Bashing Bankers

TUESDAY, SEPTEMBER 23, 2008

Bashing Bankers

And he wasn't even a banker*

Now it's turned out greed maybe ain't quite so good after all, nobody is going to defend the boys and girls who've been rinsing it at the trough. And nobody can be surprised that grandstanding politicos of every complexion have been queuing up to demand Action. 

But what action exactly?

An incomes policy for bankers? A ban on bonuses? A cap?

The central casting trade union leaders speaking in Manchester are demanding it, but government ministers have taken fright. They presumably realise that with financial services accounting for nearly 10% of GDP, the City directly employing 350,000, and their post-election jobs to think of, bashing bankers right now might not be the greatest idea.

And incomes policies for bankers are most unlikely to work: bankers are far too smart/greedy to get boxed in by the kind of lumbering one-size-fits-all restrictions beloved of Whitehall.

As Tyler may have said before, back in the early 80s he joined a City merchant bank. Maggie had abolished Labour's incomes policy, but its marks were still visible. The bankers were all wedged with non-cash benefits specifically designed to get round the restrictions of incomes policy - company cars, heavily subsidised mortgages, enhanced employer pension contributions, some even had their kids' private school fees paid by the bank.

And when it comes to bonuses, the possibilities are endless: the Major's brainy friend Herr Docktor Professor Franz Kuntz has already dusted off his Super-Enhanced Kruegerrand Roll-up Fund (Cayman) for distribution to needy bankers.

No wonder the government has handed the problem to the FSA. Somehow, they will find a way of regulating bank bonuses without having an incomes policy per se.

How? New FSA Chairman Adair Turner tried to explain last night. His idea is that the FSA will review a bank's remuneration policies as part of its risk monitoring activities; if they decide employees are being incentivised to do too many risky deals, they'll impose tougher capital requirements on the bank, so there will be a cost.

Er... yeeeesss. It's one of those classic ideas that sounds OK in a vague arm waving kind of way, but hasn't a prayer of getting past the detail devil. Especially when you remember that this is the same FSA that was "asleep at the wheel" as the Crock kereered towards the cliff edge (see previous blogs for just how rubbish the FSA actually was - eg here).

Everyone now agrees that bank regulation must be tightened asap. But the need is to protect us against systemic calamity by further restricting the riskiness of the banks' balance sheets. Bashing bankers might be fun, but it's a dangerous distraction.

*Footnote - don't Wall Street's 1987 salary numbers now sound quaintly small - $200K pa for a top US executive? In recent times, a junior Wharf trader wouldn't wipe his bottom on $200K.

MONDAY, SEPTEMBER 22, 2008

Debt And Taxes... Oh, And Inflation

Charting a crisis

So once again, it's taxpayers to the rescue. The bill will be big and will have several chunky elements:

• Debt - governments are taking on a stack of debt from floundering banks; in the US the transfer is adding hundreds of billions to taxpayer debt; here in the UK we've already got the Crock's £100bn, plus whatever implicit guarantees Brown may have given Lloyds on their takeover of HBOS; there's undoubtedly more to come; and always remember - government debt is nothing more than deferred taxation.
• Borrowing - as our economies fall into recession (now inevitable), fiscal deficits will soar; serious forecasters are already suggesting the UK deficit could easily reach £100bn pa; if we returned to levels of borrowing seen in the early 90s recession - quite conceivable - borrowing will increase to around £120bn pa ; just for reference, the government's 2010-11 borrowing forecast currently stands at a ludicrously optimistic £32bn.
• Inflation - we're already up to nearly 5% and the lesson of history is that heavily indebted governments default via a good dose of inflation - savers pay; of course, as things stand, the Bank of England is meant to save us from that, and somehow get inflation back down to 2%; but with the financial markets in turmoil and a recession looming, the heat is on them to be "more flexible"; they could rationalise it on the basis of anticipating a fall in future inflation... as indeed, many commentators are already proposing.

So what to do?

Head for the hills is one option. But we suspect the hills aren't big enough to accomodate us all, so we need to find some alternatives.

And despite last week's panic, the least unattractive options still involve making the banks and their shareholders sort out the mess themselves. They did the lending, they reaped the profits, and they failed to manage the risks properly. Why should taxpayers be forced to bail them out?

The answer of course - as Hank Paulson spelled out to US legislators on Friday - is that we don't want innocent bank depositors to be wiped out, and we don't want the financial system to seize up. But if it transpires that the only way of achieving that is to bail out greedy bankers when they run out of cash, then we've lost. We might as well nationalise deposit takers, and much else besides (see this blog).

Unless we come up with some more market-based solutions pdq, the left are going to walk away with this (as you can hear quite clearly from the likes of Neal Lawson and Yvette Cooper at the Labour Conference).

What we need to do is to find a way of leaving the cost and the headache with the bankers themselves. Leave them with the problem of how to work-out their dodgy debts over the long-haul. Not only is that fairer on taxpayers, but also the bankers know far more about the issues - eg "where the bodies are buried" - than any government administrator can hope to know.

A government bulk take-over of so-called toxic debt is fraught with danger for taxpayers. First, at what price do we take the debt? Not full face value, for sure. But if not there, then where? Who sets the price? Bearing in mind of course, that one major cause of the current crisis is the feeling that many banks have not written down their debt investments nearly enough yet, for the simple and scary reasonthey don't have enough capital to recognise the full loss. If we cram them down too much, they'll have to shut up shop.

And also what happens down the line? Taxpayers don't want to be funding the debt for ever, and it would likely get resold once the current panic has subsided. But again at what price? We could well end up with the debt being resold back to the very same bankers at a knock-down price, from which they could then make afurther profit. Is that what you want?

There are some interesting alternatives being kicked around by a range of eminent economists on Martin Wolf's FT blog. One emerging theme is that instead of nationalising the toxic debt outright, we taxpayers should offer the struggling banks an equity injection. We should recapitalise them to give them a breathing space. In that way we'd leave them with the problem and cost of working out their toxic debts over time.

But wouldn't that just be pouring petrol on the flames? Wouldn't it mean we'dnever see our money back?

On the second point, it might well do: if the problem debt actually has no value, we're stuffed. But then, we're no worse off than we would be if we simply nationalised the debt, as is currently proposed.

And on the first point, our equity injection would carry some stiff conditions for the banks.

To start with, it would not be straight equity, but a form of equity loan known as preferred stock. It would eventually have to be repaid, once the current difficulties had passed.

Second, any bank joining the scheme would have to agree a realistic write-down of its problem debt: we'd insist on full disclosure so as to remove the fear that banks are not fessin' up to the full extent of their problems.

Third, our equity would rank ahead of existing shareholders, and a participating bank would be banned from paying any dividends to those shareholders until we had been fully repaid.

Fourth, we could insist that a joining bank should raise matching equity funds from its existing shareholders. They couldn't rely solely on taxpayers.

And all those bank bonuses that people are so exercised about? Should we ban them?

No. Government incomes policies have always been a disaster, and it would be in our interests to retain the talent in our banks. But we'd be shareholder activists, and we'd encourage existing shareholders to get much more involved in designing longer-term incentive schemes that rewarded the realisation of value rather than the assumption of risk.

There's a lot to think about here, and thinking in a crisis is always tough. But even after last week's drama, taxpayers should not simply get bounced into nationalising the bad debts of the banking sector. There are still alternatives.

SUNDAY, SEPTEMBER 21, 2008

Market Sharks In Formaldehyde

Art for money's sake

During a most enjoyable dinner last evening, Tyler found himself sandwiched between two market experts.

On his right was an expert in financial markets. Well, a hedge fund manager anyway.

And on his left was an expert in art markets - to wit, a professional artist.

Naturally, the discussion turned to markets. Just why did the financial markets blow up?

The hedge fund manager groaned. "Confidence shot - can't trust anyone - haven't a clue what anything's worth - can't price risk - cash is king - 1930s - God, is there anything left in that bottle?"

Well, maybe it's time to switch into sharks in formaldehyde, suggested Tyler brightly. True, nobody has a clue what they're worth either, but Damien Hirst's Sothebys sale seems to have gone spectacularly well.

"Yes, doesn't it," replied the artist. "Yes, £111m... most successful single artist sale ever! Yes, yes... amazing... absolutely amazing... althoooough..."

Although what?

"Well... it's just that there's a whisper going round that the sale wasn't all it seemed. Some of the major bidders seem to have been people associated with Damien himself... apparently more than half the opening day's successful bids came from his own dealers."

The hedge fund manager looked appalled: "What? What!! You mean he rigged the auction? I'll tell you what! If he did that in the financial markets, he'd go to jail! And they say we're the sharks! God! Is there anything left in that other bottle?"

Tyler frowned. But surely Hirst's associate bidders would have been seriously out of pocket? Wouldn't they have had to pay the auctioneers' commission? 12%?

"Yessss... well... there are all sorts of rumours about Sothebys cutting him a pretty keen deal. I mean Joan Collins went to the auction FFS! It was a media celeb fest - look at all the free publicity they got from the BBC etc. Nobody thinks the commission rates were anything like 12%."

Our hedge fund dining companion looked a tad glazed. "Assshllly. Acccssshllyyy! I've just had a brilliant idea!! If Morgan Shchtanley auctioned all its dodgy debt to Goldmans, and Goldmans auctioned all its dodgy debt to Morgan Shchtanley... hey preshto, problem solved! Everyone can shee theresh a proper market prish! A proper prish! Thish ish brilliant... why hasn't anyone... "

Unfortunately, at that point he sank below table level, so Tyler was unable to hear the rest of what seemed to be an inspired market recovery plan.

PS Our man at the Wharf has spent the week chained to his desk, and sadly seems to have contracted another bout of Nile Shorting Fever gravissimus. But during a brief moment of lucidity earlier today, he urged us to switch the entire family fortune into UltraShort Financials ProShares. Shorting financial stocks is now illegal, but this is a highly leveraged fund that seeks to generate twice the inversedaily performance of the Dow Jones U.S. Financials Index. You know it makes sense.