The Financial Services Club's Blog

The future of capitalism

It’s Davos time, as usual.

In the last week of January, the great and the good of the world’s leadership from governments, business, academia and media all gather in Switzerland to debate the future of the world’s economies and the World Economic Forum, #WEF.

In the build-up to this year’s WEF, it seems that all the magazines, media and men are talking about capitalism, what capitalism means post-crisis and what the future of capitalism will be.

David Cameron made a speech about this last week, as did Nick Clegg and Ed Miliband, and much of the debate resonates with the speech of Amartya Sen that I attended last week.

The core of the debate is embodied in the quote by Winston Churchill that “capitalism is the worst form of economics, except for all the others that have been tried.” 

Link: TrogloPundit

True.

The debate is then what form of capitalism you want: state capitalism or liberal capitalism.

A wholly state run economy fails, as demonstrated by communism; whilst a wholly liberalised, free market economy also fails, as demonstrated in 2008.

So there needs to be a middle ground, but how middling is that middle ground?

Somewhere between the extremes of Western and Eastern approaches to commerce.

Some believe that the West is crumbling due to over-excessive free market liberalism.

In a 2011 report, the Organisation for Economic Co-operation and Development figured that the level of income inequality in the 22 member nations it studied increased by 10% since the mid-1980s, with conditions deteriorating in 17 of them.

A recent report  by the Institute for Policy Studies, a Washington-based think tank, found that CEOs at large U.S. firms earned, on average, $10.8 million in 2010, a 28% increase from the year before, while the average worker took home $33,121, a mere 3% more. At that level, CEOs’ paychecks are 325 times bigger than their employees’. In the 1970s, CEO pay rarely topped 30 times more.

Meanwhile, the average income for an American has reduced every year for the past three years.

On the other extreme, Asian markets are rising fast and taking over, using a more state-led capitalistic approach.

“The world’s ten biggest oil-and-gas firms, measured by reserves, are all state-owned …  state-backed companies account for 80% of the value of China’s stockmarket and 62% of Russia’s.”  [The Economist]

“The ten largest economies in Asia now spend roughly $400 billion a year on research and development (R&D)—as much as America, and well ahead of Europe’s $300 billion. China’s investment leapt 28% in a year, propelling it past Japan to become the world’s second-biggest spender … America’s share of global R&D spending is falling. In the decade to 2009, it tumbled from 38% to 31%, whereas Asia’s rose from 24% to 35%. But science is not a zero-sum game.”  [The Economist]

So there is a new model rising which, according to Time Magazine, “is not so much between capitalism and another ideology but between competing forms of capitalism. The financial crisis, growing inequality and faltering economic performance in the U.S. have tarnished American ‘leave it to the markets’ capitalism, which is being challenged by ‘capitalism with Chinese characteristics’, euro­capitalism, ‘democratic development capitalism’ (India and Brazil) and even small-state entrepreneurial capitalism (Singapore, UAE and Israel). All these models favour a more significant role for the state in regulation, ownership and control of assets.”

The Economist furthers this debate, asserting that the winner is ‘state capitalism’.

Link: Ifyouhavetoaskyoudontknow

“The crisis of liberal capitalism has been rendered more serious by the rise of a potent alternative: state capitalism, which tries to meld the powers of the state with the powers of capitalism. It depends on government to pick winners and promote economic growth. But it also uses capitalist tools such as listing state-owned companies on the stockmarket and embracing globalisation.”

Examples of state capitalism include:

“The 13 biggest oil firms, which between them have a grip on more than three-quarters of the world’s oil reserves, are all state-backed including the world’s biggest natural-gas company, Russia’s Gazprom, China Mobile and Saudi Basic Industries Corporation is one of the world’s most profitable chemical companies. Russia’s Sberbank is Europe’s third-largest bank by market capitalisation. Dubai Ports is the world’s third-largest ports operator. The airline Emirates is growing at 20% a year ...  State companies make up 80% of the value of the stockmarket in China, 62% in Russia and 38% in Brazil. They accounted for one-third of the emerging world’s foreign direct investment between 2003 and 2010 and an even higher proportion of its most spectacular acquisitions, as well as a growing proportion of the very largest firms: three Chinese state-owned companies rank among the world’s ten biggest companies by revenue, against only two European ones.” [The Economist]

“State-Owned Enterprises (SOEs) make up most of the market capitalisation of China’s and Russia’s stockmarkets and account for 28 of the emerging world’s 100 biggest companies.” [The Economist]

“France owns 85% of EDF, an energy company; Japan 50% of Japan Tobacco; and Germany 32% of Deutsche Telekom. These numbers add up: across the OECD state-owned enterprises have a combined value of almost $2 trillion and employ 6m people.” [The Economist]

The Economist believes the trend for the next decade will be towards state capitalism based upon the Chinese model, albeit with caveats and issues along the way, and  concludes that “the Chinese no longer see state-directed firms as a way-station on the road to liberal capitalism; rather, they see it as a sustainable model. They think they have redesigned capitalism to make it work better, and a growing number of emerging-world leaders agree with them. The Brazilian government, which embraced privatisation in the 1990s, is now interfering with the likes of Vale and Petrobras, and compelling smaller companies to merge to form national champions. South Africa is also flirting with the model:

• Over the past 30 years China’s GDP has grown at an average rate of 9.5% a year and its international trade by 18% in volume terms. Over the past ten years its GDP has more than trebled to $11 trillion.
• China has taken over from Japan as the world’s second-biggest economy, and from America as the world’s biggest market for many consumer goods.
• The Chinese state is the biggest shareholder in the country’s 150 biggest companies.
• China’s 121 biggest SOEs saw their total assets increase from $360 billion in 2002 to $2.9 trillion in 2010 … in 2009 some 85% of China’s $1.4 trillion in bank loans went to state companies.”

But note that, unlike America where CEOs’ paychecks are 325 times bigger than their employees, state capitalism is fairer in terms of income disparities: “in 2009 the average SOE boss earned $88,000 and the highest-paid, the chairman of China Mobile, $182,000.” [The Economist]  China Mobile has 600 million customers and is one of the largest telecoms in the world.

FYI, I debated these points a couple of years ago, and concluded that the future is one where capitalism is heavily influenced by the influence of the Chinese and Islamic principles.  

Seems to be coming true?

Link: The World Is Not Enough

Postnote:

The main reading behind this blog post is inspired by two cover page stories:

• How to Save Capitalism, Time Magazine
• State Capitalism, Economist supplement

 

Amartya Sen: thoughts on poverty and the global financial crisis

I attended an interesting lecture last night from an economic legend: Professor Amartya Sen of Harvard University.

If you haven’t heard of him, he’s known as the Mother Teresa of economics in his native India, and has spent a lifetime fighting poverty with analysis rather than activism. 

Awarded the Nobel Prize in Economic Sciences in 1998, for his contributions to welfare economics and interest in the problems of society's poorest members, Sen is best known for his work on the causes of famine.

He is currently Professor of Economics and Philosophy at Harvard University, as well as being a senior fellow at the Harvard Society of Fellows, distinguished fellow of All Souls College, Oxford and a Fellow of Trinity College, Cambridge, where he previously served as Master from 1998 to 2004.

An impressive guy.

Amartya delivered his speech as part of the London Stock Exchange Group series of lectures on the future of global finance, and the evening was hosted by LSE Chairman, Chris Gibson-Smith.

Here’s a brief summary of Amartya’s sentiments (I say ‘sentiments’ as this is not a record of his speech and incorporates my own spin on his words).

Some people say we live in interesting times, but I think we live in baffling times.

We live in baffling, rather than interesting, times because it is very hard to get any clarity about the future. 

The only thing that is certain is, in the words of George Bernard Shaw, “the greatest of evils and the worst of crimes is poverty”.

Shaw wrote this in the Preface to his brilliant play, Major Barbara, published in 1907. 

The tragedy of poverty is, of course, obvious to all - whether in Latin America, or in Asia or Africa, or in Europe and the United States. 

The calamity of deprivation and penury can hardly be missed by those who have bothered to think about the subject, no matter whether they are themselves poor or not. 

Lives are battered, happiness stifled, creativity destroyed, freedoms eradicated by the misfortunes of poverty. 

But Bernard Shaw was not talking, on this occasion, about the hardship of poverty, or the misfortune that goes with it. 

He was commenting, in a rather unusual way, about the causation and consequences of poverty - that it is bred through evil and ends up being a crime.

If poverty is indeed an evil, not to mention “the greatest of evils” as Shaw puts it, then there must be some wickedness, or at least some culpability, behind poverty - some wrong-doing that allows such human tragedies to occur and persist. 

This raises the immediate question: who, then, are the wrong-doers?

If you look to protesters today, such as the Occupy Wall Street movement, the wrongdoers are represented by the corporate greed of capitalists and the banks.

You can just as easily take the opposite view however, and look to the Tea Party movement who see the failure being that of government and government policies.

The Tea Party align with Adam Smith, the guru of capitalism, and believe that free markets should rule.

Who is right and who is wrong?

Or is this the right question? 

In thinking about strategic issues, we cannot but go into the question of culpability and the failure of duties and obligations. 

We have to ask: how can things be done differently so that the evil of poverty is ousted? 

We have to identify the nature and genesis of the wrong-doing that is responsible for the affliction. 

That is not, however, the same as trying to identify the wrong-doers?

The identification of wrong-doers is not our task and trying to identify the evil-doers is not the right strategy since the responsibility for creating an evil is very widely dispersed in the society. 

We have to see how the actions - and indeed inactions - of a great many persons together lead to this evil, and how changing our modes of actions - our policies, our institutions, our priorities - can help to eliminate poverty. 

Our focus definitely has to be on removing evil-doing, as part of our strategies and programs, rather than going on the wild-goose chase of catching the hugely dispersed collectivity of evil-doers, who may not even fully understand how their actions can be seen as part of an evil state of affairs.

In fact, we should eliminate the discussion of wrong doers completely, and focus our efforts more on how to stop poverty full stop.

This is why strategies such as closing sweatshop labour factories in poor countries, or arresting those who employ children in the making of carpets, would fail to eliminate the poverty of the victims if such action is separated from a general economic and social program. 

In the vast majority of cases the employees are there in those terrible jobs because they have very few options - none that are particularly good. 

This is because there has been a failure of the state and the society to create opportunities for decent employment, which makes it possible to recruit labour to do terrible jobs as the alternative may be unemployment and starvation.

That is why exploited labourers are led to soul-destroying work today in the poorer countries, and closing down sweated-labour factories without giving the victims alternative opportunities for employment or education - the latter is extremely important in the case of child labour - is not an adequate solution to the problems and predicaments of the precarious poor. 

There is, of course, moral merit in restraining the pursuit of profit of businessmen through exploiting vulnerable and freedom-less labour, but a fuller solution can emerge only through positive opportunities of alternative employment and occupation, and that demands societal action. 

So the first action to address poverty is to expand labour opportunities and assist in education, and not to just shutdown existing sources of income.

My argument so far has been based on seeing poverty as lowness of incomes. 

Is employment with income a full solution to all problems of poverty? 

To believe that would be to underestimate vastly the complexity of poverty, particularly the nature of persistent poverty. 

By way of example, lowliness of income is the primary cause of starvation rather than the lowliness of the availability of food.

Is employment for income in order to buy food the answer to everything therefore?

No, as this misses the point of why there is persistent poverty

Strategic examination about eliminating poverty, or even reducing its burden, has to go more deeply into the nature of poverty. 

Poverty is about the inability to lead a decent, minimally acceptable life, and while low income does make it difficult to lead a life of freedom and well-being, an exclusive concentration on seeing poverty as lowness of income misses out a great many important connections.

What are the other non-income factors that contribute to poverty: a lack of education, availability of work, investment in infrastructure and more, and capitalism addresses these issues by providing an insurance.

For example, all affluent societies have addressed extreme poverty issues through public policy programs, such as the public pension, the provision of school education, the availability of healthcare and more non-market non-commercial arranged facilities.

The economics of these areas are not obvious except that an insurance system run by the state or by some other social support system, not by profit-oriented private firms, may be a necessary part of the elimination of poverty. 

Affluent societies focus upon profit maximisation and the unrestricted search for profit, but if they only relied on profit maximisation they would not function.

As a result, they balance between market mechanisms and state activities.

There is no strategic formula as to the correct balance between market mechanisms and state activities – the contrast between China and Taiwan or America and Sweden are good examples of how approaches differ – but we need to understand these balances in order to create a better world that addresses poverty with finance.

Does this mean arguing against Adam Smith’s principles for free markets?

Not really.

That view is a result of a huge misunderstanding of Adam Smith’s principles, and my position is strongly influenced by his.

Adam Smith clarified how markets work and how they can work exceedingly well.  He believes that you need a well-functioning market economy and clarity of why you want such efficient markets to be.

The task of politicians in managing the economy is then to search for two distinct objectives: first, to provide plentiful revenue to cover the basic subsistence needs of the people before the subsistence needs of the state; and second, to provide the state with enough revenue to finance public services.

The financial focus of public services is a critical part of Smith’s work and Adam Smith had an overwhelmingly clear view about support of the poor and undersupported in his market view.

Within his free market principles, he clearly defended the role of the state to fund public services, such as education and poverty relief.

Adam Smith was deeply concerned about the inequality of society and never used the word capitalism.

The word capitalism does not appear in any of his books or any other writing, and it would be hard to carve out anything in his works on market economies that were based purely upon capital.

For example, he specifically argued about protections from unlimited usury practices.

So how should we think about the wrongdoers that need rectification, and how should we address poverty?

According to Adam Smith and my own thinking, the key is increasing employment.

Increasing employment must remain a worldwide priority and China, Brazil and India are doing much better at this than America and Europe.

As employment and economic welfare rises, the state must use such employment to improve public services for good living and public welfare and, in this respect, India is not doing this as well as China and Brazil.

Finally, for the West in general and Europe in particular, the crisis of 2008 was created by the malfunctioning of market economies – the result was the state had to create support for their economies and this is the reason for rising sovereign debt.

But the cause of this malfunctioning is clearly what was thought of as lack of accountability of governments, but governments are accountable and this is what we are seeing today.

What we are seeing is that, in order to pay back their debts, governments have far more accountability.  However, they are addressing this accountability in the wrong way.

It’s hard to see how massive austerity drives, which cuts demand and growth, can therefore be supported,

Just look at Japan and learn from what happened there over the last 20 years of austerity, which is still biting.

What these governments need is fast economic growth.

Economic growth creates resources to address unemployment and poverty.

This is the key to addressing issues in Europe and the West, and it is the indiscipline of governments that has failed the markets, not the markets themselves.

Europe needs a better form of economic accountability and management of their economies, rather than austerities which decimate human lives and economic growth.

In conclusion, I end by affirming that George Bernard Shaw was right, a hundred years ago today, to point to the connection between poverty and evil and crime.  The fact that this insight came not from an economist but from a dramatist and literary giant fits in well with my general thesis that the economics of poverty involves much more than just economics.  Human lives in society are interlinked through economic, social, political and cultural associations.  The nature, causes and consequences of poverty reflect the richness of those connections.  We have no reason to be surprised by that elementary understanding.

Amartya then took Q&A from the floor and was asked a few interesting questions.

Q: You appear to be saying that in this current crisis, it is the failure of states to regulate markets effectively that failed, rather than the markets themselves. Is this your view?

You cannot separate markets and state, and this crisis was a failure of both, but you also have to be aware of the relationship between free markets and state influence. 

For example, Adam Smith argued against usury, but was convinced to change his thoughts on interest after reading the works of Jeremy Bentham. 

The core of how markets and state should work is that free markets is the most efficient model of economic management, but free markets need states that set efficient regulations to avoid failure in order to be truly workable.

As this shows, free markets and the state are two separate entities that are interdependent.

A key question in the last crisis however is whether globalisation killed that interdependency to cause the spiral of crisis we see today.

Globalisation may have undermined national states, as government can no longer effectively regulate the free markets?

There may be some truth in this statement, and this is why the G20, G8 and other global activities – the World Bank and IMF included – are key to solving these issues this time around.

Q: Do you think the euro will survive?

No.

When the euro was created, I didn’t see why it was needed and didn’t believe it made sense.  I am a fan of Europe, don’t get me wrong there as my late wife was Italian, but to start a European integration without a fiscal foundation meant that it was never going to work.

You can see this today as many parts of the EU are not served well by a Europe that has no fiscal union.   Greece is a good example.

Now however the loss of a country would be very destabilising for this European Union.

This is why Germany is being forced to bailout Europe.

Could they retreat out of it? Yes.

Is that the right thing to do? I think so.

 

Postnote: some of Amartya’s speech is taken from a write up of an earlier presentation he made in 2007.  These words of wisdom are integrated in parts of this article to ensure more accuracy of content.

 

How will the world look post-crisis?

I’ve been debating some future presentations with various folks today, and a little ray of light went off in my head.

The light was triggered by a comment: “can you talk about what impact regulatory change may have on bank to corporate relationships using examples historically?”

The question was really asking about the unintended impact of regulatory change in the past and what it might mean for their future, but it made me think about something else.

Each time we have seen a major bubble burst, the cause has been a coagulation of several forces of change.

Forces for change come from four major directions: Political, Economic, Social and Technological (PEST).

These forces for change are used in many ways, and can be seen in my banking history discussions (and soon to be published book) which talks about many historical periods including the Italian Renaissance, the Great Depression and the Credit Crisis.

In each of these, we can see Political, Economic, Social and Technological forces working together at the same time to drive change.

In the fall of the Renaissance Italians, it was a mixture of change between the break from the Catholic Church with the Protestant and other movements (Political), mixed with the ruin of the Italian banks due to over-extension of credit to overseas Royal Houses (Economic), along with expansion of merchant shipping and colonisation (Technological).

In the Great Depression, we saw the end of the Industrial Revolution (Technological) combined with post-war wrangling over the gold standard (Political and Economic).

Right now, we see a major world of change too.

We have the rebalancing of power between America and Asia/China (Economic) combined with an internet revolution that is connecting everyone on the planet (Technological), leading to changes in society, where a Molly Katchpole can reverse a bank’s policy and an #Occupy movement can change global thinking (Social).

The Political outcome of all of this is what is driving bank regulations right now.

And the outcome of all of this will be a massive change.

A New World Order?

Probably not.

We already have a New World Order as China is expected to be the world’s largest economy by 2018 (ten years ago, it was estimated to be 2047).

But we will see a restructured playing field and one that is not level.

We can see this already as one major economy (America) bans prop trading whilst another (UK) just separates prop trading from retail bank operations.

Even more pronounced are the differences between the US and EU on OTC Derivatives regulations and how to define and regulate Systemically Important Financial Institutions (SiFi).

From CME Group in October 2011:

“In an ideal world, global financial regulators would function something like a team of horses, with policymakers in the United States, Europe, Asia and elsewhere all pulling at once in the same direction, and moving toward a common goal.

“Reality is turning out be far more chaotic, however. Regulators and lawmakers are having a tough time forming a consensus even within their own national borders, let alone across international boundaries. The result is turning out be a patchwork of overlapping and often inconsistent approaches to regulation in the aftermath of the financial crisis that gripped global markets in 2008 and 2009. Many financial experts fear that the inconsistent global regulatory framework will alter the flow of capital around the world, as trades are directed to the cheapest jurisdiction, a process known as regulatory arbitrage.”

So we end up with a world where the politicians are trying to react to the implosion of markets at the end of another revolution – Globalisation – and find that they are seriously lacking consistency, vision, leadership or agreement.

The Eurozone is one of the best illustrations of this, although America and China aren’t guaranteed to come out of this stainless as the American elections will change ground again, as will China’s challenges of a property market bubble and inflationary pressures.

All in all, the PEST approach to the world today says that we are going through a momentous change from all angles – Political, Economic, Social and Technological.

Where will it end up?

Probably in a place no-one expects and one which, on this blog, I’m going to avoid predicting decisively.

From Reuters:

“By 2020, the workforce in western Europe will shrink by 2.4 percent, including a 4.2 percent contraction in Germany, according to a Boston Consulting Group study.

Looking further ahead, HSBC projects that Germany's working population will shrivel by 29 percent by 2050, Russia's by 31 percent and Japan's by 37 percent.

Over the same period, the population of many African countries will double. Nigeria will log a rise of 3 percent a year in its workforce - in contrast to a 1 percent decline in Russia and Japan - and will have as many people as the United States by 2050.

On current projections, Pakistan will be the sixth most-populous nation by the middle of the century. And the Philippines could be the world's 16th-biggest economy, HSBC reckons.”

 

Save the City

There’s an interesting economist out this week with a front page saying: “Save the City”, which seems to be getting everyone a little bit worked up.

Why?

Because it’s in defence of the City.

The story talks about the history of the City, and how its future may be jeopardised by the regulatory and taxation changes taking place today.

The actual main story this relates to – three pages about “Death by a thousand cuts” – is actually a very good factual piece about the City’s role in the UK economy.

Here’s a short summary of the key information in this article by Gary Neill:

First, Britain let banks get out of hand, creating a bubble of exposure that could have ruined the country if the government had not acted the way it did.

“At the height of the financial crisis Britain feared not only the collapse of banks that were too big to fail, but the terrifying risk of having to bail out banks that might have been too big to save.”

This is why the costs of the new regulations proposed in the Vickers report “is likely to be significant: perhaps £3.5 billion to £8 billion ($5.4 billion to $12.5 billion) a year, or even higher”.

But it won’t cripple the City whose “growth over the past six decades has come from international banks choosing to do business in London rather than from the growth of British-owned banks. TheCityUK, a lobby group, reckons that 251 foreign banks have branches or subsidiaries in London and that over half of all British banking assets are owned by foreign banks.”

It is why we talk about London to banking as being like the Wimbledon to tennis – we provide the courts but not the players – and is reflected in the UK’s popularity for trading in OTC Derivatives and FX.

But then other rules are worrying, such as the EU’s proposed financial transaction tax which will raise money for Europe – some believe as much as €55 billion a year, with up to 70% collected in Britain – but would seriously impact London as a viable trading centre. 

“The European Commission’s own impact assessment reckons that it could force 90% of some sorts of trading activity simply to move from the EU, with the loss of hundreds of thousands of jobs.”

Combined with other proposed changes to regulations, all designed to “threaten a market that Britain dominates, to the benefit of centres such as Paris or Frankfurt.”

Add onto all of this that, “on a rough calculation for The Economist by KPMG, getting out of London would be advantageous for high earners.”

Similarly, “the share of Britain’s GDP accounted for by insurance and finance, including retail services like arranging mortgages, has already dropped to just under 8% from above 9% in 2007. The number of people employed by the industry in Britain fell by 7% in the three years to the third quarter of 2011. More jobs losses are likely …

“London has hung on to its top ranking in the closely watched Global Financial Centres Index published twice a year by Z/Yen, a consultancy. But the gap between London and New York, in first and second place, and Hong Kong and Singapore in third and fourth has narrowed in recent surveys …”

At this point, the article makes a strong case for why London succeeds as a financial centre when others fail:

• “Incumbency is a powerful barrier in industries, such as finance, where there are strong network effects.
• Trading attracts liquidity and thus more trading.
• A steady supply of skilled financiers adds to the virtuous circle.
• The use of English around the world gives London an edge over other European centres.
• London goes to work in the middle of the global trading day: the City day starts just as Asia’s financial markets are closing and its financiers are still at their desks when the New York market opens. That makes it an ideal spot for global asset managers.  One-third of the £4.8 trillion of funds managed in Britain is on behalf of foreigners, according to TheCityUK.
• London is also an ideal place to strike deals between parties from different countries, because of its highly respected body of commercial law and experienced judges.
• London’s lead in foreign exchange, as well as in interest-rate derivatives, grew out of its reinvention in the 1960s and 1970s as an offshore centre for dollar deposit-taking and lending, after sterling’s decline as a reserve currency.”

But it also talks about threats to this strength, such as many of the City’s bigwigs are from the 1980s, and a new breed of financier is coming out of Asia.

I liked this piece, and think it builds on my history of the City of London series which is soon to be released as a new book.

The article is balanced, informative, factual and has some great content.

Then there are the two supporting articles that go with it, which are not.

They are contentious, ill-informed, biased and potentially xenophobic.

These pieces really are not good, with some saying it’s an appalling piece of journalism, such as Ian Fraser.

Ian is an outspoken journalist about the crisis caused by the British banks, and is often damning in his views about the banking system.

With this piece, he’s surpassed himself.

“This intellectually lazy piece of journalism is a disgrace. More than any Economist article I’ve recently read (some of which have been excellent by the way), it has made me give serious thought to cancelling my subscription to The Economist.”

Why so harsh a criticism?

Well, here’s the article Ian picked on: “Save the City”.

He claims “it doesn’t even start to acknowledge the multifarious failures of the financial sector, or the damage it has wrought on the UK economy in recent years. The article fails to mention the massive risks posed by “crony capitalism” and “regulatory capture”, including wilful blindness to fraud, and even includes the words –

Finance—the funnelling of savings to their best use—is a vital industry. Britain is very good at it, leading the world in various financial markets, including foreign exchange and over-the-counter derivatives.

Who wrote this garbage I wonder?”

I don’t think it was quite so bad myself.

Instead, I took offence at the other article supporting the City.

This one is from Schumpeter – named after a famous Austrian-American economist from the last century – and is entitled: “the dangers of demonology ”.

Here's a brief excerpt of what I found misleading:

“Throughout history, moneylenders have been persecuted. Ethnic minorities—most obviously the Jews in Europe and America but also the Chinese in Asia—have clustered in the financial sector first because they were barred from more respectable pursuits and later because success begets success. At times, anti-banking prejudice has acquired a strong tinge of ethnic hatred.

“In medieval Europe Jews were persecuted not only because they were not Christians but also because killing them was a quick way to expunge debts. Karl Marx, who came from a Jewish family, regarded Jews as the embodiments of capitalism who could only be rescued from their ancestral curse through revolution.

“The forgers of the ‘Protocols of the Learned Elders of Zion’ wanted people to believe that Jewish financiers were engaged in a fiendish global conspiracy. Louis McFadden, the chairman of the United States House Committee on Banking and Currency in the 1930s, claimed that ‘the Gentiles have the slips of paper while the Jews have the lawful money’”, and “a survey in the Boston Review in 2009 found that 25% of non-Jewish Americans blamed Jews for the financial crisis, with a higher percentage among Democrats than Republicans.”

In other words, the Economist is running an article that implies the banking crisis could lead to anti-semitism on a grand scale once more: “demonising bankers will not solve these problems—and may well, if unchecked, bring a lot of ancient ugliness back to life.”

I personally think that is incredibly inflammatory and biased.

When combined with the Save the City, these two articles undermine the Economist’s credibility and heritage.

It’s a shame, as the death by a thousand cuts piece has some real substance.

Ah well.

So much for the heady days of journalism with integrity, I’m off to watch Hacks again.

 

 

 

 

2012: an economic outlook

2012 is here and we all hope it’s better than 2011.  Sure, some of you may have had a very good last year, but most thought it pretty dire with job losses, austerity measures, civil uprisings, protests, a second financial crisis in the Eurozone and more being the name of the day.

Time Magazine named their Person of the Year as a collective Protestor, rather than an individual …

And the Times named Mohamed Bouazizi - the young market trader who set fire to himself outside the government offices in Tunisia as a martyrdom act that fuelled the Arab Spring - as their Person of the Year.

Is this a time when societies worldwide change their world or will media, finance and government, continue to control and direct?

Probably a mixture of both.

Thanks to this internet age, the individual can change things and change things fast – the Arab Spring, Occupy Wall Street, Anonymous and Wikileaks prove this – but those in power will still direct, as far as they can.

The question may be who is in power, as demonstrated by the Eurozone issues of 2011.

Where are we going in 2012, is therefore a key question.

To put this question in context, I said three years ago that the next resurgence in the economy would be in 2014, after plateauing in 2012. 

I still believe that.

This year is going to be a tough one, as things haven’t finished yet, but things are stabilising. 

Europe’s going to a have a mild recession, America is going to revive and Asia is going to wonder where it’s going.

So here are the four key things that reflect the economic times of 2012:

1. Asia’s light continues to shine, but not quite as bright
2. American equities is the place to invest
3. There will be a major European bank failure
4. A country will leave the Eurozone

Asia’s light continues to shine, but not quite as bright

Asia, particularly China, continues to astound. 

 

From Urban Times, 2010 

Ten years ago, China had more mobile phone users than America, and last year it manufacturer more and registered more patents.  In 2014, its retailers will sell more too and the day that China becomes bigger than America is getting ever nearer.

In 2003 – when Jim O’Neill coined the term the BRICs for Brazil, Russia, India and China – he estimated that China’s economy would overtake America’s by 2041.  Last year, that estimate had moved fourteen years nearer, to 2027, thanks to the economic crisis.  As the crisis has continued, the estimate is now that 2018 will be the year China gets to be bigger than the USA, according to Emma Duncan in the Times.

Nevertheless, with the American and European market demands contracting, China is not sailing a static sea.  For example, Reuters Breaking Views blog states that China’s growth may dip under the magical 9% this year – even falling under 8% – as multiple challenges hit: falling house prices, a slump in property investment, and slowing exports.  Add to this that salaries surged 40% last year – admittedly to just $160 per month – and we can see that global growth and stability will not be plain sailing at all in 2012. 

 

Source: PhilSTAR / Bloomberg

So where should you invest?

American equities is the place to invest

In a bout of good news for Barack Obama, in the year where he fights for his political future against Mitt Romney, the US looks to be a safe bet for investments in 2012.

Terry Ewing, head of US equities at Ignis Asset Management, believes the US can continue to surge, as its economy has differentiating growth characteristics that will underpin both earnings growth and the stock market.

Mr. Euwing has expectations of 2% GDP growth, compared with the 'inevitable European recession' this year. By way of history, US industrial production rose by 8% between 1993 to 1995 whereas Europe's shrank by 5% and he believes a similar divergence could well happen again.

He lives with good company, with Jim O’Neill of Goldman Sachs saying that American equities could rise by as much as 20% this year, and Paul Frank agrees.  John Paulson promotes buying US stocks over US government bonds, whilst James Paulsen sees this year as the ‘gear year’.

Source: PhilSTAR / Bloomberg

With all those “Pauls” behind it, something’s gotta be right and so yes, invest in America is the message in 2012.

Unfortunately, that means don’t in Europe.

There will be a major European bank failure

In July 2011, the European Banking Authority (EBA) issued its summary of how fragile the European bank system was after stress tests on 90 European banks.  Eight failed that test – nine if you include the German Helaba Bank that dodged it – and a further 16 were in the danger zone.

However, the tests did not include a sovereign debt default, such as the issues we now see in Greece.

And with the ECB lending €500 billion it should stabilise the system, except that the ECB is receiving a similar amount back in overnight deposits and European banks still have to face almost €2 trillion of toxic assets on their balance sheets.

Add on to this that European banks also face a major capital shortfall – at least €115 billion and more like €350 billion – and we are bound to see more European banks failing this year.

I said a third of European banks would fail two years ago.  It won’t be that many, due to the €440 billion European Financial Stability Facility, but there will still be some major failures with Commerzbank already in the frame.

It should be noted that this is not unique to Europe however, as 92 banks failed in the USA in 2011.  It’s slightly down on 2010 (157 failed) and 2009 (140) but it’s still high and will continue as an analysis by The Wall Street Journal suggests that failures are down because troubled banks aren't failing as quickly.

A country will leave the Eurozone

Due to fragility in the European banking system continuing, along with a lack of confidence in Europe’s leadership, one or more countries will be forced to leave the euro.

There’s already been lots of speculation that a Eurozone member will need to breakout of the euro.  Greece is the usual one cited, but Italy and others are also regularly debated.  There has been lots of simulation and planning for such an event and so, when it does, it won’t cause any major ripple in the markets at all.

It will be a disaster for the country concerned of course, but the idea of continuing the Eurozone where a third of the members – Portugal, Italy, Greece, Ireland, Spain and more – are being propped up by Germany, and to a lesser extent France, is just not workable long-term.

And I’m not the only one saying this.

The Wall Street Journal is charting its demise, whilst the Guardian is talking about it every day, as are many people in the countries affected themselves, such as Greece and Ireland.

The UK Treasury is planning for it to fail; as are most bank analysts, banks and companies.

In fact, the only ones saying it won’t happen are the ECB, obviously, and Wolfgang Schäuble, the German Finance Minister.

But what does it mean if it happens?

Well, it ain’t good, but it doesn't mean the end of the Eurozone.  Just that Europe has to rethink a lot of the Maastricht Treaty, and come up with a new Economic & Monetary Union approach.

Peter Sands, CEO of Standard Chartered, puts it succinctly:

“I think the probability of countries leaving the Eurozone has increased because we have had several successive plans announced to solve the problem of the Eurozone which simply haven't convinced the market.

“Nobody should underestimate what a big deal that would be, because it would be very difficult to manage the contagion risk, even if it was only Greece. The disruption from that would really be quite significant.

“That will have ramifications all over the world . . . because the simple maths is that the Eurozone is a very large part of the global economy and if it is going slower, then economic trade will be slower around the world.”

So there’s a short guide to the 2012 economic outlook:

• Asia’s light continues to shine, but not quite as bright
• American equities is the place to invest
• There will be a major European bank failure
• A country will leave the Eurozone

This is one of three 2012 outlook pieces:

• 2012: an economic outlook
• 2012: a banking outlook
• 2012: a bank technology outlook

 

Get Shorty! Andrew Haldane speech

Last night was the occasion of the Sir John Gresham annual lecture.

This year it was held at the Four Seasons Hotel in Canary Wharf with the keynote speaker being Andrew Haldane, or Andy as is the preference,  Executive Director for Financial Stability with the Bank of England.

Andy is speaking at the Financial Services Club in 2012, so I was particularly interested in his speech, as well as the fact that I’ve heard and read much about him in the past.

Andy’s theme for the night was short versus long-term investing, and whether short-termism is a good or bad thing.

This theme was based upon Gresham’s Law – bearing in mind this is the Sir John Gresham lecture – that bad money will drive out good.  In today’s parlance, short money will drive out long.

But this is nothing new, Andy argued, as short-termism has been with us since time immemorial.

Just look at a few notable quotes from history:

“The untutored savage, like the child, is wholly occupied with the pleasures and troubles of the moment;  the morrow is dimly felt;  the limit of his horizon is but a few days off”, Jevons (1871)

“Like children who pick the plums out of their pudding to eat them at once”, Marshall (1890)

“It implies only that our telescopic faculty is defective, and that we, therefore, see future pleasures, as it were, on a diminished scale.” Pigou (1920)

It’s all about impatience versus patience and our inability to defer today’s pleasures until tomorrow.

That’s the nature of why we are short rather than long term.

But patience is a uniquely human characteristic.

No animal demonstrates patience like humanity, as it is part of how our brain is built with the pre-frontal cortex providing patience whilst the limbic mid-brain around the cerebral cortex dominates with impatience.

So what is this all about?

Well, from a million or so B.C. to around 50,000 B.C., very little happened.

The GDP of the planet stayed consistently low.

Then something changed.

In 50,000 B.C., Neanderthal man died out and homo sapiens took over.

What changed?

The Brain.

Neanderthals had a short frontal lobe, which is why their forehead is angled, whilst their skull was larger at the rear to accommodate the cerebral cortex.

This is similar to most animals, who are impatient therefore and seek instant gratification to instant needs.

Homo sapiens emerged, and their foreheads elongated as the frontal cortex increased in size.

Hence, patience is a virtue that homo sapiens discovered and is the reason why productivity increased so rapidly from 50,000 B.C. onwards.

The brain is still developing dynamically, and technology today is changing how our brain works.

For example, there was recently a study released that proves that internet search engines are changing the way our brains remember information, as readily available information online makes people easily forget facts since computers become their external memory.

Our attention span is shortening as a result, with jobs, relationships and attention all collapsing into shorter time cycles.

Football managers used to get four or more seasons to prove themselves; now they’re lucky if they last more than one.

Alex Ferguson may well have lost his job 25 years ago, if today’s climate of rapid churn had applied back then.

CEOs used to have a tenure of ten years or more; today, the average is under five.

And marriage is an institution that is lucky to survive till death doth you part.

This applies equally to shareholdings, where the average holding of shares today is months compared to decades forty years ago.

The result is the short money will drive out long, and this self-destructive behaviour is easily seen in evidence today.

For example, in a recent survey, 78% of CFOs said that they would rather sacrifice economic value for smooth quarterly earnings.

That means they would rather avoid investing in their firm’s future if it meant this quarter’s earnings would be consistent.

We see this in dividends.

Forty years ago, dividends were not always issued.

If the company was struggling or needed to invest, they would withhold dividends.

Not now.

Dividends are issued every quarter, regardless of how the firm is coping.

Maybe this reflects the pressures on stock prices and management who often have a stake in their firm’s performance due to share options.

Or maybe it’s just the pressure of the short-termists and the capital markets.

But myopic investing is not necessarily good for growth.

For example, using net present value discounting in a myopic view means that you can see negative returns on projects that would actually be delivering profits in a rational view.

As little as a 0.1 change in NPV can make the difference.

Equally, it shows itself in how firms operate their Research & Development (R&D) budgets.

A survey of the Top 1000 UK corporations found that only 1.39% of revenues were invested in R&D in listed companies compared to an average 2.63% for unlisted companies; similarly only 1.44% of revenues were placed into R&D for UK owned companies compared to 2.7% for UK based companies owned by overseas corporations.

Short-termism is rife in our businesses and it constrains long-term growth and value.

A similar survey was performed across 100,000 US companies by Asker and company found that private firms are over twice as likely to invest in the long-term value of their firms when compared with public companies, and over three times as likely to consider such investments.

So Andy’s presentation kind of summarised the nature of short term capitalism, or quarterly capitalism as McKinsey call it, and he concluded with a few ideas as to how to rectify such short-termism.

These included bringing in some longer term performance metrics for corporations and investors based upon their rate of portfolio churn, R&D spend, etc; linking shareholder rights to the length of a shareholder’s share holding; linking capital gains tax to length of the holding, such that you pay lower taxes for longer holdings; and more.

All good ideas and a view that, at the end of the day, we need to stop the short-termists “picking the plums from the pudding” or allowing the “untutored savage” to ravage the markets.

Andy was then asked a few questions form the floor.

I was amused to hear him talk about lessons from the crisis and that we thought we needed “more regulation and this time it will be better, and more regulators but this time they will be smarter.  That kind of didn’t work.  We must look instead at the fundamentals of the financial markets structure and address core issues such as the fact that there are some very big banks and many small banks but a missing middle.  There aren’t enough mid-size banks out there.”

He did say that regulators are getting some things right now: they recognise the importance and implications of systemically important financial insitutions (SIFIs) and the capital requirements for large banks that go with this.  On the downside however, regulators are still grappling with births and deaths - making it easier to get new banks born and unworkable banks removed.

He also has a dramatic turn of phrase.

Take this one for example: “almost all dinner party conversations I go to about the post financial crisis, I go in depressed and leave suicidal.”

But, on regulations and monetary policy, he concluded that “the game is to slow down the deleveraging of the global markets and that is what we have done through zero percent interest rates and quantitative easing.”

On that note, I think he’s pretty much spot on and look forward to meeting and hosting Andy at the Financial Services Club next year.

 

For a more expansive version of this speech, a similar presentation was given by Andy in May 2011, to the 29th Société Universitaire Européene de Recherches Financières Colloquium:  New Paradigms in Money and Finance?  in Brussels.

 

Jim O'Neill on the BRICs - the next decade

Just tweeted to our friends in the #OccupyLSE group – that’s Occupy the London Stock Exchange (LSE) for those who are not aware of the protest outside the LSE at St Paul’s – that I attended a meeting at the London Stock Exchange this morning.

Yes, I occupied the LSE!

Well, just for an hour in order to hear the thoughts of one Jim O’Neill, Chairman of Goldman Sachs Asset Management.

Jim is the man who coined the term BRICs for the growth countries of Brazil, Russia, India and China ten years ago (his paper was published in November 2001).

Since then everyone has taken the success story of China as read, although it has also been noted that the Brazil, Russia and India growth story also came true.

Now, ten years later, Jim was asked the question by the LSE: “Do BRIC countries still need the West for growth or is the reverse now true?”, and this was the theme of his presentation.

Here’s my spin on his talk (this is not a direct transcription therefore):

The question “Do BRIC countries still need the West for growth or is the reverse now true?”, couldn’t be more apt after the G20 meeting in Cannes last week.  In fact, I would claim that this is the most important question facing global economies and leaders today.

And my answer is yes, the reverse is true.

The West has been the most challenged since 2008 as their deleveraging crisis has been with them ever since, and the BRICs are an ever increasing part of the solution.

That being said, the BRICs are living in the same planet as the rest of us and cannot let the West completely implode.  For example, as we watch the troubling worlds of Greece and increasingly Italy, the BRICs are seeing more and more impact.

This is especially key for London, in its role in global finance, and is illustrated by the interesting events taking place a few yards away outside St Paul’s Cathedral (where the occupy LSE movement is demonstrating), which means it is very important that all of us involved in business and finance get a bit more objective about the issues being discussed in public forum these days.

Over the last decade the nominal increase in GDP amongst the BRICs has been greater than any other group of countries, apart from the G7.

This is difficult for people of my generation to see or accept, because it is new, although younger people get it far more easily.

Maybe this is because older people find it hard to adapt or change.

During the last decade, the GDP of G7 increased by $11 trillion.

Meanwhile, the Growth8 as I call them – the BRICs plus Indonesia, Vietnam, Mexico and Turkey – increased by a similar amount.

These countries are therefore so economically important that it’s rather sad and stupid that people still call these countries “emerging markets” when they have now emerged, and are contributing so much to growth and global markets.  We should call them something else, which is why I choose to call them the Growth8, as opposed to other countries which are emerging markets.

BRICs represent 80% of the Growth8’s $11 trillion growth in the last decade.

The ‘C’ in particular – China – has seen its GDP increase faster than the USA in the last decade.

Another example is Brazil, which has seen GDP increase faster than Germany, Japan and the UK.

From 2010 to 2019, the Growth8 will again rise faster, with China still leading the way.

BRICs will see GDP growth of over $12 trillion of the $16 trillion rise in the Growth8, with China contributing around $8 trillion, or half of that GDP growth.  This assumes an 8% average growth rate in their economy, so it assumes China’s growth will slow down.

However, if you look at the figures, the USA will only grow about $3 trillion in GDP by comparison, and Euroland by under $2 trillion.

In these figures, you would need a magnifying glass to see where Greece would sit in the global economy.  It’s not big enough to matter.

For example, China will grow by the equivalent of three Greece’s this year – it creates a new Greece GDP size every four months.

Unfortunately that is not the case with Italy.

Looking to the future, the global share of GDP in 2020 will be 41% for the G7; and 35% for the Growth8.  Of these, 27% of global GDP will be with the BRICs; 19% with the USA; 17% for China; and 16% for the whole of Euroland!

So during the next decade, the BRICs will be bigger than the USA.

This is important change, as the G20 and IMF are already changing their thinking about the BRICs.

For example, the IMF said at last week’s G20 meeting that it is going to review its Special Drawing Rights (SDR) basket of currencies before 2015, when it was next scheduled for review.

This implies that the Remnimbi (RMB) will be brought into the SDR basket before 2015 because China has moved far closer to full convertibility of their currency sooner than expected, which is incredibly important for everyone in finance, whether you invest in China or not.  

This means that debt or equity issued in Chinese RMB becomes normal, which is infinitely more important than what’s going on in terms of Greek and European politics.

For example, when we berate others about their fiscal affairs we have to be careful as, when you look at the budget deficits and government debt, it is clear that this not a sovereign debt crisis.

The gross government debt, as a percentage of GDP, in particularly high in the UK (85%), USA (100%) and Japan (233%) are far worse than in the Eurozone, but their governments still have highly rated sovereign debt. 

So the Eurozone issue is more a question of revealing the issue of the weakness of the European Economic & Monetary Union (EMU), rather than a question of sovereign debt.

And if you look at debt in the Growth8, the gross government debt as a percentage of GDP is under 25% for many.

This is why these economies are so key to the future and is illustrated by retail sales.

Retail sales since 2007 have dipped significantly in advanced economies but, in growth and emerging markets, are going up rapidly.

This is why German exports in the last four years have seen the biggest rise in sales to China, India and Russia.  By 2012, Germany will be exporting more to China than their neighbour France, which is a real shock.

This demonstrates why the BRICs are now independent of the West and the West needs them far more than they need us.

But the BRICs are not some homogenous area or singular market.

Two are democracies and two are not, and their wealth is very different. Brazil and Russia average around $15,000 a head; China $5,000; whilst India is under $2,000; so they are not similar in terms of wealth or politics.  Equally, they differ in content with two commodity producers and two importers, so they are not a region together.

The fact that they now meet as a group annually however is a symbolic move to Western leaders for change in economic governance, and to have these guys at the centre of it.

For example, the G20 is way too big and ugly, so we need a new G7 or G8, of which the BRICs and China will form a key part.  For the UK and Canada that’s tough as, in terms of their size of GDP, it makes you wonder what they’re doing there.

The real topic now is what’s happening to Chinese inflation.

It should get under 4% next year, which will be massively important as it will stop China’s tightening of monetary policy and will help the global economy as a result.

We should also note that 2020-2029 might be India’s decade.

China’s demographics will create a turndown and growing anywhere near 10% per annum will be tough a decade from now.

India has great demographics however, with India’s working population increasing by the size of the total USA population in a decade.

Finally, political instabilities are a factor in this outlook.

We have a Goldman Sachs Growth Environment Score (GES) that looks at 13 variables related to the sustainability of growth and productivity, and India scores the lowest of the BRICs on this score.

So when people ask me if I was mistaken about Russia being in this list, I respond by saying I’d take the ‘I’ out of BRICs before the ‘R’. 

India is challenged in terms of sustainable growth due to government finances and the lack of a credible framework for economic policy.  They also have many other issues of corruption and indecisiveness, which means that they can conceptually be a leader by 2020 or after only if they address these challenges first.

 

The Brown Bottom

From my friend Derek Bond …

With the gold price hitting new nominal highs, now may be a good moment to remind ourselves about the consequences of Gordon Brown’s sale of much of the UK’s gold reserves.

Between 1999 and 2002 he sold 395 metric tons of gold at an average price of $275 an ounce.

Today the price stands at $1,749 an ounce.

No wonder Brown’s sale on the gold price charts is known as The Brown Bottom.

He also gave notice to the market that the sales would take place, thereby giving market participants every opportunity to drive the price down further.

Here are some calculations of the value which would have been accrued if we still held the gold today:

                                         Sold then             Value now
                                       1999 - 2002                2011
Quantity sold tons                  395                        395
Average price $/oz               $275                     $1,700
Sum realised US$m            $3,477m               $21,492m
Exchange rate                       $1.52                    $1.63
Sum realised £m                   £2,287                 £13,185

The 2012 Olympics are estimated to cost some £9 billion, so we could have paid for the Olympics with the amount of value he surrendered and had over £2 billion in change left.

p.s. at the 10 year anniversary of the sale in May 2009, the loss was only £3.9 billion [Ed: did someone just say 'only']

 

 

Shocker: Skinner thinks EBA stress tests not worthwhile

In my usual quiet way, I was interviewed by Bloomberg last Thursday in anticipation of the European Banking Authority (EBA), previously the Committee of European Bank Supervisors (CEBS), about the forthcoming stress tests released on Friday.

Last year, these tests were quite laughable and this year I expected more of the same.

Here's the whole ten-minute interview and, for those who missed it, I loved this article in the Telegraph:

Europe's bank stress tests as bad as 1979 Irish driving test

Seeing large numbers of his fellow citizens failing their driving tests, Mr Barrett – in a quick bid for votes – declared that anyone who had taken their test twice and not passed would automatically qualify for a licence.

The consequences were predictable. At any one time, about 40pc of the Irish population were allowed to drive on the roads without ever actually having passed a test. Traffic accidents went up and insurance costs followed.

Andrea Enria, the chairman of the European Banking Authority, may not like the comparison, but the limited bank stress test results he unveiled on Friday are born of a similar motivation that led directly to Ireland’s until only very recently dysfunctional driving test system.

Like the Irish government 32 years ago, the EBA and the European Union are under the impression that their power to pass and fail banks will translate directly into making them better at what they do.

The fallacy of this approach is as obvious as the needlessly ruined lives and extortionate insurance premiums that once-blighted Ireland will attest.

 

Stéphane Garelli on the future economic outlook

I recently attended a conference where I interviewed lots of the keynote speakers for a vidvertisement ... or whatever you call it.

Anyways, the interviews are timely, relevant and pertinent to the readers of the blog, so I'm reposting a select few here.

The first is Stéphane Garelli.  If you don't know him, Stéphane Garelli is the guy who made Davos what it is today, as Managing Director of the World Economic Forum for over twenty years.  Now a Professor with the University of Lausanne, Switzerland, he's pretty well informed on all matters economic, and believes the future is Africa.  

Worth a viewing:

Chris Skinner interviews .... Stéphane Garelli from the Financial Services Club on Vimeo.

 

Let the bank tax and accounting wars begin

After the bank reporting season in the UK last week, the most notable row that has emerged – alongside bonuses and a lack of lending – is the lack of taxes banks pay.

Banks are remarkably adept at being tax efficient – or should we say, tax avoiders – and this has been known for years. It is tolerated by governments as the taxes they avoid are all legitimate accounting techniques to minimise corporation tax whilst, on the other hand, they are big payers of national insurance contributions, pay-as-you-earn and other employee earnings-related taxes.

This conundrum puts governments in a bind: if they clamp down too hard on their banks, then they lose a possibly major chunk of tax revenues. However, by not clamping down on the banks, they lose a major chunk of tax revenues anyway.

This dilemma is the one facing the UK government in particular, as they see a dysfunctional banking system that they want to tax heavily but they know that, if they do, the banks will leave.

This was clearly demonstrated by the often mooted rumour about HSBC relocating to Hong Kong – that’s been around since Michael Geoghegan’s office moved there two years ago, although it’s interesting that new CEO Stuart Gulliver has clearly said the office should be in London – and Barclays to New York.

Such sabre-rattling frightens the likes of George Osborne and Vince Cable, but does it frighten the likes of Mervyn King and Sir John Vickers?

Probably not, as Mervyn King has been quite outspoken over the weekend about bankers bonuses and poor treatment of customers whilst promoting the idea that banks should be split between boring banking – retail and commercial – and casino banking – investments. A view that appears to be increasingly endorsed by Sir John Vickers, who will provide the regulatory framework for long-term bank reform later this year.

If it does go this way – higher taxes on bonuses and salaries, the forced split of proprietary trading (the casino bit of investment banking) and general restructuring, then be assured that it will mean the banks will relocate.

Not Lloyds and RBS – the government owned banks – but the big two of the big four: HSBC and Barclays.

Now, is this a big loss?

Yes and no.

It comes back to the taxation piece.

According to a report by Pricewaterhouse Coopers, banks more than pay their way in the UK economy.

The industry contributed an estimated £53.4 billion to UK government taxes in the 2009/10 financial year, accounting for 11.2% of the total UK tax take.

The figure, which excludes the 50% top rate of tax and the Bank Payroll Tax, is down by £8 billion from the previous fiscal year but the sector has overtaken North Sea oil and gas to become once again the largest payer of corporation tax in 2010.

The sector employs over one million workers which helped to generate £24.5 billion in employment taxes.

Wonderful.

That’s slightly less than the amount stated by the banks in Project Merlin’s documentation (HM Treasury published summary, pdf document), where the banks say they will “contribute a cumulative £8 billion of total tax take (covering direct and indirect sources, including the Bank Levy and VAT) in 2010 and, on the same basis, £10 billion in 2011.”  

But what’s £45 billion here or there?

The real issue is that the banks can easily offset tax liabilities based upon clever accounting.

For example, leading accountant Richard Murphy writes that the UK banks received an effective subsidy of £19 billion, by writing down this amount as deferred tax liabilities due to expected losses in 2008:

“If some £19 billion in tax might not be paid as a result at some time in the future, there is an extraordinary double subsidy going on for these banks. Not only were their losses underwritten by the state in 2008 (and in most cases they still are receiving some form of state support, if only by way of asset guarantees), but they will now receive a second round of subsidy when over years to come they will offset those state subsidised losses against the profits they might now make only because they have been saved for the benefit of their shareholders by the UK government.”

So there is some issue here about tax isn’t there?

It’s one raised often by the Treasury Select Committee and, in particular, by campaigner MP Chuka Umunna who asked Bob Diamond in the last meeting how many offshore companies the bank had in global tax havens.

About 300, Bob Diamond answered.

No wonder they only managed to pay £113 million in Corporation Tax last year. That was on the back of pre-tax profits in of £11.6 billion.

Similar questions are being raised by analysts about Lloyds and HSBC.

For example, Lloyds Banking Group won’t pay any corporation tax until 2015 or after, even though it made over £2 billion in pre-tax profits.

Ian Fraser writes a good summary of the analysis of Lloyds results over on Naked Capitalism, and the point made is that creative accounting can make any bank look good.

Lloyds were buoyant about rebounding from more than £6 billion in losses in 2009 to a £2.2 billion profit in 2010 … except that the statutory profit was a loss of £320 million.

There are many definitions of profit.

Charges of £1.65 billion as the cost of integrating HBOS with Lloyds, a £500 million purse to reimburse mortgage customers for over-charging and a £365m loss on the sale of two oil-rig subsidiaries had been stripped out of the ‘profit’ figures.

There are many definitions of profit.

There is also a thing called “fair value unwind”.

In Lloyds accounts, they have a specific area relating to the HBOS acquisition representing fair value, and the “fair value unwind represents the impact on the consolidated and divisional income statements of the acquisition related balance sheet adjustments. These adjustments principally reflect the application of market based credit spreads to HBOS's lending portfolios and own debt.”

In other words, it is the write down of what was over-valued in the HBOS takeover and, as a result, higher valuations on HBOS assets and business lines since the deal was done had added £3.12 billion to Lloyds’ headline pre-tax figure.

There are many definitions of profit.

There was a further £7.9 billion of largely unidentified ‘available for sale’ assets also moved into a newly-created accounting basket of ‘held to maturity’ assets as part of the “fair value unwind”. This is a good move as such assets don’t need to be marked to market, which can also improve the accounting view.

There are many definitions of profit.

HSBC has faced similar questions about taxes from US authorities and UK activist groups, whilst Royal Bank of Scotland doesn’t have to worry about profits right now – they made a £1.1 billion loss  – but they don’t have to worry about taxes either: “RBS finance director Bruce van Saun also admitted today the bank would pay no corporation tax again in 2011 as it has deferred tax assets of £6.3bn it can use up from previous losses before paying any tax.”

All in all, this new dialogue is quite concerning as transparency in bank accounting is hard – there are differences between USA and International Accounting rules for example, between GAAP and IFRS, and then there are all these complexities layered on top between mark-to-market, fair value, liabilities and impairments, on balance sheet and off balance sheet, and so on and so froth.

Which finally brings me to Basel III.

Basel III is a subject I generally try to avoid, but it has raised its ugly head this week with a report from the Matrix Group, published online by David McKibbin.

Why does this report worry me?

Checkout the management summary:

“We believe that changes in regulations for bank capital are a ‘game changer’ for the sector.

“The proposals from the Basel Committee published in December 2009 will increase the quantum of capital in the system, improve its quality, force out complexity from balance sheets and ultimately drive down ROE.

“We undertake a thorough analysis of what happens to the banks’ capital in an attempt to replicate as closely as possible the anticipated findings of the Basel Committee’s own impact study, due H2 2010.

“The results are very interesting.

“The UK banks Lloyds and HSBC are significantly impacted by the proposals.

“We see Lloyds, in particular, having a new Core Tier ratio of only 4.4% by the end of 2012.

“The fall is mainly due to the full deduction from common equity of investments in other financial institutions of £10bn (mainly insurance), which under the present FSA transition rules, is only deducted at the total capital level (not 50:50 from Tier 1and Tier 2 capital as for most other banks).

“Basel III is essentially crystallising the problem that Lloyds has been able to get away with for years of double counting the capital in other financial entities on the group balance sheet.

“We also see HSBC’s Core Tier 1 ratio falling to 6.0%, significantly below peers and in line with what we would deem to be an appropriate regulatory minimum.

“The reasons for the substantial fall in the Core Tier 1 ratio are more varied than for Lloyds and arise mainly from the deduction of negative AFS reserves, the deduction of minorities, the increase in market risk weights and the deduction of investments in other financial entities.

“For the last point, HSBC has, like Lloyds, taken advantage of the FSA transition rules currently in force and opted to deduct investments in financial entities at the total capital level rather than 50:50 from Tier 1 and Tier 2 capital.

“We believe that management may ultimately desire to raise more common equity to obtain a capital buffer and regain parity with peers.”

Be assured that bank accounting rules are under intense scrutiny, and will be more so in the future.

But no bank is going to appreciate Basel III adding layers of excess capital requirements to their already over-burdened balance sheets.

For example, take note of this quote from Karen Fawcett, Senior Managing Director and Group Head of Transaction Banking with Standard Chartered Bank (pdf of SIBOS Issues, October 2010): “If the regulations are implemented as they are currently written, we could be seeing a 2% fall in global trade and a 0.5% fall in global GDP.”

What the banks are really saying is that if Basel III is implemented as it is currently written, and if banks ever move to accounting practices where apples can be compared with apples, then global trade will decrease because the lubricants of trade – leverage and risk – will be curtailed.

Is that such a bad thing?

 

Blog inspired by Ian Fraser’s tweets 

 

The Establishment is just PANTS!!!

I was quite intrigued to hear a speech by Ben Ramsden, Founder and CEO of Pants to Poverty.

Ben's talk was all about social business which, when combined with social finance, creates a completely different and new form of commerce that, if the next generation has any say, will compete with and potentially merge with traditional finance and business over time.

Ben began his talk by saying how he used to be motivated by money, like most of us.

His career launched into a trajectory in telco’s before the dotcom implosion, at which point he decided to try something different and travelled out to Guyana to see how other people lived.

It changed his life, and he ended up getting heavily involved with Amnesty International and, through that work, the “Make Poverty History” Youth Movement of 2005.

This was the event, wrapped up with Live8 and lots of other NGO (Non-Governmental Organisations) pressure groups changed the world, or was meant to, by getting the G8 to sign up for relief for African nations from debt.

Only five years ago, but a very different world.

At this time, Pants to Poverty was launched and sold 11,000 pairs of pants in just five months.

After a while, Ben realised this could be a business and created it as a social business.

What is a ‘social business’?

There are lots of definitions of social business, with many mistaking such businesses as charities. They’re not. They are businesses, but they are there to deliver against social and environmental needs, as well as financial ones.

The core of such businesses therefore is that they redefine the profit and shareholder view of the world.

Profits are based upon contributions to the environment and society, as well as the bottom-line, and shareholders are all of the stakeholders, not just the investors. So the farmers, shippers, staff, customers, investors and community all get a share of profit here, not just the business investor.

It may sound airey-fairey, but it works in practice as Pants to Poverty sources cotton from fair-trade farmers, turns it into pants at ethical factories in the developing world, and sells them in ways that raise awareness as well as making money.

And Pants to Poverty is very good at creating awareness. For example, the business holds the Guinness world record for the most people gathered in pants in public ...

 

... as well as the biggest pair of pants ever created!

The point that Ben made is that this had started as a social movement – to Make Poverty History – and had moved to being a social business – Pants to Poverty.

By being a social business, every stakeholder in the supply chain has a stake. The cotton producers get pesticides; the factories have inspectors to avoid any labour misuse such as child labour; and the distributors get rewards in both cash and kind.

For example, Pants to Poverty is going through a round of funding right now, to try and get £250,000 in order to build the brand and capabilities of the firm.

In order to raise the £250,000, the company has issued 100 convertible bonds valued at £2,500 each. The bonds last ten years and are designed to sell to friends and family, and anyone else who might buy them.

And interestingly enough, Pants to Poverty is finding a lot of High Net Worth Individuals are interested in taking the bonds.

Why?

Well, apart from the philanthropic virtues and the fact they are helping the world, there’s actually a really interesting triple bottom-line financial product on offer here.

What is the product?

For your £2,500 per bond investment, you get 8.65% annual interest.

The interest however, is paid in three ways via quarterly instalments consisting of:

• 12 pairs of Fairtrade and Organic underwear (inclusive of delivery)
• £21.63 paid in cash to offset tax at source
• £50 donation to the Pi Foundation, a charity set up by Pants to Poverty to help develop sustainable business models in the fashion industry

In other words, you actually only a small amount of real interest, the £21.63 cash, but add in the other components and it’s worth a lot more.

No wonder Pants to Poverty is gaining ground.

But what really intrigued me is the likes of Ben, Venessa Memis, Nicholas Negroponte and others, because they’re doing something for the world.

Changing it for the better.

Some in small ways and some in big ways, like Bob Geldof, and though the majority of us capitalist banking community might think they’re all a bunch of tree-hugging hippies, there’s something that struck me as Ben talked.

You see we have this old world, let’s call it the Establishment, and the new world, let’s call it the People.

The Establishment affirms the views of old, and believes that management of the People is through control mechanisms of which a key part is the traditional media.

The People represent the views of the next generations, and believe that anything can be achieved through crowdsourced change.

The Establishment has trashed the planet whilst the People want to change the planet.

And there’s the rub.

There is a real friction between Old World and New World.

This is what has occurred to me more and more as I think about Wikileaks, the rise of social networks and media, the ability for P2P to crowdsource globally and to think differently.

I thought it worth illustrating, and so created a few slides to illustrate the point ...

Future trends

 

If the key drivers of change accumulate to force old bubbles to burst, then the new outcomes will be different.

And the key drivers of change are accumulating today to force the old bubbles to burst:

• Political: the belief in our political leadership has been undermined by the Iraq War, expense and other scandals, with Wikileaks leading the charge to expose corruption and weakness;
• Economic: there is a loss of trust in the capitalist system, with leaders of the world striving to find new ways to rebuild whilst global socials build new financial models;
• Society: as the ageing population become a burden on the young, Gen Y will be the next generation of leaders who will have to manage the books to support the boomers and Gen X retirees whilst nurturing the Millennials; and
• Technology: is transforming the world by linking everyone P2P globally.

Not sure where all of the above leads, except that it is becoming more and more obvious, and some form of hybrid model will need to be created.

Otherwise, when two tribes go to war, a point is all you score.

 

What happens if a country leaves the Eurozone?

It’s a funny old world.

One minute we’re all talking about the great European plan, the Lisbon agenda, the Directives are rolled out, SEPA and MTFs are spawned, the level playing field of the Eurozone is harmonised and so on and so forth.

The next is OMG, it’s all doom and gloom.

What about Greece? Ireland? Portugal? Spain? Italy?

This is a disaster!

Meanwhile, the Eurocrats continue to focus upon euro enlargement with Serbia, Macedonia, Montenegro, Albania and Bosnia all in the frame, as well as Turkey of course. In fact, Turkey’s chief negotiator on EU accession believes that: “the European Union needs Turkey more than Turkey needs the European Union”.

Very diplomatic ... and possibly true as Turkey represents the point where West meets East for many.

So what’s the reality?

I was thinking about this the other day, as someone asked me about Ireland’s future.

To be honest, I don’t think there’s a problem if a country has to leave the European Union or the Eurozone.

Think about it.

So far, the reason why we balk at such an idea is because no-one’s ever done it before.

No country has left the European Union so far.

Some have changed and adapted, as in Germany is different today than twenty years ago thanks the Berlin Wall coming down.

The UK is different to what it was twenty years ago, as we now have a Welsh and Scottish Assembly and a more stable Northern Ireland Assembly.

Belgium is breaking apart into Franco-Belgique Wallonia and Dutch-Belgique Flanders (correction).

Yugoslavia exploded into the Serbian-Bosnian war, but it hasn’t stopped Serbia and Bosnia seeking to join the Union.

So what of the future?

Could Portugal leave the euro, as recently implied by their foreign minister, even though just nine months ago there was an emphatic view this could never happen.

And what does it mean if a country leaves?

For the UK, it was a good thing.

The UK left the Eurozone plan in 1992 thanks to George Soros and, ever since, we’ve thanked our lucky stars we did.

UK sterling looks like a good bet in the short-term against the euro, and we have been able to fully engage in actions to halt the slide into depression by printing money through the Quantitative Easing (QE) program and rapidly reducing interest rates to zero.

All of the latter actions are impossible for Eurozone countries to engage in, as they are dependent on the policy across 16 countries controlled by the European Central Bank (ECB).

And there’s the issue.

The UK can issue bonds, t-bills, print money and create more debt because we are a strong country with strong investment yield and credit rating.

Portugal, Ireland, Greece and Spain don’t have any of these capabilities.

First, they are not strong countries with good credit ratings, as demonstrated by the downgrade of Greece in April by Standard & Poors that kicked off this crisis of confidence.

Second, they cannot control any fiscal policy effectively as all interest rates are controlled by Frankfurt, which handcuffs these economies to centralised control.

Even more of an issue for these countries is that they cannot ease their debt burden by priniting money through QE as the UK and USA has done. This is because it would have to be issued through the ECB again, and they have been loath to delve into such areas.

Even if Portugal, Ireland, Greece and Spain could print money, it would need to be substantiated by bonds and government treasury bills that had value to support such an increase in debt ... and these countries do not have the ability to sell such debt due to the downgrade of their credit status.

This is the real issue as Portugal, Ireland, Greece or Spain could leave the Eurozone and EMU ... but to go to what?

If Ireland went back to the punt and Greece the drachma, what does this give them?

It gives them the ability to control interest policies, print more money through QE and issue further debt ... but does anyone believe in or want such burdens from countries already teetering towards junk status?

Maybe ... Argentina survived such a crisis for example.

Others would say that, for the European Union, it’s a good thing to get rid of basket case countries that weaken the Union.

A small few might say that any country leaving the European Union or even the Eurozone is no issue. It may not have been done before, but that’s no reason why it shouldn’t happen and, if it did, it does not signal the end of the Union or the euro.

However, the bottom line is really that any country forced to leave the Eurozone would be an embarrassment to the Grand Plan.

That’s the main raison d’être for bailing out Greece and Ireland, and why Portugal would be bailed out too.

However, with over €1 trillion exposure in Spain, the big question is what happens if their economy tanks?

Mmmm ... we’ll deal with that when it happens I guess.

 

Postscript: the BBC studies the practicalities of a country leaving the euro today.

 

 

An Irishman, a Politician and an Economist walk into a bar

I don’t want to comment too much on the Irish problems, so collected a variety of the best news from around the world to share here.

First, some background on the issue: 

Q: Why is the Irish economy in such a crisis?

A: Because they always think their capital should be Dublin.

And some solutions?  

First, merge with Australia as they “have lots of mineral wealth but no water and no culture, whilst Ireland has no mineral wealth but lots of water and lots of culture.”

Second, even better, get the Corrs to save Ireland.

This is because Ireland has no prenuptial laws, so all that needs to happen is that Corrs sisters Andrea, Sharon and Caroline marry a few folks like Facebook founder Mark Zuckerberg, Mexican billionaire Carlos Slim and the world's wealthiest investor Warren Buffett.

They then immediately divorce them and take half their net worth, which would bring in about $US50 billion.

That's just about enough to bail out the banks.

Both of the solutions above are obviously far better than the Irish government’s best plan, which is to give all of their citizens free cheese.

This created a very negative reaction from some Irish folks, who were heard to say: “Cheese us Christ. They say that cheese can give you nightmares, and now the nightmares are giving us cheese. They’ve all gone em’mental.”

Worse, this week's the Week makes the point strongly with their front cover:

 

This is reinforced by some folks who believe Ireland should rest in peace, with this obituary notice placed in the local news rag:

Ireland, 1922-2010, after a terminal illness bravely borne.  Predeceased by founding fathers Arthur Griffith and Michael Collins. Survived by 4.3 million grieving children. Removal from Cowen and Lenihan’s funeral home to the Church of the IMF.

But it’s not that bad. Ireland’s purely been downgraded from AAA+ to AA.

“What does that mean? Before, we were a battery for the remote control, but now we're only good for a Walkman?”

If you appreciate the humour, most of the above was spawned by the Kilkenny Kilkenomics Festival.

As they say, it must be bad when economics becomes interesting, although economics is far too important to be left to the economists!

 

Taxes explained in the bar

I received an email with this great story which you may have seen but, just in case, is worth sharing here.

How do taxes work?

Suppose that once a week, ten men go out for beer and the bill for all ten comes to £100.

If they paid their bill the way we pay our taxes, it would go something like this..

The first four men (the poorest) would pay nothing.

The fifth would pay £1.

The sixth would pay £3.

The seventh would pay £7.

The eighth would pay £12.

The ninth would pay £18.

And the tenth man (the richest) would pay £59.

So, that's what they decided to do.

The ten men drank in the bar every week and seemed quite happy with the arrangement until, one day, the owner caused them a little problem. "Since you are all such good customers," he said, "I'm going to reduce the cost of your weekly beer by £20." Drinks for the ten men would now cost just £80.

The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still drink for free but what about the other six men? The paying customers? How could they divide the £20 windfall so that everyone would get his fair share? They realized that £20 divided by six is £3.33 but if they subtracted that from everybody's share then not only would the first four men still be drinking for free but the fifth and sixth man would each end up being paid to drink his beer.

So, the bar owner suggested that it would be fairer to reduce each man's bill by a higher percentage. They decided to follow the principle of the tax system they had been using and he proceeded to work out the amounts he suggested that each should now pay.

And so, the fifth man, like the first four, now paid nothing (a100% saving).

The sixth man now paid £2 instead of £3 (a 33% saving).

The seventh man now paid £5 instead of £7 (a 28% saving).

The eighth man now paid £9 instead of £12 (a 25% saving).

The ninth man now paid £14 instead of £18 (a 22% saving).

And the tenth man now paid £49 instead of £59 (a 16% saving).

Each of the last six was better off than before with the first four continuing to drink for free.

But, once outside the bar, the men began to compare their savings. "I only got £1 out of the £20 saving," declared the sixth man. He pointed to the tenth man, "but he got £10!"

"Yeah, that's right," exclaimed the fifth man. "I only saved a £1 too. It's unfair that he got ten times more benefit than me!"

"That's true!" shouted the seventh man. "Why should he get £10 back, when I only got £2? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison, "we didn't get anything at all. This new tax system exploits the poor!" The nine men surrounded the tenth and beat him up.

The next week the tenth man didn't show up for drinks, so the nine sat down and had their beers without him. But when it came time to pay the bill, they discovered something important - they didn't have enough money between all of them to pay for even half of the bill!

And that is how our tax system works.

The people who already pay the highest taxes will naturally get the most benefit from a tax reduction.

Tax them too much, attack them for being wealthy and they just might not show up anymore.

In fact, they might start drinking overseas, where the atmosphere is somewhat friendlier.

... maybe we should remember this when we talk about punishing investment bankers for getting big bonuses*?

 

 

* oh, forgot to mention, most investment bankers are paid via Cayman Islands and Monaco, so no taxes paid**

 

** oh, forgot to add, that most other investment bankers are non-domiciled in the UK of course, so no taxes paid

 

The Long Blog about the Long Now

Much of last week was focused on the Long Now and Long Finance for me.

Working with a group of thought leaders that included Venessa Miemis, Thierry Touchais, John Hagel, Stefan Nusser, Michael Mainelli, Paul Saffo, Bruce Davis, Brett King, Nova Spivack and more, we debated big topic items all week.

And yes, there were some conclusions too, so here’s the Long Blog Entry on the Long Now and Long Finance at SIBOS 2010.

First, it’s difficult to get the concept across and make it meaningful. Someone said to me: “What are you doing this week?” and I replied: “Building the concepts for a banking system that will last for 100 years.” They snorted dismissively and said: “Who cares about 100 years, I’m just interested in the next 100 days”.

As a result of this comment, the week taught me about why the Long Now is important, as it is totally concerned with what we leave our children.

When we think in business, we think short. Usually the next month or quarter.

If you are in charge of strategy, then maybe you think about the next year or two.

If you’re really lucky you get to think about the very long-term, especially if you are in charge of grand schemes like building, construction, oil or the environment.

Even then you are thinking long-term about how to make money rather than long-term about legacy.

What legacy are you going to leave your children?

Your wealth? Your savings? Your house? Your memories?

Does it matter?

Well, it’s only when you think about your children, their children and their grandchildren that you start to personally think Long.

The Long Now asks: what is your footprint going to be on this planet?

Many of us might not be that bothered about the footprint we leave on this planet as we just want to exist and enjoy the Now, not the Long Now.

Luckily, a few folks think differently, and I’ve blogged already about those thinkers who created Pyramids and Cathedrals.

Second, the Long Now is important for more than just a few bricks and buildings. Think about the current construct of our world? Our world is made up of forces that shape decades and centuries through decisions made today.

• If Alan Greenspan had left office in 2000, would there still have been a financial crisis?
• Where would Africa be today if there hadn’t been a Live Aid?
• Would the world be different if JFK had lived?
• What would have happened if Neville Chamberlain hadn’t signed a piece of paper with Adolf Hitler?

All of these decisions and moments in time shape the future. That’s why the Long Now is really important.

We are shaping the next decades today as we reconstruct our financial system from its meltdown.

• How do you want to shape this?
• How should it work?
• What happens if we rebuild it and it only lasts till 2020?
• Could the world survive another economic shock of this size and nature so soon?

These are the fundamentals with which the Long Now grapples, so sure, focus on 100 days and let’s just screw the children, the planet and our futures.

Third, Thierry Touchais gave a fantastic insight into Long Now thinking as he talked about the environment in the future.

Climate Change brings our world into sharp focus because we all now accept that this is important.

If you think you don’t believe climate change is important, do you recycle?

Do you think about carbon credits?

Do you fly as cheaply as possible, or do you accept there should be a carbon tax on your flights?

Finally, Paul Saffo finished our week with a view that again brought into focus the sharp reality of the Long Now.

He outlined the legal perspective, and said that rules and regulations were political fashion statements made to last a term in office.

Directives and legislation were structures made of cement, but that would only live for decades and not centuries.

What is really important is to focus upon the bedrocks of the system: the Magna Carta, the Constitution, the Napoleonic Code.

These are the Schema that rule our legal view of the world and, if these are shaken, our bedrocks of trust are shaken.

And here’s the rub: the longer the system lasts, the more we trust it works.

If the system changed every year, you would trust nothing and no-one.

This is why Facebook is not a trusted global currency: they are too young and fragile.

PayPal can create a global currency: but it’s not proven for the long-term. It is still not wholly trusted as a global conduit.

Banks can offer global commerce and trading finance: it is trusted because banks have been around doing this for over five centuries (the oldest bank in the world still surviving is Monte dei Paschi di Sienna, established in 1472 and still going today).

But has that bedrock trust been shaken?

If Facebook is the political fashion statement, and PayPal is the regulatory directive, have the banks that are the Constitution of the financial system cracked?

That is the question we were really grappling with last week: Do we need a new Magna Carta, Constitution, Napoleonic Code for the Financial Markets?

Is this what the authorities are creating right now anyway?

And no, we did not get an answer.

But what we did get was some illumination and, between the dialogue, some progress towards a view regarding what would ensure a robust financial market for the next century?

SWIFT, Long Finance, the Financial Services Club, IBM and others have determined to continue this work, and it will be interesting to see where it takes us.

In the meantime, we had several blogs produced, two videos and numerous white boards full of ideas, so here are a few of the other contributions.

Blogs from other attendees at the Long Now SIBOS sessions:

• Bruce Davis: A magna carta for money?: reflections on a week of talking about 'the long now'
• Brett King: What innovations will rock our world in the next 25 years?

The summary video (3 minutes 30 seconds), produced for Paul Saffo’s closing plenary.

This was a combination of the trailer of Sean Park's and Motherlode's "Financial Reformation" video and the "Future of Money" video produced by Venessa Miemis (Emergent by Design) and Gabriel Shalom.

The full videos are also worth watching individually.

The Financial Reformation by Sean Park (4 minutes)

Video on the Future of Money by Venessa Miemis and Gabriel Shalom (7 minutes 32 seconds)

The Future of Money from KS12 on Vimeo.

Full details: Web Premiere of Future of Money video; Now where do we go from here? 

Throughout the week, the guys from the ValueWeb provided scribing and visioning through their white board mindmap illustrations.  Here's a small selection of just a few.

The six big questions I raised and blogged about before the show:

"Trust" in banks and the creation of virtual currencies were a continual source of debate, especially Facebook credits.

Then PayPal announced a partnership with Facebook to do just that.

By the end of Day One, we had lots of themes and the challenge was how to put these into practice.  As a result, we asked team members to work on stories on Day Two about how to describe the Long Now.

And there were lots of good ideas.

Equally, we studied Long Now from many angles: political, economic, social, technological, environmental and legal.  I've mentioned the last two above in the text, but here's the picture of the social and technological views:

And finally, if you're really into the Long Now and Long Finance, here's my own 50-page summary from all the blog entries to date:  Download Long Now (PDF, 250Kb).

 

Why a double dip appears more likely

Everyone wants to avoid double-dips and market issues, we want to talk up the economy and feel good, we want our glasses half-full and capital secure. And after this week’s bank results, you could be forgiven for thinking everything was back to normal:

• Lloyds Banking Posts First Profit Since HBOS Purchase...
  

• Standard Chartered reports a 10% rise in first-half profit, helped by a reduction in impairment provisions ..
  

• The UK's biggest bank HSBC reports pre-tax profits of $11.1bn (£7bn) for the first six months of 2010.
  

• Quarterly profits at Société Générale more than triple after an "excellent performance" in its retail bank.
  

• French bank BNP Paribas sees its second-quarter profit grow, thanks to gains in its retail banking division.
  

Even state-owned bank Northern Rock reports a return to profit during the first half of the year.

Then we have all of these new bank start ups including Metro, Virgin and Tesco, along with Santander becoming one of the largest banks in Britain as they take over the branches RBS have had to sell.

So things are all good aren’t they?

Yea ... but maybe no.

You see, I’ve got a little bit of worry as we read the signs in the tea-leaves of economists and financiers. Those signs make it sound like times ahead aren’t quite so good.

First, most of the profits have been delivered as a result of the 2010 losses on debts being lower than anticipated.  In other words, 2009's losses due to reserving capital to cover 2010's bad debts have not been realised.  That won't happen again.

Second, we had the leader of the world’s markets – the Federal Reserve and Ben Bernanke – saying that times are too uncertain to withdraw fiscal stimulus.  In fact, Bernanke is seriously worried about life as house prices are still tanking whilst unemployment insurance claims are still rising.

He claimed that things should get better as consumer spending would turn things around.

I don’t think so.

A day after Ben Bernanke said rising wages would likely spur household spending, a range of very weak American economic reports paint an entirely different picture.

In fact, the question everyone is now asking is whether the USA can handle a lost decade of deflation, like Japan did during the 2000’s.

Mmmm ... I don’t like that.

That’s why Mervyn King was so dour the other week, saying that “the wider economic problems around the world underline the fact that we cannot be confident that the recovery in demand, output and employment here in the UK will be sustained.”

Why’s he so worried?

I guess because if the USA takes a dive, what does that mean for Europe?

Which brings me to my third point.

Europe is still suffering from stress. The stress tests may have distressed the situation for a while, but the underlying stress is still there.

The PIIGS are still an issue and their debt and sub-AAA grading are still a problem.

This is why so many are saying Europe still has a problem. Here’s just a couple of comments that show the flavour of things:

“It is getting very, very difficult for us to make a forecast about where we'll end up at the end of this year. There clearly has been a substantial decline in confidence. Europe is making people nervous.” Nicholas Moore, Chief Executive, Macquarie

“We've got a coalition government in the UK (that) may or may not hang together. We've got Angela Merkel in Germany doing the right things but under a lot of heat from a lot of people because they don't like what she's doing, so I mean, I think that there is a lot of uncertainty around.” Tim Pistell, Chief Financial Officer, Parker-Hannifin Corp

Then I sit down with regulators and policymakers here in London and they’re worried.

You see, their real worries start with the government’s policies of reducing spend and increasing taxation.

Sure, the rise in VAT from 17.5% to 20% will have an impact of increasing inflation in the short-term, but come 2011, the austerity measures will begin to bite and, in 2012, will really hurt.

Although George Osborne defends his budget, the idea that we can cut to growth just doesn’t stack up.

How can you take out £6 billion a year from the public services and expect the economy to grow?

And if you want any proof of the wheels coming off that trolley, just look at last night’s Evening Standard:

“Research today from the Chartered Institute of Purchasing and Supply showed the dominant services sector — which includes hotels, restaurants, estate agents and stockbrokers — grew at its weakest pace for a year in July.”

You may think exports may save us, but it’s no better in our major export markets – Europe – as Europe is also following the austerity route of cutting for growth. That’s bad news as, bearing in mind that the UK exports less to the BRIC economies combined than it does to just Ireland, this means we won’t see growth through balance of trade.

Maybe that’s why some say this means buy dollars.

Not sure about that myself, as Macquarie’s CEO Nicholas Moore went on to say that the USA makes him nervous. It should. From the latest publication of the American:

“Europe’s PIIGs are in a poke, but U.S. states and municipalities risk their own sovereign debt crisis, with a huge liquidity risk from short-term debt. According to the Federal Reserve, at the end of the first quarter of 2010, state and local governments had $2.8 trillion in outstanding debt.”

No wonder Business Week leads this week with the front page headline “The New Abnormal”: “Americans are broke and depressed—and also swilling $3 lattes and waiting in line for iPhones. Welcome to the schizophrenic economy.”

Finally, the banks tell me that 2011 and 2012 will be challenging because the government and central bank’s policy of fiscal stimulus and quantitative easing has come to an end.

Now I blogged in April about the UK bank’s trillion dollar maturing debt mountain.

Since then, the Bank of England has produced an updated financial stability report with several telling charts. Here’s Chart 9 that outlines Bank refinancing requirements internationally:

And Chart 4.16 that shows the maturing debt mountain updated:

Now you could remove the Residential Mortgage Backed Securities (RMBS), according to some (see discussions at end of last blog item), but everyone believes the cost of refinancing UK bank debt is going to be an issue.

“Morgan Stanley says UK banks have to refinance £450bn of funding across 2011 and 2012. To do so, the Bank of England believes, this means raising £25bn a month – a historic high. As the markets are not as open as they once were, the funds will be expensive. The Bank estimates refinancing will cost the industry as much as £10bn above current costs. The crisis is twice as severe for UK banks, particularly Lloyds and RBS.”

So you have a storm of issues still to come: American stagnation and then deflation; European contraction, spending cuts and depression; the end of financial stimulus and access to central bank generated liquidity; and the possibility that all of this leads to consumer and business contraction.

For example, in Lloyds Banking Group’s results yesterday, CEO Eric Daniels noted that customers had been repaying loans faster than it was able to grant them, as its overall loans and advances to customers fell to £612bn from £627bn the same time last year.

The trouble there is that if you add in a business investment contraction and consumer spending downturn, then everything moves towards a double dip in 2011.

Mmmm ... best tip: move to Hong Kong.

p.s. found these great charts from Reuters whilst researching this ...

EU Banks' First Half 2010 Profits

EU Banks' Market Capitalisation

 

EU Banks' Tier 1 Risk-Adjusted Capital Ratio

 

 

Stressed? Don't worry. The French and Germans will sort it out ...

I will not spend much more time on this, but was irritated by the CEBS stress tests last week and so one more quick note.

The reason CEBS, the European Commission and European Central Bank gave for not including the scenario of a sovereign default in the stress tests is that they just don’t think it’s going to happen.

“It is not possible”, they said.

“Why”, we asked.

“Because it is just incredibly unlikely and, even if anything did start to fragment in the fissures of finance in Greece or Spain, we have the European Financial Stability Fund (EFSF) to solve it”, they replied.

Now that’s an interesting statement ... because it is also a fuddle.

The EFSF is a €440 billion fund designed to cover any sovereign debt crisis in Europe in the future.

Therefore, the concept of a bank being exposed to huge losses from Greece and Spain is no longer an issue.

That is the logic.

And it’s quite good.

But it’s already been shot to pieces.

Ken Wattret, a market analyst with BNP Paribas, performed a really interesting analysis of the EFSF and issued a note in July that provides a clear Q&A overview. The analysis is available through their website (large pdf, see page 10) and a public version was summarised nicely by Financial News.

Here’s my summary of Ken’s research note:

The EFSF is a limited liability company based in Luxembourg announced in May as a measure to “preserve financial stability in Europe”. Its CEO is Klaus Regling, a former senior German Finance Ministry official who worked on the preparations for EMU and who has also worked at the IMF.

The purpose of the EFSF, according to its terms of reference, is “to collect funds and provide loans in conjunction with the IMF to cover the financing needs of Eurozone member states in difficulty, subject to strict conditionality”.

According to the Framework Agreement, the EFSF will finance the provision of loans via the issuance of “bonds, notes, commercial paper, debt securities or other financing arrangements” which will be backed by unconditional and irrevocable guarantees from those member states which participate.

Only the member states of the Eurozone participate in the scheme, providing guarantees up to a total of €440bn on a pro-rata basis.

If a Eurozone member state seeks assistance from the EFSF, they must initially agree a Memorandum of Understanding (MoU) with the European Commission, in liaison with the IMF and the ECB. This MoU will set out the budgetary and economic policy conditions which the Eurozone member state must comply with in order to receive financial assistance.

The detailed terms and conditions would then be set out in a Loan Facility Agreement which is subject to the agreement of all the guarantors (i.e. those countries in the EFSF).

The EFSF will enter into force when five or more member states, comprising at least two-thirds of the total guarantees, have confirmed that they have concluded the necessary procedures under their national legislation. It will last for almost three years, with the guarantees applying to loans made on or before 30 June 2013.

Now then, what Mr. Wattret did next is the most intriguing part. He produced this chart (double click to see larger image):

Column C3 is the one that interests me, for it shows that Germany and France contribute almost half of all of the ECB’s capital for this scheme, whilst the PIIGS – Portugal, Italy, Ireland, Greece and Spain – contribute almost 35% of the scheme, with Italy and Spain representing 30%.

Greece does not contribute anything to the scheme at this time for obvious reasons.

So what the ECB are saying is that the $1 trillion exposure of European banks to the sovereign debt of just Greece and Spain, as discussed yesterday, can be covered by the €440 billion available in an emergency through this scheme.

But let’s take this a step further.

Spain gets into distress and has to leave the scheme.

That removes a further 12% of the scheme’s funding.

In fact, if Ken had continued his percentages and logic across columns C6 and C7, then the new figures look like this:

In other words, should Spain have issues, the burden on France and Germany increases by a further 7% of the fund – or an additional €7.5 billion to bring their number to a total of €250 billion between them.

This is what prompted me to ask at the end of the CEBS press conference: “so what you’re really saying is that you didn’t use the scenario of a sovereign default because you believe French and German citizens will be happy to bailout Spain like they did with Greece?”

That didn’t go down well but it had to be asked and, no matter how unlikely it is for this to occur, it is the reality of the situation.

Stress tests useful or misleading?

Having spent much of the weekend absorbing the European bank stress test results, I’ve got to ask why they bothered.

OK, so it was to get bank share prices up, but the whole thing was just a typical European sham where every country does things in a different way, with the whole thing designed to cover up the real weaknesses in the European banking system.

Bearing in mind that the stress tests were called to shore up confidence in the system due to the concerns in the markets over a sovereign default in Greece or Spain, the fact that the tests left out that particular scenario is ridiculous.

In case you didn’t catch it, the tests looked at a double dip recession and a sovereign debt shock, but purely based upon debt that banks were trading, not debt that banks had in their vaults. 

Now I blogged a while back about the fact that Europe’s banks held over $1 trillion in debt to just Greece and Spain (double click picture to enlarge):

With sovereign debt trading on the bank's books worth about a tenth of their total exposure, that means that around $900 billion of potential sovereign debt has been ignored.  How this can be ignored is beyond me.

Secondly, the tests ignore any liquidity risk issues, and just looked at market and credit risks. Why?

This crisis started with liquidity risk when interbank lending dried up, and then exploded when sovereign debt became a major concern. The fact that CEBS left out these two clearly important dimensions just seems silly.

But then it is purely a politically motivated exercise to try to stop the haemorrhaging of confidence in the European system.

Now, I actually went to the press briefing on Friday night – a time chosen to ensure that markets could not react immediately to this sham – and saw the baying hounds of the media looking totally incredulous as the headlines were announced.

“We have seven bank failures that, between them, in the most adverse scenario would need €3.5 billion of new capital.”

I’m sorry, but that’s nuts.

When the Americans did their stress tests, half their banks failed and they needed $75 billion of new capital. So how come, in the worst of situations, our banks would only need €3.5 billion and fewer than 10% fail?

Because it’s a fix.

It’s fixed because each country interpreted the stress test conditions for unemployment and house prices and other economic conditions in their own way.

It's fixed because each regulator and central bank applied the test conditions against their bank's balance sheets in dfferent ways.

And it’s fixed by leaving out the sovereign debt exposures and potential defaults on the bank’s books.

Nevertheless, something useful did come out of it: data.

There's lots of data about the state of the bank's balance sheets released by CEBS that can now be analysed by the markets, rather than the fudge that the regulators applied.

Therefore, with the reservations stated above, I went through the numbers over the weekend and found an interesting result.

First, a little explanation of the numbers.

The tests are based upon three scenarios.

Scenario 1 is the benchmark, which is based upon the current ECB forecasts for macroeconomic developments across the European Union.

Scenario 2 is then based upon a double dip recession, which sees no growth in 2010 and a 0.4% downturn in GDP in the European Union in 2011, versus 1% in 2010 and 1.7% forecasted in the benchmark.

Scenario 3 studies the impact of a sovereign debt shock to the European Union on top of this recession, and is geared towards higher debt losses and impairments in the PIGS – Portugal, Ireland, Italy, Greece and Spain – than in other countries.

This does not assume a sovereign default, just corporate debt and sovereign debt on the trading books of the banks. That’s about 10% of the total exposure for the banks, should a country default.

In the CEBS tests, they looked at Tier 1 Capital Ratio – not core capital, just Tier 1 capital – and said that the ratio should not fall under 6%. Under the EU Capital Requirements Directive, as it stands uncorrected since this crisis hit, the lowest level by law is 4%. Meanwhile, the likelihood is that a minimum 8% Tier 1 Capital will be required in the future and, in this context, is a far better ratio to apply.

For example, based upon the CEBS view of the world, using the combined worst case of a double dip recession and a sovereign debt shock, they find seven banks would fall under the 6% Tier 1 Capital Ratio level: five in Spain, one in Germany and one in Greece.

Looking at the numbers using an 8% Tier 1 Capital Levels - a level that is rumoured to be required under revised terms for EU bank trading in the future - 39 banks would fail in the worst case scenario: one in Austria, one in Cyprus, five in Germany, three in Greece, two in Ireland, four in Italy, one in Portugal, one in Slovenia and twenty one in Spain.

Figure 1: 8% Tier 1 Capital Measures Failed by 39 Banks (double click image to enlarge)

Figure 2: Banks that Pass the 8% test (double click image to enlarge)

That would have been a far more realistic number to have announced and, based upon the fragmented application and interpretation of the tests by member states, is probably more likely to be the worst case scenario than the seven bank fails CEBS announced last Friday.

NOTE: failure does not means the banks are insolvent just undercapitalised, and so this would have been a much better way for CEBS, the ECB and the European Commission to have achieved some credibility from this exercise.

Skinner Says Stress Test Methods 'Pretty Weak' - Washington Post

Bloomberg appearance, 26th July 2010 from Chris Skinner on Vimeo.

Meanwhile, if you’re interested, here are the CEBS documents related to the stress tests:

• CEBS Press release (pdf)
• Summary report (pdf)
• Q & As (pdf)
• Joint Press Release CEBS, ECB, European Commission (pdf)
• Summary of the 91 bank-by-bank results, by country (pdf 5MB)

And a few of the more interesting tidbits that I picked up when looking at the background to these tests:

“According to a survey by Goldman Sachs, 10 of the 91 banks subjected to the stress tests are expected to fail. The poll of 376 respondents, shows that European banks are expected on average to raise £40.6bn in extra capital following the tests.” Money Marketing

“Hypo Real Estate’s Tier 1 capital ratio was 7.7 percent at the end of March, according to a presentation on its website dated June 2010. The lender said in May that it holds 72.1 billion euros ($93.4 billion) of debt in Greece, Italy and Spain, among the highest held by a bank in Europe, according to data compiled by Bloomberg ... Germany’s Soffin bank-rescue fund had provided Hypo Real Estate with 7.87 billion euros in funds by the end of March. The bank has said it may require a total of 10 billion euros from the fund. The lender said on July 8 that it received approval to establish a so-called bad bank to transfer as much as 210 billion euros of investments consisting of ‘non-strategic assets and risk positions.’ The amount represents more than half of Hypo Real Estate’s total assets at the end of 2009.”  Bloomberg

“According to CEBS, the other German lenders tested are Deutsche Bank AG, Commerzbank AG, Deutsche Postbank AG, Landesbank Baden-Wuerttemberg, Bayerische Landesbank, Norddeutsche Landesbank Girozentrale, WestLB AG, HSH Nordbank AG, Landesbank Hessen-Thueringen Girozentrale, Landesbank Berlin AG, DZ Bank AG, WGZ Bank AG and DekaBank Deutsche Girozentrale ... Among the banks on the list above, we note that e.g. Commerzbank has leverage of roughly 150:1 (tangible assets divided by tangible common equity), Landesbank Berlin has leverage of 75:1, WestLB 68:1 and Deutsche Bank 56:1. For the sake of comparison, by the time of its demise, Lehman Brothers is said to have been leveraged about 30:1. How can any of these banks not be de facto insolvent? If they hold any PIIGS bonds at all (and some of them do, in spades – e.g. 468% of Commerzbank's tangible book value was invested in PIIGS bonds as of about six weeks ago), it is a near mathematical certainty that they are.” Pater Tenebrarum

Why banks have no competition

I had a couple of really interesting dialogues with bankers yesterday.

The first was with a career banker who is now working with one of the New Banks on its launch. The second was with an Asian bank manager running his bank's UK operations.

As I talked with both, they expressed their frustrations with the UK regulatory system, the FSA, licensing and operations.

Here’s roughly how the commentary went.

The Government, Treasury, Bank of England and the FSA are all publicly stating that they want more competition in banking. They seek to actively encourage new entrants, according to their press, but then they do their darndest to ensure no-one can compete.

In particular, it’s the FSA’s stringent rules that create inordinate hurdles to getting approvals to open and operate in the UK.  These controls are needed, as loose control is what caused the crisis, but how much of a barrier such controls create to new entrants is a question we should also be asking.

For example, in order to get a banking licence you must first assemble a group of people of whom the FSA approve. Getting that approval can be hard.

First, you have to ask for approval for all key staff. That can be a lengthy process and is restricted to approval by the FSA for the individual to perform one or more strictly 'controlled functions' on behalf of an authorised firm.

These controlled functions relate “to the carrying on of a regulated activity by a firm”, which means that each time you change roles or add activities you need to be vetted again.

And that vetting is not just for one person, but for each member of the bank’s senior management from non-executive directors and executive directors, through Chief Executive and key functional heads of compliance, risk and audit.

For a new bank, that can be a phenomenally time consuming process but it is needed to ensure integrity and appropriateness (what happened when they vetted Andy Hornby, Adam Applegarth, Fred Goodwin ...).

Thing is, if you’re engaged in a controlled activity and not approved then the individual can be fined and possibly jailed, and their firm’s license rescinded.

This means that each time a person changes role or function, they need to be re-approved.

As you would expect, management of the bank’s processes, procedures and people to ensure compliance is a full time job and can be hard for an existing bank.

For a new bank or foreign bank, it can be near impossible.

For example, one of the individual’s selected for a senior role with one of the new bank entrants was a mighty talented chap ... from an Icelandic Bank. Once those banks found their assets thawing, the FSA immediately gave them the cold shoulder and the talented individual was shown the exit door before he’d even been hired.

In another case, the foreign bank operating in Britain tells me they have just appointed a new CEO. The CEO’s appointment was notified to the FSA in April but, due to the vetting process, he’s still not able to take up his key role and the bank is therefore headless ... they hope he can take his position in August.

Even with that, as a foreign bank they have to comply with FSA rules and with UK Home Office rules. These state that when a foreign bank employee changes their job title, they cannot have their business cards changed to reflect their new role until a work permit is issued reflecting the new title. That can also take months.

Phew.

This stuff is hard and it is getting harder, as the FSA are getting increasingly aggressive on enforcement and increasingly stringent on their criteria for approval.

But let’s say that you can be bothered gathering a group of competent and capable people who get FSA approval: is that it?

Nope.

You then need your banking licence.

That’s tough too.

Here’s how tough that is, as articulated by a compliance consulting firm:

“Applying for a UK banking license is a complex process. You will need to complete a comprehensive set of application forms and provide the regulator (the Financial Services Authority) with a full set of supporting documents such as your business plan, risk management policy statements, compliance manuals and procedures and other information.

“You will need to show the regulator that you have a clear and workable business plan. You will need to evaluate your capital requirements and to demonstrate that sufficient capital is in place.

“Applying for a banking license is officially known as a ‘Complex Application’, and is unlike the vast majority of Financial Services License applications.”

Jeez.

It’s so darned complex that you have to hire a consultancy to advise you how to do it.

For some banks, it's too much and they give up.  For others, it takes them about three years of administration and form filling to get to the start line.

Meanwhile, you may think you can short circuit all of this by buying an existing bank.

That's what I thought when I heard that JC Flowers is trying to acquire Kent Reliance or that Virgin buys Church House Trust.

Nope.

Y’see getting the people approved and gaining a licence has no relationship with your ability to conduct business.

That’s a separate matter.

By way of illustration, I thought that the likes of JC Flowers and Virgin were buying a banking licence so that they could take over the branches of RBS and Lloyds, and become a fully fledged bank with several hundred branches.

Nope.

The banking licence only provides you with a licence to take deposits and offer loans.

But the deposits and loan levels you can provide are restricted to the capital you have to cover the business from day one.

So if you have one branch supporting 10,000 customers, you must have the capital to cover the exepcted holdings of 10,000 customers; two branches, 20,000 customers; ten branches, 100,000 customers; and so on.  And you must have that capital coverage for all customer holdings before you open those branches.

This is illustrated in a recent speech by Thomas Huertas, Director for the Banking Sector with the FSA, who states that: “the only capital that really absorbs loss whilst the bank is a going concern (at least in the UK) is core Tier I capital or capital that is convertible into core Tier I capital whilst the bank remains a going concern.”

As a result, the FSA has increased the Tier 1 Capital levels a bank must reserve against its potential losses, with the rest covered by contingency capital (convertible equity).

This means a new bank must have enough capital to cover all of its projected exposures from day one ... a tough call, and one that means that even if you have a banking licence you cannot suddenly open hundreds of branches without loads of money in the bank.  And getting a return on that money will take years.

All of these challenges and issues are the reasons why we are not seeing massive new competition in banking in Britain, or anywhere else for that matter.

But then all of these rules and regulations are there to safeguard society aren't they?

So when you hear politicians saying that they want to see lots of competition in banking, it is a complete untruth.

In conclusion, and to quote Thomas Huertas again from a speech in June 2008 before the crisis:

“Regulations do not restrict competition. Entry into banking, especially in the UK, is free to anyone who can meet the threshold conditions for establishing a bank. The UK places no barriers to the ownership of banks on the basis of nationality, and under EU directives any EU-incorporated credit institution is, under the so-called passport granted to all banks under the single market, entitled to establish a branch or sell its services cross-border into the UK. This policy of free, but orderly, entry underlies not only London's position as one of the world's leading financial centres, but also contributes to competition in retail banking.”

What he actually meant was that banking is open to free competition, but only from other existing banks with banking licences from their country of operation, and with major capital assets to cover their exposures.

This is why there hasn’t been a new bank opening in Britain for over a century and the only new competition has been from existing foreign banks, such as Santander.