Obama's Banking Reforms...

In my Money Week column this week, I'm arguing that Obama's banking reforms will just tee-up the next crisis. Here's a taster.

Where will the next financial crisis come from?
As the global economy steadily, if slowly, recovers from the credit crunch, plenty of attention is quite rightly being paid to the next shock. Such is the fragility of the financial system, there isn’t any shortage of candidates. Perhaps it will be a sovereign debt crisis, led by countries on the brink of default such as Greece. Maybe an implosion of the Chinese economy, which is increasingly the sole engine of world trade. Or it could well come from central banks withdrawing the stimulus the have been pumping into the system, so provoking a fresh round of bank collapses.
In reality, however, the answer is probably none of the above.
The seeds of the next crisis are being sown in the political and regulatory response to the current one. The new taxes being levied on bankers and their bonuses in the UK, the US, and elsewhere, are going to drive the financial system offshore and push debts off the balance sheet. Risk won’t be abolished, it will simply be driven underground. At some point it will blow up – creating a fresh round of trauma for the world economy.
This month, President Obama has put forward a tough new tax on the banking system. The Financial Crisis Responsibility Levy is craftily constructed, imposing a 0.15% levy on the total liabilities of the 50 largest financial institutions in America. It is estimated that the tax will raise around $9 billion a year, and, over ten years, will re-coup the bulk of the money the government had to spend bailing-out Wall Street during the crisis.
In the UK, the Government has imposed its one-off tax on bankers bonuses, designed to confiscate the bulk of the money London’s bankers might have earned during 2009. Other taxes are being discussed. Lord Myners, the City minister, has said that Britain may well impose a levy on its financial system similar to the American one. Angela Merkel, the German Chancellor, praised the tax, but said she preferred an ‘international levy’ on financial transaction. The chances are that other countries will follow the UK and US leads.
It is impossible not to sympathise with the thinking behind the new taxes. The banks have been bailed out with massive taxpayer support, and have shown few signs of contrition. They appear intent on going straight back to their bad old ways. At the very least the taxes may assuage public anger, and build up funds to deal with the next crisis.
And, in fairness, there are ways the taxes will help. The US levy will discourage what might be called the ‘Fred Goodwin syndrome’ – massively increasing the size of your balance sheet by ramping up leverage and offering more and more credit to everyone who walks through the door. The more liabilities you take on, the more tax you pay. On top of that, it will favour small banks, who will be exempt, over bigger ones. Insofar as it encourages smaller, less risky banks, that will be a good thing.
In the UK, everyone acknowledges that the bonus culture played a role in creating the crash, so it makes sense to impose taxes on what bankers get paid: it won’t fix the problem by itself, but if it brings some sanity back to bankers wages, it will help.
The trouble is, there are big risks as well.
Both taxes may well drive more and more business both offshore and off-balance sheet.
Take a look at the way they work.
Obama’s levy sets up a very clear incentive to use off-balance sheet vehicles. If you can roll-up your liabilities into a new company, and park it somewhere else, so that they don’t appear on the balance sheet, you can avoid the tax. We have to assume that if you give bankers a big incentive to indulge in some fancy financial engineering, they’ll jump at the chance. The result? Liabilities that used to be on the bank’s balance sheet, where everyone could at least see them, will suddenly disappear behind a brass plaque somewhere in the Cayman Islands.
Likewise the bonus tax. There is already plenty of evidence that banks are reviewing whether they should base themselves in London: JP Morgan has already hinted that it may re-think its decision to build a new European headquarters in Canary Wharf because of the tax. Individuals will go to work in hedge funds based in Zug or Malta instead of working for a London-based investment bank. The result: trading and investment will move away from the UK, where it could be regulated, to offshore centres, where it will be largely invisible.
That is hardly an improvement.
In the wake of the credit crunch, it was clear that one of the main problems was the way banks had hidden their loans. It wasn’t that the losses on sub-prime mortgages were that terrible: by historical standards, they were relatively containable within the financial system. It was that they were rolled up into products of such bewildering complexity that nobody could figure who owed what to whom, or how much money might have been lost. As a result, the circuits of the financial system blew out, creating a crash far worse than the losses themselves really justified.
The risk now is of repeating precisely that mistake. Instead of demanding that the financial system becomes more open, and more easily regulated, the new taxes are creating a massive incentive to make it even more secretive, and even harder to monitor or control. It is very hard to imagine the results of that will be pretty.
Roll forward a few years. Imagine there are some nasty losses to deal with. Greece, for example, has defaulted on its debts. It is a bad but manageable crisis, with banks facing heavy but far from crippling losses. Except for one thing. The liabilities have all been hidden offshore. No one knows which bank is taking the hit, or for how much. Meanwhile, half the losses have been traded away to hedge funds. But who they’ve sold them on to, and whether they can survive, no one really knows, because they haven’t the foggiest who owes what or where.
A small problem ramps up quickly into a real crisis. And all because of the taxes introduced to cope with the fall-out from the last crisis. The measures may well be well-intentioned – but they are just sowing the seeds of another crisis.

Why Can't Pirates Be Arrested?

There's a great piece in the Telegraph by Norman Tebbitt, about why pirates can't be arrested. It's bonkers, of course. There is effectively no sanction against them. When I researching this for 'Shadow Force' it appeared the ship-owners weren't even allowed to employ armed guards. Crazy.

Iceland - Can't Pay, Won't Pay.

In my Money Week column this week, I've been explaining why Iceland shouldn't pay back the money it owes to Britain. Here's a taster.

To pay or not to pay? To paraphrase the Prince of another small, snowy kingdom, that is the question the Icelandic people are going to face in a referendum.
The country hardest hit by the collapse of the financial system is pondering being the first to say, heck, the bankers can go swing. Someone might have to clear up the mess they created, but it isn’t going to be us.
What should the rest of the world make of that? In truth, there are complex, complicated issues at stake. On the one hand, debts should be honoured. Integrity and trust are important to countries, as indeed they are to companies and individuals. Against that, it is surely crazy that a whole country, for a whole generation, should effectively be bankrupted.
In reality, the Icelanders are right to draw a line in the sand. They should say something very simple: that whole country’s can’t be held responsible for the losses run up by a wild and irresponsible financial elite: and that investors can’t expect always to be bailed out. If they make that point clearly and forcefully enough, the independent-minded islanders will be sending out an important message to the rest of the world.
The facts at issue are not terribly complicated. Some of the Icelandic banks sold very aggressively priced saving products abroad, mainly in the UK and the Netherlands. When their banks collapsed during the credit crunch, the British and Dutch governments agreed to guarantee the deposits that people had been made with the Icelandic banks.
Now, the Icelandic government has agreed to repay slightly more than $5 billion to both countries to help shoulder the cost of that bail-out. The trouble is, the ordinary Icelanders aren’t quite so sure they want to foot that bill. Iceland is a democratic little country. A petition gathered enough signatures to force a referendum on the deal. The vote is now scheduled for late February or early March. If it gets voted down, Iceland won’t pay.
The polls suggest they won’t. The latest test of opinion found 62% of voters supported blocking the re-payments, whilst only 38% were in favour to writing the cheque. Unless someone can come up with some compelling arguments over the next few weeks why they should pay up, it looks like the deal is going to be thrown out. The debts won’t get re-paid. And the British and Dutch governments will both have to add a few more billion to the cost of the financial rescues.
It would be easy to criticise that. A country, you might argue, should pay off its debts, just as an individual should. It can’t expect other countries to ride to the rescue. If Iceland doesn’t agree to the repayments, its credit rating will be shot to pieces, and its reputation will never recover. True, paying the money back might well be a long, hard slog. But it is better than being known as a country that rats on its obligations.
There is truth in all of that. And yet, the arguments on the other side of the ledger are just as compelling.
The debts were not, let’s remember, run up by the Icelandic government, or by the Icelandic people. They were run up by a few wild bankers, who swallowed too much of their own propaganda, and expanded with a recklessness that makes even Sir Fred Goodwin’s reign at Royal Bank of Scotland look sober and responsible by comparison.
There were other parties who were just as guilty. What about the host governments? Regulators in Britain and the Netherlands allowed Icelandic banks to operate in their country. Surely they must bear some responsibility as well?
And what about the depositors themselves? Again, shouldn’t they shoulder some of the losses? When they saw that one of the Icelandic banks was offering 1% more on a deposit account that the local building society, didn’t they pause to wonder how that was being achieved? And whether excessive risks were being run? And if they didn’t – since it was surely obvious - haven’t they only got themselves to blame.
After all, the sums involved aren’t trivial. The debts amounts to £11,000 per Icelander, or 40% of the country’s GDP. It is a big burden to carry, particularly for a nation that has to embark on the arduous task of rebuilding its economy following the collapse of its banking system. It will create a debilitating shortage of capital. In effect, meeting these obligations may cripple the country for a generation.
There is point here that is of far wider significance than what happens to Iceland and its debts. The nub of this debate is that whole countries can’t be held hostage by the actions of a financial elite. And that not all debts within the financial system can always be covered by a government somewhere.
If Iceland voted no, it would give people pause for thought right around the world. Why, for example, should the British taxpayer have to spend billions bailing-out the mistakes made by RBS? Or why should Swiss taxpayers be on the hook for every derivatives contract taken out by UBS? There is no real reason why they should.
The case against Iceland rests, fundamentally, on the idea that national governments should always ultimately stand behind the liabilities of banks that happen to be domiciled in their country. And that taxpayers should always ultimately pay for bankers mistakes.
And yet, when you think about it, that is precisely what we should be trying to change.
If Iceland said no, it would send a clear signal to bankers that they couldn’t always expect their governments to rescue them every time they got into trouble.
And it would send a clear signal to investors that before they put money into a bank, they should make very sure that it was a safe, well-managed institution – because they shouldn’t expect the government to bail them out if it went bust.
Both, surely, would be a good thing.
Which is why, if I was an Icelander, I’d be voting no in the referendum.

Let Greece Go Bust.

What happens to Greece is going to be a fascinating test for the euro. In the Spectator this week, I've written a piece arguing that EU should let Greece go bust (and incidentally, Mark Gilbert wrote a great piece for Bloomberg on a similar theme). If they bail the Greeks out, the euro will be doomed in the medium-term: it will be a weak, political currency. If they stand firm, however, it could be the making of the currency.

Is Writing Depressing?

Sympathy is obviously in order to Mirian Keyes, who has admitted to suffering from a depression so severe that she no longer feels able to write. One hopes she gets better soon. It prompts an interesting question, however. Is writing an intrinsically depressing profession?

There is certainly quite a wealth of scientific evidence to suggest that they might. And there are certainly plenty of anecdotal examples of writers who have been through periods of mental illness.

It is not that hard to understand why.

Writers are by their nature introverts. You have to be to do the job.

It is solitary. You inevitably have to spend a lot of time by yourself in front of a screen.

It is intensely personal. You have to put a lot of yourself into the work. And everything you do is subject to constant criticism.

It is insecure and pressurised.

None of those are recipes for a healthy mental state.

That doesn't mean that all writers suffer from depression. But I'm sure if we are being honest we will admit that we all have quite a few down days. And you need to be pretty resilient to do the job.

Getting Japan Wrong....

In my Money Week column this week, I've been looking at the 20th anniversary of the Japanese crash...and suggesting we learnt all the wrong lessons from it....

As anniversary’s go, it was hardly one anyone would want to celebrate very much. Twenty years ago last week, on December 29th, 1989, to be precise, Japan’s Nikkei index reached its all time peak 38,957. From there, it spiralled into an eternal collapse from which it still shows very little sign of recovering.
It is the mother-of-all-bear markets. Yet it is also significant for far more people than the few unfortunates who bought into the Tokyo market as the 1980s closed. Economic policy making is dominated by the fear of repeating Japan’s two decades of stagnation. The policies Japan forged to combat it – printing money, and massive government deficits – have been followed by the US, the UK, and most of Europe.
And yet, now that we have some perspective on the collapse of the Nikkei, it is clear that we learned all the wrong lessons from the bursting of the Japanese bubble. Printing money that didn’t exist and endless rounds of extra government spending haven’t worked for Japan. They merely led the country into bankruptcy. The same policies aren’t likely to work out much more happily for the rest of us.
If it was a marriage, the Japanese bear market would now be marking its China anniversary. During the 1970s and 1980s, the Japanese economy and stock market was one of the strongest in the world. From 11,000 in 1985, the Nikkei index nearly quadrupled over the next four years. Property prices went even crazier. At one point, the value of all the land in Japan was worth four times as much as the whole of the United States, even though the US is four times the size. (Property prices, since you ask, are still 60% below their peak levels).
Like all bubbles, the Japanese boom took a kernel of truth, and stretched it to absurdity. The country was on a roll. Its auto and electronics industries were crushing the bloated dinosaurs of Europe and the US. It was emerging as the richest, most technologically advanced society in the world. It was no surprise that everyone wanted a piece of the action. Prices massively overshot themselves – as prices in a free market usually do. A collapse of the bubble was inevitable at some point.
The government and the Bank of Japan were initially fairly relaxed. But once it became clear that growth was taking a hit, and the banking system was badly injured, two policies were developed in response. Interest rates were slashed, and when that didn’t work, it was followed up with a novel policy called ‘quantitative easing’. And the government ran up huge deficits to stimulate demand.
The world’s central bankers have looked at the Japanese experience and drawn a simple lesson. Monetary and fiscal policy “should have become even more aggressive in an effort to prevent a deflationary slump,” argued a key paper on the fall-out from the Nikkei’s collapse published by the US Federal Reserve. In effect, the lesson policy-makers have drawn is that Japan came up with the right medicine, but not quickly enough. The Japanese experience inspired their response to the credit crunch. We’re doing what they did more than a decade ago, only more aggressively.
There is just one snag, however. In Japan, it didn’t work.
Two decades on from the crash, the Nikkei still hasn’t recovered. In the depths of the crisis last year, the index went down to almost 7,000, and is still hovering around 10,000. The economy splutters on life support. The banking system refuses to spark back into life. The deficits remain huge.
In truth, we learned the wrong lesson from Japan.
There are two important points.
First, the cure has been worse than the disease.
Japan has landed itself with a potentially massive debt crisis. The budget deficit is running at 10.5% of GDP, one of the highest in the world (although not, of course, as high as Britain’s). According to International Monetary Fund, government debt will hit 246% of GDP by 2014, compared with 108% for the US. The markets are looking at Japan, and wondering if that kind of debt will be affordable. The possibility of default is already being discussed.
Next, the Japanese were being unrealistic in expecting to get back to the growth levels of the 1970s and 1980s. For much of the post-war period, Japan was a young, smart country, playing catch-up with the West. By 1989, its companies couldn’t play catch-up with anyone. They were already world leaders, whether it was on design, technology or manufacturing savvy. Growth was always going to be a lot harder.
On top of that, Japan was rapidly aging. More than 20% of the Japanese are already over 65. Since 2006, the country’s population has been steadily shrinking, and over the next decade will fall by 3.2% from its current 127 million, according to government projections. In the light of that, Japanese growth wasn’t all that bad. Between 1991 and 2000 it grew at an average rate of 1.5% a year, which was about the same as France and Italy. Between 2004 and 2008 it grew at more than 2% each year. Japanese companies continued to be some of the most formidable in the world, and its designers and entrepreneurs as brilliant as ever. Take a look at the number of Toyotas and Nissans on the roads, the Nintendos in every satchel, and the Uniqlos in every shopping mall. You can perfectly plausibly argue the Japanese economy has been doing fine for the last 20 years.
In effect, Japan should have accepted that the excesses of the 1980s bubble had to be purged. And that an aging, advanced society was not going to be capable of rapid growth. All that government spending did little to revive the economy. But it has bankrupted the country, and may create an even worse crisis some time in the coming decade.
It should be going into an era of an aging, declining population, with government finances in good shape. And it should have accepted that its days of rapid growth are behind it. At best, the policies of printing money, and massive deficits, have been irrelevant. At worst, they are storing up problems for the future. And the real tragedy is that we seem intent on repeating their mistakes – when we could have been learning from them.

Mercenaries as Assassins...

There's some interesting allegations that the CIA used the American mercenary company Blackwater to plot the assassination of a Syrian-Greman businessman based in Hamburg. It remains to be seen whether that is true or not. But if it is, it certainly extends the kind of operations that the Private Military Contractors are getting involved with.

I've been exploring both themes in the Death Force series. In 'Fire Force', which is out next month, the unit get hired for an assassination. In 'Shadow Force', which I'm writing right now, they get hired for a black op by British intelligence.

Now, it seems its all coming true.