets on RBS’ commercial loan book are loans to non-UK borrowers. In order to get lending to UK borrowers moving again, Mr Brown’s government will have to share the risk in assets that they don’t understand or know about. Mr Brown feigns suyrprise, but given that he was responsible for regulating the banks and understanding how the economy worked he can hardly blame anybody but himself.

Some facts for you Mr Brown.

1. London is the centre of the European capital markets and since the 1980s when the Japanese banks turned up in a big way, the British banks have lost market share, particularly in the large corporate sector to Japanese, US, French and German banks.

2. Large scale capital investment in British industry has been virtually non-existent since 1997. Your pro-globalisation policies and your increasing burden of taxation have driven investment to other parts of the world. Don’t give me any guff about dropping the rate of corporation tax. The last drop was funded (your words) by reducing the standard rate of capital allowances from 25% to 20%, which hit capital intensive businesses disproportionately. The one before that was funded by bringing forward the timing of tax payments. Paying tax at 30% 10 months after the end of the accounting period has the same economic cost as paying a lower rate of tax on estimated payments through out the year. It also gave you an extra years corporation tax revenue. Equally disastrous was the auction of 3G spectrum which sucked capital out of British firms that were expanding rapidly in foreign markets and killed off a lot of British overseas interest in the strongest growth industry in the last 10 years.

3. NatWest, RBS, Barclays, Lloyds and Abbey used to fund a large percentage of the fixed plant and machinery in this country through long term finance leasing, which gave British banks a pricing advantage over foreign lenders and provided certain long term finance to UK companies. For the sake of short term revenue gains you killed this industry with many pieces of legislation in successive Finance Bills. It was your decision, so don’t act surprised if RBS has very few UK customers.

The bank guarantee scheme

Let’s make a few guesses at how it works:

The banks have some bad assets on their books and are short of capital. They pay an annual premium to the government to cover the banks on any losses above a certain amount on those bad assets. Let us say the figure is 50%. So the banks take the first 50% of losses/risk and the government take the risk on the remainder, which is hopefully an acceptable deal for the tax payer - but don’t count on it.

The advantage for the banks is that with the government guarantee they may expect to be paid out to a limited extent if the assets go bad (although don’t count on it because of the state of the UK economy), but to the extent they are covered by government guarantees they will be zero-rated for capital adequacy purposes. So the banks will pay a premium of perhaps 1% of the amount guaranteed and will thereby avoid using up Tier 1 capital equal to 8 or 9% of the risk adjusted amount that they would otherwise have to pay if/when the bad assets are downgraded. Not a bad deal for a bank that is short of capital.

On the other hand the government gets paid a premium that it pretends represents value for money and in return incurs a contingent liability. The government likes that because not only does it have to come up with any more cash for funding (which needs more borrowing), but it also gets to exclude the liability from the government accounts (on the same basis that it excludes the guarantees it has given against National Rail's borrowings). There is no valid accounting reason to do so. It is simply using its often practised techniques of lying and self-delusion.

Financial Crime of the Year 2008

Nobody has made out like Bernard Madoff, and made off he apparently did, although where the money has gone is not very clear. Some reports mention $50 billion which is a truly staggering sum, if correct.

If it was all on bad investments then the market would have known. Asian financial futures markets knew all about Nick Leeson’s losing ways long before he burnt through all of Baring’s money. The trouble was that Barings management didn’t and the market didn’t think it was the job of other companies’ traders to tell them. Alternatively he may have just be siphoning off the money, but it is very difficult to move large cash balances through the banking system without them being noticed.

Which brings us to the SEC, who had received several complaints over 10 years but had singularly failed to act. A cursory examination of the Madoff Fund’s accounts and bank statements would have shown what was happening on a massive scale, but they didn’t, but that’s civil servants for you.

Which in turn leads us to Nicola Horlick with her media protestations that she couldn’t be blamed if the SEC hadn’t checked out the company. Wrong answer, Ms Horlick. You aren’t paid X% plus upside to make investment decisions based on whether a company has been banged to rights by the SEC. Any fool can do that, and many fools can read a company’s annual reports. That is not how you are paid.

You are paid to understand a company’s business, the industry within which it works and the macro and micro factors likely to affect its future performance.

It seems you didn’t get past step 1 ..... which is why your funds are losing money, your firm is losing money and, as an investment vehicle, my socks (long and black from M&S if you want to know) outperformed your Bramdean Alternatives this year - and didn’t charge any management fees.

So out of a very strong field this year, Financial Crime of the Year 2008 goes to Nicola Horlick.