A Tax Catastrophe For The City

Judging by the amount of e-mail I had today for my Bloomberg column on the new 50% top-rate of tax for the UK, it really is going to be a catastrophy for the City. Dominic Lawson has written a good piece for The Independent about it as well. And yet no one in the Government appears to care.

Don't Bet On The Banks

In Money Week this week, I've been writing about the banks, and how despite the small recovery, they won't get vack to their old strenght. Here's a taster....

It has been a great couple of weeks for the global banking industry. Admittedly, it is coming off a low base, but after a year in which banks went bust, begging bowls for bail-outs were handed out, and bankers were pilloried for their greed and rapaciousness, there were at least some signs of health back in the financial system.
In the US, Goldman Sachs, always the class act of the industry, produced a terrific set of results. Morgan Stanley managed to do better than anyone in the market expected. And in this country, the stockmarket has started marking up the shares of the battered banks again.
Has the long-awaited bounce back in the banking industry started? In truth, probably not. Ignore the green shoots. Banking around the world remains a deeply troubled industry, and it is still going to be a very long time before it starts returning to a healthy level of profitability again.
Still, there is little mistaking the signs of recovery. If you were feeling optimistic, you might even be inclined to call them ‘green shoots’. In the US, Goldman Sachs posted earnings of $1.81 billion last week, easily besting even the most optimistic analysts’ forecasts. The old Wall Street rule that after a nuclear holocaust there would be only there things left alive – cockroaches, Keith Richards, and Goldman Sachs – appeared to be coming true again. Even the worst financial carnage in a generation turned into little more than a blip for the firm.
But it was far from alone. Wells Fargo last week posted record earnings for the period, as did JPMorgan Chase. Citigroup, perhaps the most bombed out of the major American banks, managed to end five consecutive quarters of losses by posting a profit of $1.6 billion. The American banks that survived the carnage looked to be clawing their way back towards health.
There are similar signs in Britain. We’re not yet seeing big bounce backs in profits. But the shares prices of our main banks are starting to anticipate better news down the track. Take Lloyds. From a low of 33p back in January, the shares have broken back through 100p. They jumped by a third last week alone.
Or Barclays. It said in March Barclays it had made a “strong start” to the year, and in February posted a 49 percent increase in profit for the second half of 2008. The sale of its iShares business has boosted its capital position. The shares have started to reflect that. From a low of 47p they are back above 200p.
Even Royal Bank of Scotland, now majority owned by the British taxpayer, is twitching back into life. From a low of 10p the shares are above 30p. It is a long way from recovery, but at least the corpse has been dragged out of the morgue.
True, fund managers have been seizing on any good news they can find. Everyone knew, even at the start of this year, that some kind of banking system would emerge from the crisis. Eventually it would be a profitable industry once more. At some point, there was always going to be a massive rebound in burnt-out share prices. Fund managers don’t want to miss out on that. They are making sure they are long on the shares wells before it happens.
There are positive signs. The worst of the credit crunch has passed. No more banks are likely to go bust – not big ones anyway. And there are reasons for thinking that profits may grow from here on. First, house prices are steadying, both in the US and UK. That will stem the flow of losses from sub-prime lending – and from a lot of commercial loans as well. Next, competition has been reduced, as anyone looking for a mortgage or a credit card will have noticed. Less competition means fatter margins, which is always good for profits.
Against that, however, there are three big issues overhanging the global banking industry.
One, there is still way too much capacity – they only reason competition has lessened is because of a shortage of funds. Banking looks set to become the auto or airline industry of the next decade. There are too many players making very similar products, but just as governments wouldn’t let their flag-carrier airlines go bust, and are still reluctant to let their car manufacturer go under, so they won’t let their banks go bust either. They will stagger on, over-staffed and barely profitable, until finally someone puts them out of their misery. Eventually there will four or five global mega-banks, and a host of niche players – but it will be a long time before we get there.
Two, banking is about to become zealously micro-regulated. There are already plenty of signs of that. In the US and the UK, Europe and even the offshore centre, financial supervisors are busy devising new rules and regulations. There will be caps on pay. There will be limits on lending. And there will be a clampdown on innovation. You’ve probably got more chance of getting a new type of cigarette advertised on children’s TV than you have of launching a clever new financial product right now.
Three, the best people are about to quit the industry. For a generation, banking attracted the most hard-working, ambitious, creative talent on the planet. Admittedly they devoted much of that brainpower to blowing the system up. Still, it made the industry dynamic. But a low-growth, micro-regulated industry isn’t going to attract anything but clock-watchers and pen-pushers – hardly a recipe for growth.
In reality, the banks will stabilize at some point. We may have reached bottom in January and started the bounce back. But it won’t be another boom in finance or banking – that is going to be the dullest of dull industries for a generation or more.

How To Beat The Pirates

In The Spectator this week, I've been writing about the mercenaries who are taking on the pirates. It was a really interesting piece to research, because the range of techniques is so wide. The third in the 'Death Force' series is going to tackle the issue of piracy - there hardly seems a better subject in the world for a thriller right now.

Death Force in Hammersmith

I'll be speaking about 'Death Force' at the books festival in Hammersmith next month. You can read about it here.

Respect to FT Alphaville

Over at FT Alphaville they are linking to my Bloomberg column today about the big mnistakes the UK economy is making, and how it is turning itself into the New France. They headlined the link, 'Welcome to Frengland'. I wish I'd thought of that.

Goldman Sachs's and the Devil Blog

I did a column for Bloomberg on Monday about Goldman's Sach's problems with a blog called Goldmansachs666. You can read it here, and also see the discussion I had about it on Bloomberg TV here. The blog itself seemed a bit put out, which wasn't what I was expecting, since I was defending it's right to exist. I suspect banks are going to have a hard time dealing with the kind of populist public scrutiny they are now gojng to come in for. Goldman actually does a better job of PR than most. But thet still have a lot to learn.

The Curzon Group

The Curzon Group, which I've been putting together with Martin Baker and Alan Clements, is launched.

We had some great write-ups in The Bookseller and The Guardian. Hopefully more will follow.

How To Fix The British Economy

In MoneyWeek this week, I've been writing about how to fix the British economy. Here's a taster.

A banking system so bankrupt, half of it has had to be taken into state control. A regulatory system exposed as a shambles. Monetary policy in a state of confusion. And public finances shot to pieces.
Take all those together, and there can be little debate that the system Gordon Brown, and his main intellectual adviser Ed Balls, laid down for running the British economy in 1997 have been shot to pieces. If it was a house, it would have been condemned.
Now, the first signs of a debate about how to formulate a new set of rules is starting to emerge. The shadow Chancellor George Osborne made an important start last week, questioning the relationship between the Bank of England and the Financial Services Authority, and the size and role of the banks.
But the debate is going to have to go a lot further, and the policies put forward will need to be a lot more radical, if the hard work of putting the UK economy back together again is to start.
Let's start with what went wrong. In truth, just about everything. Brown mis-understood the way the City needs to be regulated. He put too much faith in inflation-targeting. He allowed the banking system to run out of control. And he mis-managed public finances. The results are plain for everyone to see -- the worst financial crisis of the major developed economies, and probably the longest and most painful recession as well.
By now, just about everyone outside of the Ten Downing Street bunker accepts that the system needs to change. But how? Here are four places we should be making a start.
One: The Monetary Policy Committee, created by Brown in 1997, needs to start targeting asset prices along with conventional measures of inflation. In retrospect, it clearly made a mistake in allowing house prices to run out of control. True, Mervyn King, the Governor of the Bank of England, issued plenty of warnings. The alarm was sounded. But, looking back, through 2004 and 2005 the MPC should have been steadily raising interest rates to whatever level was necessary to get house price inflation back to zero. Sure, it would have been painful - but not nearly as painful as what we are experiencing now.
We need to learn the lessons of that. As well as targeting retail prices, the MPC has to be told to target asset prices. If not, we are simply doomed to repeat the same mistakes.
Two: The Financial Services Authority has clearly failed. A zealously bureaucratic organisation, it focussed relentless on petty rules rather than the big picture. So, for example, it made it virtually impossible to open a bank account without producing birth certificates (in triplicate) for ancestors stretching back to 1700. But if you wanted to bankrupt the whole country, that was fine.
In reality, splitting out financial supervision from the central bank was a bad decision. In a crisis, they are the same thing. The central bank can't stand by and watch a major bank collapse – as we discovered last autumn. But if it has responsibility, it should have power as well. The Bank of England should be handed back the final say over the regulation of the banking system. The small, petty rules should be ripped up, and the replaced with broad principles designed to protect the system as a whole. Banks are full of clever, hard-working people thinking of new ways to blow up the system – only a regulator very close to the pulse of the market can be fast and flexible enough spot problems early enough to tackle them. The Bank of England is the only body that can do that.
Three: A clear strategy for the nationalised banking system should be set out. We don’t want to create the British Leyland of financial services, offering up the Morris Marina of accounts, and the Austin Princess of investments. The small, state controlled former building societies such as Northern Rock should re-mutualize: as soon as they are in decent enough shape, they should be handed back to their account holders (which would be a great way of increasing deposits as well – it would be carpet-bagging in reverse). After all, the mutual have done well so why not create more of them?
The two big state-controlled banks – Lloyds HBOS and Royal Bank of Scotland –
should be split up: Lloyds back into Lloyds and HBOS and RBS into RBS and NatWest. By themselves, NatWest and Lloyds would do fine. HBOS could be re-mutualized as soon as possible, and RBS left to whither, as a warning to other banks that get too ambitious. The important task is to create an open and competitive banking system as soon as possible – not one dominated by two nationalised giants.
Four: Public spending has to be bought under control. The ‘golden rule’ that Brown created in 1997 to keep debt under control is a joke. A rule isn’t a rule when you change it every time it looks likely to be breached. The rule that Britain needs is that public spending should be capped at a maximum of 40% of GDP over an economic cycle (which means it shouldn’t be any higher than 35% at the peak of a boom). All the evidence shows that once the state sector climbs above 40%, economic performance declines dramatically. The cuts needed to achieve that might be painful – but are surely preferable to years of French-style stagnation.
No doubt there will be plenty of other reforms needed as well. But a new inflation target, a re-regulated City, and slimmer, privatised banking system, and a shrinking public sector would give the UK economy at least the chance of relatively quick recovery.

Are Pirates Heroes?

There is a good piece in The Times by Ben Macintyre about the Somali pirates. He discusses how they see themslves more as Robin Hood figures than criminals. Right now, I'm working on the outline for the third book in the 'Death Force' series which is going to be set amidst the pirates. It strikes me that pirates are at least in part heroic figures, or at least lovable rogues, and the story needs t reflect that. They can't be purely evil.

Where's Gordon?

Perhaps the most extraordinary aspect of the row over Damien McBride's e-mail's is the invisibility of Gordon Brown. Why isn't he on TV defending himself? You can't just hide from a scandal like this - you have to go out and take some punishment. The last year of the Brown Premiership has the potential to turn into an epic calamity -- one with the potential to finish the Labour Party for a generation.

A Bull Case For Equities.

It isn't all doom and gloom for the markets. There is a bull case for equities, as I point out in my Money Week column this week. Here's a taster....

Let’s Not Give Up On Equities – This Is When We Need Them Most:


Investors could hardly be blamed for giving up on equity investment completely. Despite the slight rally of the past few weeks it looks as if this decade will wind up being one of the worst for shareholders in a century or more. Barring a suddenly doubling of the markets in next few months, and there isn’t much chance of that in the middle of a grinding recession, virtually all the main markets around the world will go into 2010 lower than they went to 2000.
And yet, it would be a mistake to write off stock markets completely. Indeed, there is an argument for saying we may well be about to go into one of the best decades yet for equities. Why? Because there are literally thousands of companies around the world with shattered balance sheets that are going to need a lot of patient nursing back into health. And with credit hard to come by, managers won’t have much choice but to get that money from their shareholders.
And when companies need you, they look after you – indeed, it will only be by looking after shareholders, and making sure they are well rewarded, that companies will be able to get the capital they need.
Still, there is no mistaking the fact that this has been a rotten decade for anyone holding equities. Up until 2000, it was evident to everyone that shares performed far better than bonds. From 1900 to 1949, the annualized real return on the world equity index was 3.5 per cent, and that was achieved after taking in a couple of world wars. From 1950 to 2000, it was an impressive 9 per cent annually, according to figures compiled by Elroy Dimson, Professor of Investment Management at the London Business School. And yet in the years since 2000, the MSCI World index has lost a third of its value in real (that is inflation-adjusted) terms, while the major markets all lost between four and six percent annually, again in real terms. Indeed, two of the four worst bear markets in stock market history have occurred in the last ten years – and it would only take another small dip in the markets to make this one the worst bear market ever.
In fact, the conventional wisdom that equities out-perform bonds over the long-term is now being turned on its head. According to the American firm Research Affiliates, if you invested 30 years ago, US Treasury bills would have provided a better return than the S&P 500 Index. There are some periods you can take - February 1969 to February 2009, for example – when the 40-year return on government bonds beat the S&P 500. Since 40 years is about as long as anyone’s investment horizon can realistically be, it is going to be hard to make a case for buying shares.
No surprise then that some people are attempting to write off the equity markets. Given those dismal statistics, it is not hard to blame them.
And yet, take it from a different angle, and there is still a good case to be made. In the coming decade, corporate managers are going to really need their shareholders. They aren’t going to have anywhere else to turn to for capital.
For much of the last decade, chief executives blathered on endlessly about ‘shareholder value’. Yet, as they say in Hollywood script-writing classes, ‘show not tell’. In reality, shareholders were just an irritant. Managers could get all the capital they needed from banks, the bond markets, or private equity firms. The only sanction shareholders had was supporting a hostile takeover – and since that meant the board collected lavish payouts, it was seldom a very scary prospect.
This decade, however, CEO’s are going to need their shareholders like never before.
The credit crunch has left thousands of companies with shattered balance sheets. Even leaving aside the hundreds of companies left with unsustainably high debt piles by the private equity industry, there are many more that need money to get them through the recession. Beyond that, they will need money to rebuild their competitive strength for the moment when recovery finally arrives.
But the banks are not going to be lending companies tons of money any more. The bond markets will be too busy feeding billion after billion to governments that have run up vast deficits, and the private equity firms won’t be on permanent stand-by waiting to buy a subsidiary at vastly inflated prices.
The only place they will be able to get money will be from their shareholders.
For too much of the past decade, the stock market has looked too much like what its left wing critics accused it of being: a casino where hedge funds gamble with shares as if they were nothing more than chips on a roulette table.
One consequence of the credit crunch though will be to force the stock market to go back to being what it was originally designed to be – a place where businesses could raise the capital they needed to build new mines, start new factories, create chains of shops, or invest in research and development. Businesses that need capital are going to have to start thinking about how to build a loyal army of shareholders who will give them money when they need it.
In retrospect, it is hardly surprising the last decade was such a poor one for equity markets. They were irrelevant. With abundant capital available for everyone, there was no need to look after shareholders. But now, with capital scare, companies will have to pay attention to their needs. The best way of doing that? By making sure they earn a decent return on their cash.
You’ll probably hear a lot less about ‘shareholder value’ from chief executives in the next decade (which will be a great relief to everyone). Paradoxically, as you hear less about it, you’ll probably see a lot more being created.

Bankers Wives

There was a rather po-faced piece in The Sunday Times at the weekend about divorces among bankers by Minette Marrin. On Bloomberg today, I've looked at the same story from a different angle: why should bankers wives walk away with fortunes. After all, they did even less to deserve the money than the bankers.

Is the UK Heading For Meltdown?

Wiht all that G20 nonsense out of the way, and no doubt forgotten about in a few days, we can get back to looking at the UK economy. And the prospects remain pretty dire. In my MoneyWeek column this week, I've been looking at the potential for meltdown. Here's a taster....

Take A Deep Breath, and Examine The Meltdown Options For The British Economy:


Disaster Planning is meant to be a core discipline for any responsible organisation. If you were running an airline, you’d want to know what would happen if both engines on a plane failed, in freezing fog, on the same day some terrorists decided to launch a bomb attack on the airport. If you were running a hospital, you’d want to know how you might cope if there was an outbreak of bubonic plague, then an earthquake, and all in the middle of a flu epidemic.
None of those events are very likely, and certainly not at the same time. But, all the same, it’s good to have some idea of what you might do if they did. After all, there won’t be much time for thinking about it when a catastrophe strikes.
Has anyone in the Treasury been sketching out disaster scenarios for the British economy? Given the lamentable state of preparedness for the recession – it’s not long since we were being told our economy was the best placed in the world to withstand the downtown – it seems unlikely.
They should be. True, the chances are that it won’t happen. A mixture of a devalued pound, historically low interest rates, and the Bank of England printing money, should pump enough demand into the economy to keep it on its feet.
But there are three meltdown scenarios for the UK. And we should be thinking about them now – if only to concentrate our minds on how to avoid them.
One, an attack by the bond vigilantes.
We got a taster of what the bond markets can do a government last week, when an auction of gilts failed. Finding buyers for the mountains of debt the British government is going to have to issue will be a huge task. Capital Economics estimates that the budget deficit will run as high as £200 billion annually over the next five years. In fact, even that might turn out to be too optimistic. “It is not implausible that annual borrowing rises towards £300 billion,” it concluded in its most recent analysis of the public finances.
Whether the markets are willing to finance deficits on that scale remains to be seen. Of course, the Treasury might think the problem is fixed. The Bank of England’s new policy of ‘quantitative easing’ means that if it comes to a crunch, the Bank will simply print fresh money to buy up the gilts and pay for the government’s debts.
The real pain will come in the currency markets. If the government starts printing money to the tune of 10% to 15% of GDP annually, the pound can be expected to plunge. Britain imports the majority of its food and manufactured goods. Our ability to do that depends on people abroad accepting sterling as hard currency. If confidence in the pound collapses, there will be no choice but to jack up interest rates to whatever level is necessary to get foreign investors buying into sterling again. A base rate of 15% would probably be the minimum necessary – a rate that would crucify businesses and mortgage holders. In the worst case, we might even need import controls.
The chances? Probably about 10%.
Two, a return to hyper-inflation.
Forget all the chatter in the City about deflation. There are a couple of thousand years of economic history to show that once you start printing money the result is usually inflation. Cynically, policy-makers probably know that perfectly well, and have decided to accept it. A burst of inflation – say 30% over a period of five years – will effectively wipe out much of the debts of consumers and companies. It will be de-leveraging by stealth.
The trouble is, a bit of inflation is bit like having a smidgen of cocaine. It is a lot easier to start than it is to stop. The assumption right now is that all the freshly printed money can be quickly withdrawn once the economy has steadied. If it can’t be, the UK could be heading for hyper-inflation, a 20% to 30% annual increase in the price level. Savers will be wiped out, industrial unrest will be rampant, and the currency will start to lose any reliable value.
The chances: About 30%.
Three, stag-flation.
Much of the commentary on the British economy right now assumes that it was in pretty good shape until a collapse in the credit markets caused a sudden drop in demand.
Of course, that isn’t really true. The UK has been on a downward trajectory for several years. Taxes have been raised to levels incompatible with rapid growth. All the historical evidence suggests that once the state consumes more than 40% of GDP growth stagnates. The burden of red-tape and regulation has grown steadily year by year and remains the only part of the economy that shows no signs of slowing down.
In short, there were plenty of problems already – on top of which the credit markets have collapsed. So even when we fix that, the underlying economy will still be a lot weaker than it has been for the thirty years or more.
The net result will be stag-flation: a combination of moderate, persistent inflation and sluggish growth, probably never more than 1%. Interest rates will have to remain high for many years, business confidence will remain weak, there will be little incentive to save or invest, and unemployment will rise steadily because growth is too weak to create new jobs.
The chances: About 80%.
We keep being told that this recession is so threatening , governments and central banks have to throw everything they can at it. But it is worth keeping in mind that the UK now runs the risk of meltdown – and the cure might even turn out to be worse than the disease.