Showing posts from June, 2011

Asking the wrong question

Today on BBC Radio 4, Francis Maude made the mistake of discussing the "affordability" of public sector pensions with the formidable Mark Serwotka. He lost the argument - massively - and various left-wing publications have been making political capital out of it ever since.

He should never have got into the argument at all.  Of course public sector pensions are affordable. Any public sector expenditure of any kind is always affordable in a sovereign country that issues its own currency and its own debt, and whose debt and currency are freely traded on international markets (pace the Modern Monetary Theory folk, I'm not going down the "debt is an illusion" route in this post!). 

The question should be, of course - do we WANT to spend the amount on public sector pensions that will be required to maintain them in their present form?

Public sector workers say "of course we do".  Generous pensions are a part of their pay package. They are being asked to …

The hole in the fence

It looks as if Osborne's decision to jump the gun and ringfence UK retail banking ahead of formal release of the Independent Commission on Banking may have been a good call. Not because ringfencing retail resolves the issues with UK banking - I stand by my remarks in my previous post- but because it protects high street banking from possible catastrophic losses arising from the European debt crisis.

The thinking seems to be that if the savings and borrowings of ordinary British people are protected, then investment banking - which everyone knows is the rich people's gambling den, isn't it - can be allowed to fail. And there is some merit in this view. Protecting ordinary British people from the consequences of profligate lending and spending by banks and countries alike in the Eurozone is an appropriate action for the UK government to take.

The trouble is, it's wrong. We are no longer in the banking of the 1950s, when ordinary people had their life savings in high str…

Papering over the rot

A few years ago, I planted two young apple trees. I cut each sapling down to two feet, to encourage it to branch out, and encased each growing point in a plastic bag to protect it from beasties that would devour its new young leaves. And then I waited for them to grow.

One grew quickly, and soon pushed lovely young leaves against the plastic bag. But the other didn't. Mystified, I removed the plastic bag. Inside was a denuded shoot and a VERY fat caterpillar. 

I had ringfenced my apple tree to protect it and allow it to grow unmolested...but inside the ringfence was the very creature I was trying to protect it against.

Fortunately I was able to remove the caterpillar and the apple tree is now flourishing.  But of course I am not really writing about apple trees....

Today, George Osborne announced measures to force UK banks to ringfence their retail operations in separate legal entities. The aim is to protect retail depositors from possible losses arising from failures in investm…

Reserve confusion

I have been puzzled for some time by the loose use of the term "reserves" when talking about banking. I hear people talking about the deposit multiplier (which itself is a myth, see my post To Lend or Not To Lend) as if the deposits taken from retail customers form part of the capital against which banks - supposedly - lend. Er, no, they don't. They form part of the CASH reserves that banks hold to support settlement of lending. Bank capital has a totally different composition.

Let me explain.

Cash reserves are the MONEY the bank has available in its cash reserve account at the Bank of England at the end of each day.  They are intended to cover the expected physical cash drawings of loans and deposits over the next day. In practice most retail banks don't have sufficient cash from deposits to cover drawings for the next day, so they borrow the money either from other banks (usually investment banks) through the interbank lending market or directly from the Bank of Eng…

To lend or not to lend?

A couple of days ago I wrote a post showing how higher reserve requirements increased the cost of borrowing and depressed interest rates on savings.  Today, Tim Worstall came out with a similar argument in his blog.  However, he lost the plot when he started talking about the money supply and the way in which bank lending contributes to its expansion.  That's because he seems to believe that bank lending decisions are driven by the availability of reserves - this is known as the money multiplier theory.  Nothing could be further from the reality.

Any bank credit controller will tell you that availability of reserves doesn't come into the equation when lending decisions are being made.  Customer credit scoring, relationship with bank, credibility, affordability, provision of collateral or guarantees - yes, all of those are considered in depth.  But whether the bank has sufficient reserves to support that lending? Nah.

Bank lending decisions are driven ENTIRELY by commercial con…

Free market fairy tale

The other day, I had a debate with various people on Twitter as to whether there was any such thing as a free market.  I think we agreed to disagree, and personally I still question whether a really free market can exist at all in an advanced economy. But one thing we do agree on is that the banking "market" is anything but free.

Yesterday I wrote a post pointing out that the banks actually set saving and borrowing interest rates according to market demands and the needs of their business, not according to the base rate - despite what people think and the media say.  And I identified the real cause of the increased spread between borrowing and savings rates as being the introduction of higher capital and liquidity requirements to make banks "safer".  Safety comes at a price, and that price is less lending, higher rates to borrowers and lower rates to savers.

Having capital requirements for banks at all is direct government interference in the market, which creates …

Feckless spenders, prudent savers and the Bank of England

There is a myth going around that the low Bank of England base rate (currently 0.5%) benefits "feckless spenders" at the expense of "prudent savers".  Quite apart from the value judgements inherent in those labels, this is completely untrue and very unfair to both the Bank of England and borrowers.  Yes, savers are getting a raw deal at the moment. But that's not because of anything the Bank of England has done.  It's all to do with the commercial banks.

Interest rates to many unsecured borrowers are currently sky-high, having rocketed since the financial crisis. Typically these are people who are struggling a bit - they are maintaining their minimum payments and maybe a bit more, but they have a lot of debt and rarely pay off anything completely, so they are regarded as high risk and therefore hit with high rates. Interest rates for more creditworthy individuals are much lower, but that is because they are seen as a less risky proposition and therefore a g…

What NOT to do with a corporate surplus

Yesterday I issued a blogpost asking why the Government wants to cut corporation taxes when businesses are sitting on historically large financial surpluses that they are not investing in equipment or people, or even paying out as increased dividends to shareholders.

I wonder sometimes if people actually read what I say. One comment on the blog gave me the standard reasons for cutting corporation tax:

"Cutting the rate of corporation tax reduces the pre-tax rate of return required and so more projects will generate a sufficiently high return to justify investment. Hence more capital investment, higher productivity, higher wages, more output...."

 Here is the quotation from the Bank of England's May inflation report again:

Private domestic demand growth could be boosted if more of the historically large corporate financial surpluses were spent on capital investment or transferred to households in the form of higher wages or dividend payments

In other words, businesses are…

What to do with a corporate surplus

From the Bank of England's May inflation report:

Private domestic demand growth could be boosted if more of the historically large corporate financial surpluses were spent on capital investment or transferred to households in the form of higher wages or dividends.

So corporations are running surpluses while the economy lacks capital investment and households have falling real incomes.

Why, exactly, does the Government want to cut corporation tax?

And so it begins....housing doom & gloom

In my recent post Illusions and delusions: the lure of credit and the price of debt I predicted further falls in house prices leading to negative equity and increased mortgage foreclosures as people struggle with rising prices, high debt levels and tax increases.  Today's news supports my prediction.

Morgan Stanley reports today that it expects a 10% fall in UK house prices over the next two years, which will leave Lloyds TSB (the UK's biggest mortgage lender) with a negative equity overhang of about £90bn by December 2012.

The FSA warns that banks have insufficient provisions to cover anticipated defaults on mortgages and are moving people in financial difficulties on to interest-only mortgages to avoid having to increase bad debt provisions.

Although the Bank of England's weak growth forecast does suggest that base rates won't rise much for a while, increasing risk to mortgage lenders may nevertheless lead to increases in mortgage rates.  I expect a significant rise in…