Philippe Legrain

Are banks a vested interest?

Oliver Kamm at The Times, a man I respect a lot, argues in his blog that banks are not a "vested interest".

But unless I have misunderstood him, I think he is being too charitable to the banks.

He argues that "the banks are not some unaccountable lobby seeking to superimpose itself on the public interest: they are an economic sector seeking to maximise profitability within the regulatory framework".

It's worse than that. Banks are unaccountable, since they are not allowed to fail - and capitalism without risk of failure corrupts absolutely.

They do seek to superimpose themselves on the public interest: even now, the notion that what's good for the City is good for Britain is pervasive among many senior officials.

Nor is the regulatory framework a given: it is shaped by banks' lobbying and the revolving doors of finance and politics: boardroom positions for politicians and government advisory roles for bankers - including the astonishing appointment of "Win" (or should that be "Lose"?) Bischoff, the former chairman of failed Citigroup, to co-chair the writing of a report on the future of UK international financial services.

Like Oliver, I am a supporter of open, competitive markets. That's why I find it so worrying that we have allowed a complex oligopoly that earns vast monopoly profits in the good times and passes on the losses in bad to amass such huge economic - and political - power, as I argue in my new book, Aftershock: Reshaping the World Economy After the Crisis, which is out on 6 May.

Banks are a vested interest - and a dangerous one at that. 

Greenspan: Blame everyone but me for the crisis

Money quote: “To this day it is hard to find fault with the conceptual framework of our [financial risk management] models as far as they go.”

Of course not.  

Kaletsky endorses directing Northern Rock to lend

Britain's banks aren't lending, which is strangling the economy. The package of measures to support lending to smaller businesses which the government announced yesterday will do some good. But it is not enough.

As I have argued previously, the government should direct nationalised Northern Rock to step into the breach. Anatole Kaletsky endorses this position in today's Times:

the quickest and least costly emergency response would be to reverse the policy of running down Northern Rock and Bradford & Bingley. Both these banks are now fully owned by the Government and could be turned into rapidly growing state-guaranteed lenders.

The plans to run down their lending were right in the circumstances in which they were nationalised last year, when other private banks were functioning more or less normally. But things have completely changed and it now makes sense to reverse their policy of credit contraction. Northern Rock is ideally positioned to re-expand the supply of mortgages to first-time buyers, while Bradford & Bingley could revive the flow of finance to commercial and social housing. The Government could also be much less shy about exerting its majority control over the Royal Bank of Scotland and its 40 per cent stake in Lloyds-HBOS, by far the biggest commercial and mortgage lender in the country.

Don't want our money? Don't worry, we don't want to give it to you

In recent years, Western governments have voiced concerns about Asian governments' vast sovereign wealth funds (SWFs) investing in Western companies. Some called this "investment protectionism"

But as Western banks faced collapse, they were delighted to receive capital injections from Asian SWFs - and Western governments didn't object. In a crisis, needs must.

Now, though, Asia's SWFs are having second thoughts.

China Investment Corp, the country’s sovereign wealth fund, will no longer risk investing in western financial institutions because of concerns about their viability and a lack of consistency in their governments’ policies, according to its chairman.

“Right now we don’t have the courage to invest in financial institutions because we don’t know what problems we will put ourselves into,” Lou Jiwei said.

Perhaps Western governments will realise that the only thing worse than receiving investment from Asia's sovereign-wealth funds is being denied it.

Buiter on how to make banks lend

(A) All domestic non-financial enterprises that currently have access to bank financing and whose loans, overdraft facilities, credit lines or whatever other financial arrangements expire during the coming year, have the right to an automatic one-year extension of the expiring arrangements on the same financial and non-financial terms as the expiring arrangements. This mandatory ‘creditor standstill’ helps existing borrowers by providing them with a breathing space. It does, however, do nothing for new enterprises or enterprises that are not currently borrowing.

(B) Aggregate lending targets for lending to the domestic non-financial business sector are set by the government for each bank (last year’s total plus five percent, say). The banks themselves can decide who to lend to and on what terms. Any shortfall of actual lending from the target is translated pound for pound into a Deficient Lending Tax. Since not meeting the target amounts to throwing money away, the banks will lend.

(C) Nationalise the banks (paying as little as possible to the existing shareholders), fire the existing management and board of directors, and have the government appoint a new executive and a new board that are serious about meeting lending targets. With 100 percent share ownership by the state, there is no risk of lawsuits about the executive or board of the  bank not meeting their fiduciary duty to the shareholders. Full state ownership would make transparent and formal what is already true in substance: but for the financial support of the government (past, current and promised/anticipated in the future), there would no longer be more than at most a handful of viable cross-border banks in the north-Atlantic region.

He concludes:

Things are critical. Unless the banks start lending in normal volumes very soon, this recession could indeed become another Great Depression. We cannot wait for the banks to find their juju. The government may have to take it to them.

Full post here

If UK banks won't lend, Northern Rock should

The reason why the government had to rescue Britain’s banks is not that their shareholders and executives deserve special favours, but because businesses and jobs depend on the availability of credit. There is no public interest in propping up banks that won’t lend.

For sure, banks should not be lending with reckless abandon as they did in the go-go years, but nor should they be slashing the overdrafts of solvent small businesses and jacking up the interest rates on them. If the banks refuse to lend, the government must step in. It is considering all sorts of interventions, but seems to be ignoring an obvious solution.

Political pressure on the banks has been largely ineffective so far. While Peter Mandelson, the business secretary, has said that “It’s completely unacceptable to the government and to business in this country for banks indefinitely to stop functioning as banks. We are in very intensive discussions with the banks, believe me”, jawboning alone is unlikely to succeed when banks’ priority is hoarding cash and reducing risk.

Alasdair Darling is also drafting a raft of measures to support business lending. These could include new requirements for banks to give businesses greater notice of changes in the terms and availability of credit. More ambitiously, the Chancellor is looking at ways to extend government guarantees to support new business lending.

But such is banks’ aversion to lend that the government also needs to consider bolder moves. It could insure all loans to businesses. It could lend directly to companies. And it could nationalise the banks altogether.

There is also another option that the government does not appear to be considering. It already owns a fully fledged bank: Northern Rock. Perversely, while it is urging the soon-to-be part-nationalised banks to lend more, it is busy shrinking the balance sheet of the only fully nationalised one.

That made some sense when the rest of the banking sector was private: the government did not wish a state-owned bank to undermine the private banks by competing unfairly them. But now that the whole banking sector enjoys an implicit government guarantee and the overriding priority is supporting lending to avert a depression, that objection no longer holds.

So if other banks will not lend, the government should inject a dollop of new capital into Northern Rock and direct it to make it more credit available on reasonable commercial terms. If other banks do not follow suit, Northern Rock may grow to become one of the biggest banks in Britain. But so what? It can be privatised again, no doubt at a hefty profit for taxpayers, when the crisis is over and the economy is growing again.

Addendum: Northern Rock is raising its mortgage rates today. Unbelievable.

John Kay sums up the financial crisis

Banks would normally be wary of lending to someone whose liabilities were 50 times their net assets, but they happily lent to each other on that basis – until, one day, they stopped. If you want a one sentence explanation of the present crisis, that is it.

From the FT.

This is not money for nothing

Tony Blair once said that the government was best when it was boldest. Gordon Brown is – finally – heeding that advice. The government's three-pronged plan to shore up Britain's banking system is bold and right. It is our best hope of pacifying the financial panic, getting credit flowing through the economy again and thus avoiding a 1930s-style depression.

The Bank of England's half-point cut in interest rates is also welcome, particularly since it was coordinated with other central banks. It signals that the US and Europe are finally acting together to tackle the global financial crisis. But a larger cut is needed soon: at 4.5%, UK interest rates are still far too high.

The bigger challenge is to get banks lending again – to each other, to companies and to individuals. They need enough cash to conduct their day-to-day operations; secure access to medium-term funding; and extra long-term capital to provide a cushion against bad debts and allow them to lend to creditworthy borrowers.

The government's plan addresses all three of these needs. The Bank of England will supply £200bn in short-term funding; the government will underwrite £250bn of medium-term finance; and it will also inject £25bn in long-term capital initially – and perhaps up to £50bn in total – in the form of preference shares that pay a fixed return and protect taxpayers' investment.

Headline writers may describe the government plan as a £500bn bail-out, but that is completely misleading. The £200bn consists of short-term secured loans; the £250bn is a form of insurance, for which the government will be paid a fee; and the £50bn is an investment that pays a return. This is not money for nothing.

And while it is certainly true that taxpayers' money is at risk, we will also share in the upside when the banks recover – as they are much more likely to do thanks to the government's intervention. Most importantly, the risk of doing nothing – or of continuing to do too little, too late – is far greater. If the banks went under, so would businesses and jobs. By keeping the UK banking system afloat, the government – acting on behalf of all of us – is giving the economy a life raft.

Many of the details of the government's plan are still unclear. Ideally, the preference shares should pay a hefty interest rate to properly compensate taxpayers and give banks an incentive to seek private financing if and when they can. Taxpayers' money should also come with strings attached, such as guarantees that banks will use the extra capital to lend to small businesses and individuals rather than pay extravagant dividends and unjustified bonuses. And, of course, the plan must be implemented speedily and efficiently.

We are by no means out of the woods yet. Global financial markets are in turmoil; other governments need to follow Britain's bold lead soon. The UK economy has many other weaknesses: consumers are overladen with debt, often secured against housing that remains overpriced; unemployment is rising; food and energy prices remain painfully high; and the global gloom is hardly auspicious for exporters, despite the fillip of a weaker currency. What's more, the banking rescue package will swell the government's already-large deficit – although borrowing to invest in banks need not increase the national debt in the long term. But while 2009 will no doubt be unpleasant, the government's actions should stave off economic collapse. Amid all the gloom, that is certainly good news.

Taking stock

The time for half-measures is over. Britain is no longer in the grips of a credit crunch or even a financial crisis; it is suffering a full-on financial heart attack. Markets have seized up. Banks will no longer lend to each other. Credit to companies and individuals is drying up. Unless credit starts flowing again soon, a nasty recession – conceivably even a depression – looms and with it, massive job losses, bankruptcies, repossessions and a sharp fall in living standards. The government needs to act – now.

But what to do? Ken Livingstone, Seumas Milne and others argue that the government should turn its back on market economics. Since capitalism seems to be collapsing under the weight of its internal contradictions, the government should finish it off. More measured voices such as the TUC's Brendan Barbour favour a ragbag of measures, such as a new industrial policy. But all of them are missing the point. Righting the huge problems in financial markets certainly requires decisive government intervention, but lashing out at generally well-functioning product and labour markets is perilously misplaced. The last thing a heart-attack victim needs is to have a healthy leg amputated. The priority now is tackling the financial crisis; everything else is a dangerous diversion.

But while the government should not try to turn the clock back to the 1970s, it does need to change course. Its ad hoc approach will no longer do. The nationalisations of Northern Rock and Bradford & Bingley, and the government-orchestrated rescue of HBOS, were justified at the time. But damage limitation is no longer enough – not least since Lloyds' rescue of HBOS seems to be dragging it down, too. Now Royal Bank of Scotland seems under threat; Barclays may be next in line. Waiting for the next bank to collapse and then picking up the pieces will not restore confidence or get credit flowing around the economy again.

Across Europe, governments are rushing to following Ireland's lead and guarantee (nearly) all deposits in the banking system. Here, the Treasury has just raised the guarantee on savers' deposits to £50,000. But while it may soon be forced to extend a broader guarantee, this will not tackle the root causes of the crisis: a lack of capital in the financial system and sheer panic.

A cut in interest rates would do some good. Although inflation is well above the target rate of 2%, the Bank of England should slash rates when it meets on Thursday. As the global economy tanks, oil prices are sinking, so inflation is set to fall. Collapsing demand means that the real threat now is deflation, not inflation. But a big cut in interest rates will not be enough. If banks are unwilling to lend, monetary policy alone is virtually useless – in Keynes' words, it is like "pushing on a string". Bolder measures are needed.

The US has opted for a $700bn bailout. In theory, taking bad debts off banks' books should reassure markets that that they are not about to go bust. Banks may be willing to lend to each other again, their share prices may recover somewhat, and investors – not least Asian governments and those of oil-rich states – may be willing to pump some of their huge cash reserves into them. But the bailout route is deeply flawed. It provides the most help to the banks that made the biggest mistakes. It exposes taxpayers to huge potential losses. And it does little to recapitalise the banking sector and thus encourage it to start lending again.

There is a better way. As now seems likely to happen in some form, with the chancellor's statement on Wednesday morning, the government should buy stakes in – and in some cases, take over – stricken banks, an approach that worked well in Sweden in the early 1990s. With the government standing behind banks, the fear that they are about to go bust would vanish. An injection of taxpayers' money would strengthen banks' balance sheets, allowing them to start lending again. But it would not be money for nothing: the government could acquire preference shares, which pay a hefty interest rate and put taxpayers first in line to be repaid if a bank fails. These could be combined with warrants (basically, options to buy shares at a future date at a specified price), so as to give us all a share in the profits when banks – and the economy – recover.

John Hussman, a US analyst and investor, has suggested a novel variant of this idea. He proposes that the government provide capital in the form of a "super-bond". This would be subordinate to deposits, and so could be counted as capital. But if a bank went bust, taxpayers would be repaid before shareholders and senior bondholders, thus protecting the financial system, customers and taxpayers. The super-bond could pay a relatively high interest rate to give banks an incentive to shift to private financing when conditions improve, but interest payments could be deferred until banks were profitable so as not to drain their cash reserves now.

A government recapitalisation of the banking sector – combined with much tougher financial regulation to limit future excesses – would be good politics, as well as sound economics. With Labour so far behind in the polls, its only chance of recovery depends on rescuing the economy from the worst crisis since the 1930s. Decisive action would marginalise the Conservatives, who are unconvincing advocates for state intervention in the financial system and are, in any case, powerless to act. And since even David Cameron has been forced to concede that government injections of capital may be needed, the government has political cover to act.

Gordon Brown has shown that he can be bold when circumstances demand it. Now is such a time.

       

Shouldn't HBOS now remain independent?

Allowing Lloyds TSB to take over HBOS was an act of desperation: even though the merged entity would dominate the UK banking market, the government signalled that it would approve the merger in order to stop HBOS going under.

But now that the government has stepped in with its bank recapitalisation and funding plan, wouldn't it be better to let HBOS survive as an independent bank?

Britain's bold bank rescue plan

Tony Blair once said that the government was best when it was boldest. Gordon Brown is – finally – heeding that advice. The government’s three-pronged plan to shore up Britain’s banking system is bold and right. It is our best hope of pacifying the financial panic, getting credit flowing through the economy again and thus avoiding a 1930s-style depression.

The Bank of England’s half-point cut in interest rates is also welcome, particularly since it was co-ordinated with other central banks. It signals that the US and Europe are finally acting together to tackle the global financial crisis. But a larger cut is needed soon: at 4.5%, UK interest rates are still far too high.

The bigger challenge is to get banks lending again – to each other, to companies and to individuals. They need enough cash to conduct their day-to-day operations; secure access to medium-term funding; and extra long-term capital to provide a cushion against bad debts and allow them to lend to creditworthy borrowers.

The government’s plan addresses all three of these needs. The Bank of England will supply £200 billion in short-term funding; the government will underwrite £250 billion of medium-term finance; and it will also inject £25 billion in long-term capital initially – and perhaps up to £50 billion in total – in the form of preference shares that pay a fixed return and protect taxpayers’ investment.

Headline writers may describe the government plan as a £500 billion bailout, but that is completely misleading. The £200 billion consists of short-term secured loans; the £250 billion is a form of insurance, for which the government will be paid a premium; and the £50 billion is an investment that pays a return. This is not money for nothing. And while it is certainly true that taxpayers’ money is at risk, we will also share in the upside when the banks recover – as they are much more likely to do thanks to the government’s intervention. Most importantly, the risk of doing nothing – or of continuing to do too little, too late – is far greater. By keeping the UK banking system afloat, we are giving the economy a life raft. 

Many of the details of the government’s plan are still unclear. Ideally, the preference shares should pay a hefty interest rate to properly compensate taxpayers and give banks an incentive to seek private financing if and when they can. Taxpayers’ money should also come with strings attached, such as guarantees that banks will use the extra capital to lend to small businesses and individuals rather than pay extravagant dividends and unjustified bonuses. And, of course, the plan must be implemented speedily and efficiently.

We are by no means out of the woods yet. Global financial markets are in turmoil; other governments need to follow Britain’s bold lead soon. The UK economy has many other weaknesses: consumers are overladen with debt, often secured against housing that remains overpriced; unemployment is rising; food and energy prices remain painfully high; and the global gloom is hardly auspicious for exporters, despite the fillip of a weaker currency. What’s more, the banking package will swell the government’s already-large deficit – although borrowing to invest in banks need not increase the national debt in the long term.

But while 2009 will no doubt be unpleasant, the government’s actions should stave off economic collapse. Amid all the gloom, that is certainly good news.

Better than a bank bailout

What bank investors need from authorities is clarity. A concerted, pan-European drive to inject capital might provide it. As US fund manager John Hussman has suggested, that injection could be achieved via a “super-bond”, countable as capital and subordinate to customer deposits, but ranking ahead of both shareholders and even senior bondholders in the event of bankruptcy. That super-bond would pay a high rate of interest, giving banks an incentive to switch to cheaper funding. But interest payment could be deferred until the bank hit a minimum level of profitability.

From Lex in today's FT. Read the proposal in full here.