The Credit Card Crunch.

In my Money Week column this week, I've been writing about the looming credit card crunch, and why it is bound to end unhappily. Here's the piece....

Stand in the middle of any High Street in Britain this weekend, and you see hundred of people handing over small strips of plastic, and, in exchange, taking home bags full of toys, clothes, books, games, and all the other things they plan to give to their families on Christmas Day.
But then pause to think about a sobering statistic.
One in every ten of the pounds spent on all those credit cards won’t ever be paid back. It isn’t money in any meaningful sense of the word, just a kind of elaborate con trick.
The UK, in common with many other countries, is sleep-walking into a credit card crunch. Much of the country is still spending wildly on credit cards, living way beyond its means, and indulging in a fantasy prosperity, wilfully encouraged by irresponsible bankers.
Sometime soon, there will be a Dubai moment – a point where everyone realises that the whole edifice is built on sand, either the real or the metaphorical kind. When that happens, there will be a nasty hit to consumer spending, and a lot of red ink for the banks. And the flimsiness of the UK’s economic boom of the last decade will be painfully exposed.
Credit card debt is now a huge part of the British economy. It is no exaggeration to describe the last decade as one long exercise in bashing the plastic. In 1992, according to the Bank of England, the British were borrowing around £2.8 billion a month on credit cards. Now that is above £10 billion a month. It hit a peak in December 2008 – one last Christmas splurge before the credit crunch hit, perhaps – when we spent £12.1 billion of plastic money we didn’t really have.
Of course, credit cards are a way of paying for things as well as a way of borrowing money. At least a few of us pay off the balance every month. But the balance of credit card debt is still rising. The latest monthly statistics, published on Monday, showed a slight decline in overall consumer debt, but despite that, credit card debt outstanding still rose by £134 million. Overall, the amount of debt owed on British credit cards is now close on £60 billion.
We don’t know precisely how that will play out in a recession. In the last downturn, in the early 1990s, only about £10 billion was outstanding on credit cards, and defaults peaked at 4%, before dropping back to 2%. But, so far, the signs aren’t good. According to the ratings agency Moody’s the charge-off index – the technical term for bunging it on the card, then not paying the money back – hit an all time high of 11.8% in September. It has doubled since the first quarter of 2008. Nor does the agency reckon the outlook is very encouraging either. It warns that a splurge of Christmas spending may well trigger another spike in bad debts in the early part of the New Year. And the expected rise in unemployment – forecast to rise steadily through next year – will push even more people to the point where they can no longer make the payments on their cards. Don’t be surprised if the rate at which people are reneging on their debts ticks steadily up to 13% or 14% as 2010 progresses.
The conclusion is simple. Whilst the majority of people continue to keep their debts under control, a significant minority are clearly spending money they don’t have, and have no serious prospect of earning either.
The law makes it alarmingly easy to rack up debts, then walk away from them. When you credit card debts become unaffordable, simply declare yourself insolvent. Figures for the latest quarter show personal insolvencies up year-on-year by 28%, and now running at the highest level since records began in 1960.
If anyone thinks that situation is sustainable, they need to find a psychiatrist and fast. It is crazy, and the sooner people realise that they better.
So far, the banks have just about managed to get away with it, by passing the costs to the responsible customers. As interest rates have tumbled, the rates charged on credit cards have barely changed, pushing the margins up to 15% or more between what it cost the bank to access the money, and what they charge people for borrowing it.
That has allowed them to maintain their profits despite the hammering they are taking on bad loans. Barclaycard, for example, managed to increase its profits slightly this year, despite a doubling of bad debt charges.
The trouble is, that was a one-off. Sooner or later, the banks are going to be drowning in a sea of unpaid loans. They aren’t going to be able to keep passing the cost onto the rest of the customers in higher interest rate and higher charges. And the wholesale markets are going to take fright. Just like sub-prime mortgages, credit cards debts are bundled up and sold around the world. But who exactly is going to want to own British credit card debt, when one pound in ten doesn’t get re-paid, and you have no legal sanction against the debtor, nor any kind of asset you can call on?
At some point, this bubble is going to burst. Many credit card lenders will simply have to withdraw from the market – in much the same way the most of the self-cert, buy-to-let mortgage lenders have done. The rest will have to drastically curtail their lending, insisting on better credit records, and perhaps even demanding security for their loans.
That will be a big hit for the British economy. Right now, at least a billion a month of consumer spending is plastic money that is simply magic-ed out of thin air. Add to that the fact that one pound in every four the government spends is money that is similarly magic-ed from inside a computer at the Bank of England, and the extent to which the British economy exists in a twilight zone of pretend money becomes painfully clear. At some point it will disappear – and when it does, the results won’t be pretty.

Lay Off The Tax Havens

Everyone keeps attacking the tax havens. But there is very little evidence to suggest they played any role in the credit crunch, as I explain in my Money Week column this week. Here's a taster....

Which countries were most responsible for the financial crisis that engulfed the world last year? If you’ve been following the political debate over the last few months, you’d be forgiven for thinking it was a handful of secretive tax havens such as the Cayman Islands, Jersey, Switzerland or Monaco.
Everyone from President Obama to Nicolas Sarkozy of France to our own Prime Minister Gordon Brown has been queuing up to denounce the thriving offshore industry. Every G20 summit comes with a ritual denunciation of banking secrecy, and a fresh pledge to force open accounts. The suggestion is made that the huge fiscal deficits now being run up around the world could be plugged by clamping down on tax lost via offshore financial centres. Bullying tactics have been adopted against small countries to force them to change their laws in ways that suits their bigger and more powerful neighbours.
And yet two reports published in the last week showed that just about all the accusations hurled so furiously against the tax havens are just plain wrong. The British Treasury asked the accountants Deloitte to look into how much tax is lost through offshore loopholes. The answer? Not very much. Meanwhile, the left-wing Tax Justice Network, which campaigns ferociously against tax havens, has just published a report on the most secretive, un-cooperative financial centres in the world. The winner? Delaware, in the United States, closely followed by the City of London.
In truth, the attacks on tax havens are led by politicians guilty of presiding over precisely the system of secrecy they criticise elsewhere. What they are really frightened off is the way the havens provide an alternative to their own high-tax, big-spending policies.
It is certainly hard to escape the verbal hand grenades lobbed at the tax havens by the world’s leaders. In the US, Obama has launched a fierce crack-down on American companies using offshore subsidiaries for tax planning, pledging to raise tens of billions in extra revenue to plug his budget deficit. The Swiss banks have been forced to hand over the details of thousands of account holders. The French President promised to ‘put the morality back into capitalism’ by clamping down on the industry. The Germans have been bullying Lichtenstein into handing over details of account holders, whilst our own Gordon Brown promised “action against regulatory and tax havens in parts of the world which have escaped the regulatory attention they need.”
But how much tax is actually lost through the havens? And how secretive are they really? As it turns out, not nearly as much as people think.
The UK has always been in odd position on tax havens, because many of them – Jersey, the Isle of Man, Bermuda – are British crown dependencies. The Treasury has just published a report from Deloitte on their impact on the world financial system. The results were not quite what you might expect.
Written by Sir Michael Foot, a former director of the Bank of England, the report estimated that the amount of tax lost to the British government as a result of companies routing transactions through tax havens was less than £2 billon, far less than previous estimates suggested. In a country where the budget deficit looks set to breach the £200 billion barrier, that is little more than a rounding error – less than one percent of the shortfall in government revenues.
In exchange, the British banking system benefits from its relationship with the dependencies. They are used by the British banks to gather funds from around the world, which are then used to bolster the banks headquartered in London. So, for example, in a single quarter this year the dependencies provided almost £200 billion in net funds to the British banks. If the world was really to clamp down on tax havens the way Brown promises, the UK would be a net loser. It would collect only a tiny bit more tax. Against that, it would lose even more as the British banking system became less profitable – and so paid less corporation tax.
Nor does the secrecy charge have the weight you might imagine.
The Tax Justice Network’s ranking of the most secretive financial centres makes for surprising reading. Right at the very top of the list is Delaware, the US state routinely used by American corporations as their place of incorporation because of its pro-business legislation. Britain came in at fifth place, whilst Belgium and Ireland also featured in the top ten. Jersey didn’t make the top ten, nor Liechtenstein. Monaco was right down at the bottom of the list, ranking as one of the most open financial centres.
When you examine the evidence, it turns out the tax havens aren’t costing much in the way of lost tax. Nor are they particularly secretive.
There should be nothing in that, of course, to surprise anyone who actually knows how the financial system works.
In reality, the offshore centres are doing two things, both of them perfectly legitimate.
Fiscal systems around the world have become progressively more and more complex as governments attempt to squeeze impossible high amounts of tax out of the system. It is hardly a surprise that in an increasingly globalised world, companies choose to route their business through centres where taxes are simple, low and straightforward.
And they provide an alternative for people who object to paying the high rates of tax that governments in most of the developed world impose. People may or may not approve of that: but in a free world, it is surely an individual’s right to base themselves somewhere where half their income won’t be confiscated from them every year if that is what they want to do.
If they were really serious about cracking down on tax havens, Obama would be dealing with Delaware, and Brown would be hammering the City. And they would be a lot more honest about how their own policies have helped fuel their growth.
But then it is easier to launch attacks against scapegoats. And if they didn’t pretend they could raise more tax by plugging loop holes, they might have to start telling people how they planned to fix their deficits.

The Credit Card Crunch

In The Spectator, I've been writing about the credit card crunch. In many ways, that is the nub of what the credit crunch was all about: lending too much money to people who couldn't really afford it, then hiding all the loans deep in the financial system via complex instruments.

The MBA Scam.....

In my last Money Week column, I've been looking at how much blame we should put on the MBA course for creating the credit crunch. Here's a taster....

There have been many different culprits put forward for the credit crunch. Greedy, bonus-chasing bankers, asset-inflating monetary authorities, and bubble-blowing politicians have all, with some justification, been blamed for the worst collapse in the global economy since the 1930s.
But perhaps we can pin it all on the MBAs, those clever, impeccably trained young men and women, babbling jargon, and flashing power point presentations, who in the last decade have taken over the world’s leading banks, our biggest corporations, and increasingly government as well.
Some of the main MBA factories certainly seem to think so. Indeed, students at the prestigious of them, the Harvard Business School, have now launched what they call the MBA oath, a managerial equivalent of the Hippocratic oath, which tries to make sure the graduates don’t repeat many of the mistakes made over the past year.
The trouble is, the oath looks like yet more of the kind of meaningless waffle that the MBA has itself been associated with. There is no doubt that the way the global economy is run needs to change, and there would be few better places to start reforming it than with the education system. But if they the Business Schools want to contribute to that, they need a code with real teeth, they need to change what they teach, and how.
Indeed, the mere fact the oath has been launched at all raises the interesting question of how far the MBA can be blamed for the global economic crisis.
Certainly, many of the people who steering our leading banks so calamitously onto the rocks had received the best business education that money can buy.
Andy Hornby, the man in charge of HBOS when it collapsed, had been trained at Harvard Business School. Peter Wuffli, whose management of UBS was so reckless he practically bankrupted Switzerland, had been to that country’s most prestigious business school. Richard Fuld, the man in charge of Lehman Brothers when it went pop was another MBA. So were most of the leading players on Wall Street that led the financial system into crisis last year.
True, to some degree an MBA is just a stepping stone. But if a pilot school was resulting in that many crashes, we’d be asking some touch questions about what was being taught. There is no reason why the business schools shouldn’t be subjected to the same kind of criticism.
It is not hard to see the flaws in their methods. Over the last two decades, the business schools pushed a quasi-scientific approach to business that has turned out to be catastrophic. They have taken something that was essentially unknowable – risk – and persuaded a generation of bankers and managers that it could be easily quantified and traded away. They failed to teach people about the whiplash of the business cycle, and they bred an over-confidence in their methods that in many cases turned out to be fatal. The one thing most bankers needed to take into work was humility, but they weren’t learning much of that at business school.
Worse, they have ramped up expectations unrealistically. Graduating from an elite business school won’t leave much change from a £100,000. With those kinds of debts, students don’t have much choice but to get on the banking, bonus treadmill. There was a bubble of inflated pay-outs, private jets and lavish contracts at the top of business, and it started inside the MBA schools. Even if it unfair to blame the MBA for the credit crunch, the course has still become synonymous with a greedy, asset-stripping, bubble-inflating approach to management.
It is hardly surprising that at least some of the business schools think a re-balancing is needed. The oath makes a start. You can read the whole thing at mbaoath.org, but its starts: “I will act with utmost integrity and pursue my work in an ethical manner’: and continues “I will manage my enterprise in good faith, guarding against decisions and behaviour that advance my own narrow ambitions but harm the enterprise and the societies it serves”. It then carries on in much the same vein through eight core principles.
There is some recognition of past sins in there. Not many bankers could put their hands on their hearts and say they have always put their company and the wider economy ahead of their own self-interest. Nor could every company director honestly say they have always presented their financial data with complete honesty as the code will now require them to do.
But it is hard to escape the suspicion the pledge comes straight out of the textbook titled ‘How to Re-Brand a Tainted Product’. Most of the clauses look like the kind of guff we are used to seeing served up in the corporate social responsibility pages of annual reports. It is hard to take seriously a promise to “create sustainable economic, social, and environmental prosperity worldwide.” It is just words, designed to make the person reciting them feel good about themselves.
If the Business Schools were serious about reform, they wouldn’t go for a quick re-branding. They would re-engineer the product from the bottom up.
The MBA courses need to change what they teach and the way that they teach it. There should be less emphasis on financial engineering, and more on real engineering. They should be less emphasis on slick marketing, and more on building decent, good value products. They should drop the pretence that anyone with the right sort of MBA can be dropped into any company and run it properly, and put more emphasis on the enduring culture of a company that has been built up for decades.
At the same time, they might like to cut the fees so students weren’t burdened with such massive debts that they can only pay them off by working for an investment bank. And they should start reminding their students that risk can never be eliminated in business, merely planned for; that the business cycle will always re-emerge, and catch out anyone who hasn’t prepared for it; that mergers and de-mergers are just an expensive distraction from actually creating products; and that the best companies are built patiently over many years by people who love the product, not assembled overnight according to a textbook.
If a generation came out of business school equipped with some of those lessons, who knows, we might even avoid another credit crunch.

Bankers Bonuses

Back in January, I wrote a column for Bloomberg suggesting that bankers at firms such as UBS and Morgan Stanley should be made to hand back their bonuses. The argument was fairly simple: the deals had gone pear-shaped, and so they didn't derserve the money. The column took a fair amount of flak on some of the financial blogs. So I'm pleased to see that the UBS is reported this morning to be planning to re-claim some of the bonuses it paid out in previous years. Good for them. It is time investment bankers learnt that bonuses aren't just free money. You actually have to earn them.

Top of the Pops

One of the thing I enjoy about writing for electronic media is that you can see clearly waht people want to read about. My Bloomberg column on the return of the MBA was, I see, the most read story on RealClearMarkets.com yesterday. It got a lot of hits on Bloomberg as well. I guess a lot of bankers out there are thinking about what to do next with their careers.

Krugman's Nobel Prize

The decision to give Paul Krugman the Nobel Prize in economics is the surest indication yet that the world is starting to swing away from the neo-liberal economics that have dominated the world for the past the three decades. I interviewed Krugman once, and I liked him. He's an intelligent man, and his column in the New York Times is always readable. But he is, for an economist, extreme in his anti-market views. The credit crunch is going to make that fashionable. But I suspect we'll pay a price for it in the long run.

Russia Doesn't Nationalise It's Banks

Among the many ironies of the credit crunch, this one probably deserves more comment. About the only major economy that isn't nationalising, or semi-nationalising, its banking system is Russia. The Government is supporting it's banks but not looking for control in return. Maybe because that is because they know what a state-controlled banking system is like.

Gordon Brown and HBOS

I womder if it was wise for Gordon Brown to invest so much personal capital in the Lloyds TSB rescue of HBOS? The markets are turning rapidly sour on the deal, and it still has to be approved by the Lloyds shareholders. Which way will they vote? I don't think the fact that it will be a terrible blow to the Clunking Fist if the deal fails will persuade them to vote in favor. Quite the reverse, in fact. Putting himself in the hands of the Lloyds shareholders may yet prove another terrible error by the PM.

Lloyds and HBOS

I wonder if the Lloyds-HBOS merger might not be Gordon Brown's legacy - it certainly looks to be the only thing of significance he has done so far as PM. But it won't be a happy one. In effect, he has allowed a private sector monopoly to be created. That's great news for Lloyds shareholders, but bad news for every one else. Brown clearly understand that competition is vital for a free market - so much for the great economist! Naturally, there were plenty of alternatives. The Treasury could have just said it would buy every HBOS share available at £2. That would have burnt the short-sellers and stabalised the share price. Instead, he panicked, and created a mess that will have to be unpicked another day. I don't think the public will buy into his 'I saved the economy routine.' In time, they will just notice that Lloyds-HBOS is acting a predatory monopolist and know who to blame.

What's Bear Worth? Nothing.

Felix Salmon is pointing out on his Portfolio blog that Bear Stearns is still trading at more than twice the price JP Morgan (or rather the American government) is paying for it. And it's true. It's quoted at $4.81 this morning, compared to the $2 it is being sold for. Clearly, some people in the market think the JP Morgan deal won't go through. They are betting the bank can be revived. Now, it may well be true that Bear is worth a lot more than $2 and JP Morgan is getting the steal of the century. But investors such as RAB Capital thought the same about Northern Rock in Britain, and they ended up losing a packet. Once a bank has to be rescued by the government, there is no point in betting against the deal.