Why we shouldn't remutualise Northern Rock

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It doesn't take them all that long you know. Once elected they soon work out how to take our money and spend it upon what they desire:

Chuka Umunna, a Labour member of the Treasury Select Committee, is heading the campaign with the support of MPs including Sir Menzies Campbell, the former leader of the Liberal Democrats; former Conservative ministers Sir Peter Bottomley and Jonathan Evans; as well as Caroline Lucas, the leader of the Green Party.

"I think it would be a massive missed opportunity if the Government did not look at remutualisation."

Chuka has been an MP for less than a year so far but already he's willing to spend our money on his desires.

Now don't get me wrong here: mutuals are just delightful, Not only are they Burke's little platoons in action, they are also the product of the great flowering of the English working classes. The providents (and Providents), the building societies, the mutuals like the CoOp, the unemployment, sickness, pensions and even burial insurances, these were and are evidence of the ability of the people to self-organise.

But what Mr. Umunna is suggesting is something very different indeed. We, us taxpayers, have spent quite some considerable amount of cash to keep Northern Rock from collapsing entirely. We'd rather like that back if we can please. But what our newly minted MP is suggesting is that our cash, our capital, should simply be given to those who happen to have a deposit account at Northern Rock..

For that is what "mutualisation" means: that the depositors own the institution. "They" get "our" money.

No, if you wish there to be more mutual organisations in UK society (and I'm with you on this idea!) then off you go and set them up. Put your time and effort and capital into such. But no, you don't get to take our time, effort, capital, taxes, to do so.

We own Northern Rock at the moment and no, we're not OK with you suggesting it be given away to your favoured constituency.

On how short selling works and why markets tend to self-regulate

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Harry Hutton's blog (warning, very offbeat humour and often very bad language used) isn't where we might normally gather for economic insights. But he notes that, once Fifty Cent had told his army of Twitter followers about the delights of the shares of a company he himself part owns, the stock roared up 290% in one day, following a 120% rise the trading day before.

Mr. Cent may well find himself having interesting conversations with bureaucrats and regulators as a result: but as Harry pointed out, this looks like an excellent opportunity to short the stock. So I contacted the blogosphere's favourite short selling hedge fund manager, John Hempton, and asked (for research purposes, you understand) about the possibility of doing so. To get the response:

Borrow is already a problem.

Fortunately, he then translated this for me: it's necessary to borrow the stock from someone before you can short sell it ("naked shorting" isn't allowed on this exchange) and there wasn't any stock out there to borrow. A little later some became available, but only $5,000's worth. Upon asking why this is so I'm told that this is because vast numbers of people are already borrowing all of the available stock in order to short it.

Which leads us to the value of short selling: that handbag company may well be worth hundreds of percent more than the market was valuing it at before Mr. Cent's endorsement. We might also be seeing a little bubble forming as a result of the fame of the endorser: views may vary. But short selling allows people to make such differences of opinion over value known, allows their opinions of value to actually correct, as they see it, a misvaluation.

If only such short selling had been available to those who were certain there was a housing bubble inflating, eh?

For markets are, by and large, self-correcting, as long as it is indeed possible to speculate on prices falling as well as prices rising.

A few points on bank bonuses

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Bank bonuses had nothing to do with the financial crisis. The fundamental issue was low interest rates leading to an unsustainable credit bubble, which was compounded by a variety of factors, ranging from housing policies, accounting rules and capital requirements, to deposit insurance and the expectation that banks would be bailed out if they ran into any trouble. Blaming bonuses is an easy option – which helpfully exculpates politicians, regulators, and central bankers – but it is also lazy and wrong.

The rules on bank bonuses are already pretty strict. You wouldn’t know it from the current furore, but bonuses have already been the subject of extensive government intervention. The code published by the Financial Services Authority in December, which applies to some 2,500 UK firms, significantly restricts the proportion of bonuses that can be paid in cash and insists that they be spread over 3-5 years. It’s a little rich for the government to complain when their own, recently passed regulations are being complied with.

Bonuses are a sensible way for banks to manage their payroll. Because financial business is volatile, financial institutions try to keep their fixed costs low. As such, bankers often receive lower basic pay than people in other comparable professions, but get larger bonuses. Really, this is how people should look at it: bankers don’t have bonuses per se, they just have variable pay.

Like it or not, Britain needs the City of London. Let’s not forget that the City contributed an estimated £53.4bn to the 2009/10 tax take. That’s 11.2 percent of government revenue. No one denies the pressing need for reform of the financial services industry, but we don’t do ourselves any favours by bullying bankers all the way to Zug.

Envy-ridden, class-war politics is the last thing Britain needs. The most depressing aspect of this debate is how little attention is paid to economics – and how much time is devoted to pandering to people’s prejudices about the wealthy. We need to examine policy options rationally, and ditch the class war rhetoric. Too often Britain is a country that denigrates success rather than celebrating it, and in the long run that will do us just as much harm as misguided regulations and taxes.

On the regulation and mobility of markets

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If you're interested in the structure of the art market I recommend this piece. And the specific little part that I want to talk about is this:

You can argue the toss on some of these, but the main thrust is clear: the value of a work of art is to a very large degree a function of the city where it’s being sold. New York’s at the top of the heap (or, to be precise, Manhattan); Berlin punches well above its weight; Paris, the erstwhile center of the art world, is conspicuous by its absence.

Something obviously happened to topple Paris from its place at the centre of the global art market. We could all argue about what that was but I would put forward the idea of the droit de suite. This was a tax, a charge, placed upon art of suitably recent manufacture when it was resold. This charge then went to the artist or their estates. Now it seemed fair when it was brought in, after WWI. For there were those who had bought art ten, twenty, years previously and were making vast profits while the artists' families were living in poverty. But what seems fair and how things play out don't all that often connect in the real world. Paris is no longer the centre of the art world and (well, until the EU imposed the droit across the EU, meaning that all of the EU is likely to have this problem in future) as little is sold there little is collected for the starving orphans.

The larger issue, the one we really want to take note of (not really being all that worried about what happens to Damien Hirst's heirs) is that small changes in regulation, small changes in taxation, can indeed move markets over time.

The Eurobond markets are in London simply because the US used to have a with holding tax on bonds issued "onshore" in the US.

There are two things that can happen, as above. A market might move geographically over time in response to regulation or taxation: or new markets might arise elsewhere, having the same end effect of draining activity from the original place.

No, I don't expect bonus limits of 50% taxation levels to denude the City of London of its activity (and, recall, the huge tax revenues to the Treasury) overnight. But changes, regulatory and tax, will lead to a reduction in the City that we might have had without them.

Fixing the financial sector

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Earlier this week I went on Radio Five to talk about Lord Turner’s suggestion that the directors of failed banks should face having two years salary clawed back by the financial regulators (available here at 1:49:00). Surprisingly enough, I didn’t think much of the idea.

It is true that Lord Turner is identifying a real and serious problem: bank directors are sometimes insulated from the consequences of their business decisions, and have an incentive to take on more risk as a result.

But as well as being ethically dubious – the burden of proof would rest with bank directors, who would be forced to justify perfectly legal activities or face arbitrary punishment – Lord Turner’s proposal is a distraction from the real problems in the banking sector. Politicians and the media enjoy obsessing about executive compensation, but in the real world it is a very marginal issue.

The real problem is threefold:

• Firstly, we all know that governments won’t let banks fail. Shareholders and bondholders know they aren’t going to lose money, so the market supervision of banks is weak.
• Secondly, deposits are guaranteed by the government, which means people pay almost no attention to what the banks are doing with their money.
• Thirdly, commercial banks can always borrow money from the Bank of England to paper over liquidity problems – this encourages them to spread themselves thin.

The result of these government interventions is that the banking sector is hard-wired for risk in a very fundamental way. In this context, after-the-event clawback of directors’ salaries will make virtually no difference – aside from feeding anti-banker, class war sentiment.

On that point, I was quite astonished to be asked why I objected to Lord Turner’s proposals, given that bankers earn loads of money, and rules like these would make poorer people ‘feel better’. The point of financial regulation isn’t to make people feel better about themselves – it is to ensure that we have a stable financial system. That’s the only basis on which Lord Turner’s proposal should be judged.

What would a better approach look like? Well, we need a proper bank resolution scheme that avoids bailouts and makes sure bondholders and shareholders lose out – compulsory debt-for-equity swaps may be a sensible idea. We need the Bank of England to be much stricter on lending money to banks, perhaps even going so far as to close the discount window. It needs to be made clear that it is up to the banks themselves to stay liquid and solvent. And we need to get rid of deposit insurance, perhaps requiring banks to offer a 100 percent reserved ‘safe haven’ account while publishing reserve ratios for other accounts, so that depositors demand an appropriate degree of conservatism. 

For more on free market approach to financial reform, see Professor Anthony Evans’ 2 days, 2 weeks, 2 months: A proposal for sound money. On the deposit insurance point, see the Carswell-Baker Bill.

This Ireland's going bankrupt thing

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We're being offered, at present, one of those things that economics so rarely does offer us. A near controlled experiment through which we can see the results of different policies being applied to the same circumstances.

Leave aside, for a moment, how Iceland and Ireland both got there: they're both in much the same position. Entire countries essentially bankrupted by the debts of the banking system. But what each are doing is very different indeed. Iceland has, in so far as a country can, declared bankruptcy, allowed the currency to collapse, told its creditors that there just isn't any money and is waiting to see what the markets allow to happen next.

Ireland is locked into a currency regime, the euro, and so cannot change its interest rates or the value of the currency and is thus attempting to, well, do something within those strictures. As a result of political pressures within the EU it's not being allowed to tell creditors they can go sing for their money.

Both countries have large economic slumps, this is true. But what really matters is how this all pans out over the next decade or so.

One of the things that's terribly hard to explain to people is the way in which market based systems deal with failure. It can be brutal and harsh, certainly, but the most distinctive part is that market systems do in fact recognize failure. *Shrug*: so there's no money left. Well, just looks like those who lent the money are going to have to lose some or all of it then, doesn't it? Rather than the non-market usual response of deperately trying to find the money from somewhere: anywhere at all in fact.

As I say, both Ireland and Iceland are in roughly the same situation: there ain't no money left. Iceland has defaulted, something which certainly has short term effects. Ireland probably should default but isn't being allowed to.

I have a very strong suspicion that it will be Iceland that is better off in a decade's time, not Ireland. For however much creditors don't like it, it really is true that when there's no money then there is no money. Better to, as market systems tend to do, recognise this and then move on, rather than try and spend a decade or two rootling through every mattress in the country to try and find what isn't there.

After all, this is hardly the first time that a sovereign state has said "Oops, all the money's gone" now, is it? As, to take a short list, Russia in 1991, then 1997-8, Argentina in 1982, 90 and 2001, Brazil and Chile both in 1983, Ecuador in 1982, 99 and 2008, Uruguay in 1983, 87, 90 and 2003, Venezuela four times since the 1980s and, umm, Greece for fully 50% of its years as an independent country, show us.

Lining up bank privatizations

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Given their scope to deliver much-needed proceeds, there is pressure upon the Treasury to begin the process of selling down the Government’s 83% stake in Royal Bank of Scotland (RBS) and its 40% stake in Lloyds. It will be a very challenging process – especially for RBS.

Ironically, the first thing for the Government to do is – nothing. Just watch how the putative c£16 billion Initial Public Offer (IPO) of Santander, the owner of Abbey National, proceeds – the IPO is slated in for 2011.

Assuming that this IPO generates sufficient interest, the Government should seek to place a tranche of Lloyds shares with leading City institutions.

Only then is it sensible to tackle RBS – a bank, which despite some welcome stability, faces a raft of challenges.

Aside from concerns about bad debts and the Basel 3 funding obligations, RBS’s participation – at £282 billion – in the Government’s Asset Protection Scheme (APS) poses its own challenges.

Furthermore, the Independent Banking Commission should report by next September and may recommend compulsory separation between retail deposit-taking banking and investment – aka casino – banking.

However, given the threats by both HSBC and Barclays to relocate to Hong Kong and New York respectively, it is probable that the risk of losing their valuable tax revenues will prevail over any ideological reasons for compulsory separation.

By the next General Election due in May 2015, the Government should have sold all of its Lloyds’ stake and most of its RBS shareholding. In the latter’s case, the total value of the Government’s shareholding – assuming that the B shares are treated pari passu with the ordinary shares – should exceed £40 billion.

It is a vast sum to raise on behalf of one company, although Brazil’s Petrobras recently managed to bring off a near $70 billion rights issue – a world record.

Can the dramatic bank rescues be reversed by 2015?

Banks 2 – Coalition 0 (at Half-Time)

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Despite the views of the Business Secretary, Vince Cable, the prospects of banks being compulsorily split up between their retail and investment/’casino’ operations are receding.

Two years ago, the UK banking sector was close to complete collapse. The then Labour Government decided that the stricken Royal Bank of Scotland (RBS) could not be allowed to fail.

The cost has been enormous. Around £45 billion of public money has been injected into RBS alone. Neither should the vast contingent public liabilities of RBS’ asset protection scheme be overlooked.

Many eminent authorities have proposed that, to avoid any recurrence of the 2008 collapse, the UK’s leading banks should be legally split up. Indeed, the independent Banking Commission, due to present its report next September, may advocate a split, possibly with caveats.

Even so, it is increasingly unlikely that the Coalition Government would pursue this route. Threats of HSBC – the owners of the former Midland - relocating to Hong Kong and Barclays, whose earnings are dominated by its investment bank operations, settling in New York are focussing minds: far lower tax receipts would accrue. Given the UK’s dire fiscal position, would it be surprising if this fact proves decisive?

Thought for the day: Putting a price on inflation

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One reason why Britain has rising inflation is because we deem it unseemly to fire a Governor of the Bank of England. It is thought humiliation enough to require them to write to the Chancellor when inflation comes in above target. Unfortunately, now that such letters have become monthly occurrences, the humiliation has subsided. There is no price for failure. If there were, the deliberations of the MPC would certainly become a good deal sharper.

Is a gold standard feasible or desirable?

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Gold reached a new high of £1234.55 per ounce last Thursday. Though Keynes might have dismissed it as a 'barborous relic', there is no doubt that people have much more trust in gold than in the paper currencies that are printed by their national governments. Particularly at a time like this, when governments are printing (quantitatively easing) the stuff like mad just to pay their debts. So should we protect ourselves from inflation by adopting an honest-to-goodness gold standard? I ain't convinced.

The six-year-old daughter of a friend of mine asked me one of those childlike questions that fetch you up: 'How much money is there in the whole world?' I got international economist (and Adam Smith Fellow) Gabriel Stein onto it, and his best guess was $60,000bn. I then asked myself how much gold there was in the whole world, and the accepted answer seems to be about 10bn ounces. So if we replaced all the paper money in the world with gold, its price would soar to about $6,000 an ounce.

That would be a nice windfall for rich folks with a lot of gold jewellery, which of course is one reason why the rest of us would never permit it to happen. But there is a second political problem: there just isn't enough of the stuff to make it fit for purpose as a currency.

Now a lot of people have casually dismissed a gold standard on the grounds that there just isn't enough gold. I always thought that was nonsense. Sure, on my calculations you would need to weigh out about one ten-thousandth of an ounce of gold to buy a pint of milk, which isn't a very practicable way of doing your shopping. But there's an obvious answer: you issue paper certificates for such tiny quantities of the gold, and use them as your currency. The paper works because, well, it's as good as gold.

But I've been re-reading Milton Friedman's Capitalism and Freedom as part of my researches for a new book on his policy ideas, and he makes what seems to me to be a very strong practical case for why this apparent monetary paradise is a mirage. Once people start trading in gold certificates instead of gold itself, there is wide scope for fraud – over-issue the certificates and you can make some nice extra money. Since the certificates hang around in circulation for years, and people don't usually come in all at once to demand the actual gold for their certificates, your fraud is unlikely to be discovered.

The upshot is that, inevitably, some authority has to get in on the act to ensure that the contract – a certificate for an ounce of gold entitles you, on demand, to just that is properly enforced. Which means that government, with its monopoly on coercion, is going to get involved – as it always has, even under the supposed 'gold standard' of the past. Worse – and as before – the temptation of the government to get into the gold-certificate fraud itself will be overwhelming.

If governments were angels, then gold might work. But Friedman's conclusion is that a commodity standard such as gold is neither feasible nor desirable. Better, he thinks, to let them print money – but have strict limits on the quantity they print. That system is more obvious, and easy to control.

Well, Milton, good luck with that one too.