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Nationalisation and speculation: where will the dealers go?

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Paul Mason | 13:32 UK time, Monday, 8 December 2008

There's a lot of noise about nationalisation. John McDonnell is calling for it. John McFall is threatening it. In fact there is a momentum towards further state intervention and even ownership in the current situation that is coming from outside politics and is driven by the crisis of the banking business model.

Banking adopted its high-risk business model in the 2000s because its old business model - driven by flotations, mergers and privatisations, had faltered. Strip out leverage and securitisation and banking profits in the years to 2008 look meagre. Likewise much of the off-balance sheet finance was designed to get around the Basel II regulations: if you actually make the regulations effective - as the G20 leaders promised to do - much of the bloom goes off the finance sector. Further, if you close the loopholes in the global system - the offshore tax havens - the opportunity to speculate is massively diminished.

The paradox is, even by you stick to the present regulations, all the momentum is in a direction that makes the old banking business model impossible to revive; in fact it lies in the direction of a more permanently socialized banking sector - or at the very least a "mixed economy" with large parts of the system run by the state. One senior banking analyst told me, in December 2008, that we will

"...end up with banks that are essentially financial utilities; investment banks that are more Lazard than Lehman; and with a public lending institution of some description."

A number of conversations with senior banking, legal and hedge-fund managers have pointed in the same direction.

At the heart of the Basel II treaty is the concept of capital adequacy. It is a concept that makes even senior editors groan every time they hear I am going to talk about it on TV, but it is a concept that the future of the system revolves around.

Banks have to match the risks they take by holding a certain amount of capital (see my report on the current capital problems below). The more capital they hold, the less profitable their operations - because the rate of profit is calculated against the size of your capital. The original Basel II treaty set a hard capital ratio at 4%: the total value of the banks shares, known as equity, had to be at least 4% of the size of their loan book. This is known as a Tier I Ratio. Many banks were able to "game" the regulations by shoving loans off their balance sheet into arm's length companies, so they could hold onto less capital. Now they cannot, that 4% limit becomes important. But it's no longer 4%. In response to the crisis, national regulators have imposed higher capital ratios.

The British government imposed a 9% limit by agreement during the 13 October "second version" of the bank bailout. The French government did likewise. Nobody in the banking world knows what the new, permanent replacement for 4% will be, but if it is anything like 9% this means permanently lower profits for the banking sector.

But that's only one problem. The second problem is that banks will become more risk averse. Modern regulation relies on the banks calculating the risk side of the balance sheet in good faith, with sophisticated computer models based on data. One senior corporate lawyer told me:

"If you go back beyond ten years all you have are paper records. Helpfully, all the digital data they relied on was accumulated in the boom years. In the next 12 months we will have very accurate data about what a crisis looks like and that will have to be factored into the models. If a banker tells me there's a 99.9% chance this will never happen again, I say to them: let's see in a thousand years' time - because 99.9% certainty is like saying this will never happen again in a thousand years."

A combination of regulators shutting the stable door, and the new availability of negative data will push banks into raising so much capital that they will seem overcapitalized. Their profits will look meagre.

On top of that, there will be new limits on their profitability from outside the traditional form of banking regulation: competition law, temporarily ignored during the crisis months, will dictate that the huge banks created by the process of merger and collapse must face tighter protection for their customers. Bankers dealing direct with savers and borrowers expect to face a series of controls on their profits; standardization of their products; with forced transparency replacing the opaque pricing models they rely on to maximize profits.

Actually we have a long experience of what happens when you have companies that cannot make money and form a natural monopoly, essential to the functioning of the rest of business. They are called utilities. Many industry people think banking is now about to become just like an energy or water company: heavily regulated, low profit, oriented by law to achieve a social aim not a financial one.

This prospect has already got some in the banking industry so depressed that they are predicting the mass departure of the teams engaged in the high-risk parts of the banking business, into the hedge fund and consultancy businesses. One senior figure in the industry told me:

"Once they become low-profit utilities, I don't really care whether they stay in the private sector or are nationalized - they're just doing the same thing."

In short, reality is pushing the banking industry towards a utility-style solution. We have already had the Minsky Moment (which I blogged about); it is clear that some governments may be forced towards the Minsky solution: a state owned asector of the banking system. Paradoxically, there is even tacit support for this emerging within the sector itself. If the old investment banking model is toast, then the wheeler dealers will look for a role outside the traditional banking system in a revamped "speculative" sector. From Lehman to Lazard one can imagine; from Bank of Scotland to "Scottish Money" (or British Building Society)? Stranger things have happened in this crisis.

Watch: A capital problem

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(broadcast 4 December 2008)


  • Comment number 1.


    I believe the ancient Chinese had a concept of 'reality'; a reality that one relinquished at ones peril?
    They seemed to manage a high level of culture and science, nevertheless.

    Might it be that the 'Western' model is so UNREAL (the lie within which we now attempt to live) is such that only congruently unreal banking can accompany it?

    It really DOES look as if the centre cannot hold.

  • Comment number 2.

    ...It is a concept that makes even senior editors groan ..

    yes as noted before its an example of the financial illiteracy that has led to this crisis. the 4th estate doesn't work for the common good but for performance targets ie ratings.

    one could always sex it up. and its pretty easy to do. dress like bond and do reports with offshore tax havens, gin palaces, penthouses, skimpy dressed tanned bodies drinking cocktails. Those not interested and soaking in wine as they watch can look at the outfits and furnishings. That way you've got something for everyone.

    as for the banking sector.

    banking is about stability not profit. Profit is a function of risk. So where there is big money there is big risk. who makes big money? people who invent things. who spot markets with growth potential and leave before its saturated and copied.

    the power of the west is the power of fractional reserve banking. the ability to make money out of nothing then lend it to create empires or if you like enterprise.

    i read a report that ex traders were the brains behind the somali pirates? your average fisherman/pirate would need someone else to 'think and deal big' ? Like dealing in oil tankers?

  • Comment number 3.

    Glad to see you got in here first Barrie and had a dust down.

    "a social aim not a financial one"

    Well isn't that what banks and every single other service, business, organisation and individual should have had in the first place.

    Proper sustainable environmental and social aims.

    When 'things' only have a financial aim, they are divorced from the real reality, and then we have the problems we have.

    Real reality is not the one invented by politicians, capitalism, business and media.

    Somehow we are stumbling towards the correct path. Only by default when what is wrongly tried doesn't work.

    Will politicians also get there with an end to ego and pointless self aggrandisement.

    Celtic Lion

  • Comment number 4.

    Would be good to see a report on how a nationalised banking sector might function: with regards lending policies, fulfillment of social goals (keeping people in their homes, flexibility with repayments, etc.)

    Though such a banking sector would for the most part operate on a commercial basis, could this mean refusing loans to businesses with poor records on the environment, workers rights, and consumer protection?

    Might a breakup of the nationalised banking sector be in the form of regional mutuals, rather than a return to private banks?

  • Comment number 5.


    We are all aware of the rhyming slang derived from 'banker'; it has just dawned on me that 'banking' is one letter from 'barking'.
    Might there be an element of 'The Bible Code' here? A warning sent down through time from the dawn of language?

    I'll get me diploma.

  • Comment number 6.

    Hi Paul,

    Interesting article, just one point...

    The value of a bank's shares does not equal its Tier 1 ratio. Rather, the value of a bank's shares represents the market's valuation of the shareholders' equity within the business. If a bank's share price falls by 50%, all else being equal, there will be no change in the bank's capital ratios (although it could be inferred that the market is predicting future falls in the capital ratios, amongst other possible problems)

  • Comment number 7.


    This is my post from An Economic Krakatoa

    Which I titled, Betting in the Global Casino.

    2 months ago I bet, if nothing else my reputation, that nothing all the world leaders, economists and other experts Newsnight has featured on the programme since would be able to resolve the situation.

    See I was correct.

    It wasn't really a bet, as in odds of a random situation occurring. It was a 100% certainty that I wouldn't lose.

    As an engineer the first thing to do is establish a datum of what would work. Then assess the alternatives against that. The further the disparity the less chance they would have of being successful.

    Probably would have been better just to ask me what the original datum was 2 months ago, rather than the waste of time and money show casing the doomed to failure schemes Newsnight has focused on.

    Celtic Lion

  • Comment number 8.

    A Services (GATS) deal in the Doha trade talks next week (all eyes are being directed to Agriculture and manufacturing, Services kept below radar) will prohibit actual nationalising of banks and anything else, regardless of how much money is poured in.

    Maybe that's why Brown is the foremost proponent in the world for these talks. It gets him out of the liberalisation backslide.

    But - as usual - the media are missing the boat, in this case the big picture

  • Comment number 9.

    Nationalise the housing crash? Well, we'll pretend to consider it.

    America had a socialist system of housing: fixed-rate mortgages for the lifetime of the mortgage, and that rate suppressed by
    the credit rating attached to a government-backed loan-making entity.

    But this essential, limited purpose (housing for low-pay workers) was derailed by the decision to elevate the size of the mortgage eligible to high, six-figure sums (which would be a mysterious style of living for low-pay workers).

    That meant that a mild cross-subsidy was converted (in the absence of a substantial pool of non-claiming taxpayers) into a
    national liability.

    In an era of sound money, and the mini-epoch of loose money which followed, this involved no great additional expense. To
    this day, the liability remains inoperative. Interest rates are too low.

    Where did Fannie Mae go wrong? Solely, the expansion into assuming the risk of loaning large amounts of money into a precipitately high-priced housing market on the brink of a correction.

    This US correction was based on:

    (1) the active depression of wages impelled by uncontrolled immigration, the mothballing of blue-collar industry,
    uncontrolled technology transfer and massive, expensive investment of the post-Cold War 'peace dividend' into the plant and machinery located in Communist dictatorships.

    (2) the active depression of the jobs market impelled by the same forces as above, excluding immigration.

    The aetiology of the correction in the UK market is not as pertinent as the fact that it is imminent.

    The desire in the private sector for "nationalisation", however short-lived an enthusiasm, is built on:

    (1) the imminent return of house-prices to their long-run average of a 2.8-3.5 price to income ratio.


    (2) the fear of the imminent return of house-prices to...


    (3) the wave of re-possessions and loan defaults pursuant to the wave of unemployment and short-time working hours devastating the purchasing power of the world's greatest customers (measured by personal indebtedness).

    The only item that would count against a specific 2.8-3.5 ratio as the floor to be reached would be the advent of the
    double-income family. Along with the super-incomes peculiar to certain classes of employment, this had the obvious effect,
    over time, of inflating selected commodity prices (housing) rather than boosting purchasing power, as it did initially (prior
    to market adaptation). But a broad swathe of unemployment and restrictions on working hours, overtime, and company profits for those in continued employment can be counted upon to produce the level of defaults and buyer caution necessary to move housing prices closer to a level demanded by "fundamentals".

    House prices are an issue, but loan defaults are the critical stress factor. Re-possession is secondary due to the existence of various schemes (anecdotally, debt collectors report that for years banks have been quietly becoming landlords in upscale areas, and in these cases accept rent in lieu of loan re-payments. This quiet recession (or gross spending overhang) amongst outwardly prosperous individuals and families would suggest a long-standing problem of over-priced housing and over-stretched household budgets - the surge in pawnbroking business corroborates the trend which showed up earlier in these reports.

    These measures were evolved to suppress public awareness of the building problems in the pricing of accommodation and housing stock.

    Alongside the entirely upright end of the relief of familial distress, this also made sound business sense. It was a careful
    handling of a difficult situation for all parties, but it had the effect of deadening the nerve of public awareness. And the
    housing boom went beyond its natural lifespan.

    The housing boom cannot be stimulated further. Or price levels maintained. It cannot be done. And I believe they know this.

    "Nationalisation" is an exit strategy for every red-braced City shark that ever operated in or near the securitisation

    There are caveats and necessary details to attach to any proposal for an ab-initio, clean, freshly capitalised banking entity
    (whether regional or national, whether a singular journalist-plagued behemoth or a more workmanlike Fannie Mae/Freddie Mac
    duality or a more market-aligned plurality of joint ventures with each joint venture associated with a private bank).

    The issues go beyond the expected ones arising from the political management of absorbing a massive, intrinisically private

    Foreign contracts. Corporate donations. Conflict of interest rules, which would apply (de jure or de facto) when every bank
    has the same owner. Take that Halifax-Treasury. Right back at you, Abbey-Treasury. Hmmm, price wars for consumers or dividends for limbless ex-servicemen?

    It would challenge Solomon. We Abbey-Treasury think your company is an excellent bet. We at Halifax-Treasury also think that your major competitor is also a born winner. Let's put double the money into the same
    race, shall we? "ComBankSol". It is the classic dilemma of the overbearing Soviet system. Do you shoot the cow or the
    cowherd? Thanks to the certainties of the Soviet system, starvation is guaranteed.

    There is only one thing worse than
    ripping out alarm circuits and piling up company risk, worse than ignoring the cost of externalities and blithely piling up "social" risk and that thing is pretending that interdependencies do not exist at all.

    Today, we can treat PanAm as a legal
    fiction that outlived its usefulness. We can turn on British Rail, the Royal Mail, the Ordnance Survey, British Telecom. On
    the Tennesee Valley Authority. But frequently the successor institutions are impossible to regulate to any greater degree - while the focus is upon ownership and power rather than decisions and rules. And it is the interdependencies between these factors which dictate outcome rather than pure ownership questions.

    And it is not that a "ComBankSol"-sourced corporate donation to a political party is the only flapping, loose piece of out-paced regulation, nor that the issue could simply be re-regulated for present circumstances. What could possibly police the influence of corporate 'spend' on TV advertising over current affairs coverage? Not including fees for after-dinner speeches to political notables and political and economic commentators (Are you SURE we are in a depression caused by corrupted regulatory oversight? We'd love to have you after the shrimp).

    To compare the dream with real-world experience, in which parallel universe have tightly-regulated Mr Big water utilities
    wheeler-dealing in the high-tech, rollercoaster world of rainwater tanks and tube-pipes been made low-profit and socially concerned? Is E__ or whatever it is called the village dunce of globe-trotting mega-corporations?

    And this might matter in business: confidentiality. Imagine the preferred bank of the ideal Conservative donor, CEO and
    founder of his own electronics firm/pizza chain/biotech company, his company finances spiking and flat-lining on the
    "business intelligence"-enabled dashboard of a S___Point server (or any leading brand of BI provider) linked to the desk of a
    Labour-appointed civil servant fresh in from a rival firm in the private sector and fast-tracked in the new cross-pollinated,
    T-shirted civil service.

    I would only advise caution.

    There is absolutely nothing routine about investment. Check out the venture capital guru who turned down Microsoft, Compaq,
    Federal Express, etc. His refusal list looked like the Fortune 500. Overall, the semiconductor industry has lost money over
    its existence. Individually, there have been spectacular successes. Japan, deflated or not, is the second-largest industrial
    economy in the world, and the world knows that Sony's first product was a rice cooker, and it didn't work. Japan did not
    develop an undoubtedly brilliantly managed, highly refined electronics industry with cheaper televisions in the 1980s. It
    developed an undoubtedly brilliantly managed, highly refined electronics industry with subsidised televisions in the 1980s.
    High-value manufacturing is what experienced manufacturers can strive towards. Exclusively high-value manufacturing is what over-specialised novices will not have the remotest chance of cross-subsidising financially or accomplishing technically.

    So you consult for advice. A Goldman Sachs economist discussing one matter will admit an efficiency premium for experienced
    manfufacturers. They have actually quantified it. A World Bank offical will demonstrate that wages are the single lowest cost component of a high-tech industry. Discuss setting up a high-tech plant on a Krygistan salt-water flat and what will you hear about? Wages. And superior efficiency. That is not a thicket you want to send your average city councillor into, however fine a public servant he or she may be.

    And, realistically, only wealthy, established institutions and people with secure incomes will take the largest, rational risks. Undercapitalised boutique banks will take lunatic risks for the opportunity of unearned income. A pensioner may have a
    fixed income, derived from a lifetime of work, and take very little risk.

    A State bank would have to be eclectic and work within a highly specified remit: insurance (farm, factory, home, holiday), deposits (overnight, long-term, on-demand), pensions, stocks, bonds and/or foreign exchange? SMEs? Industrial development? Because the mortgage market is dead. The mortgage market carries no foreign earnings or export potential.

    The mortgage market, in all its undimmed, full-throated capitalist glory, is essentially re-distributive for all that it can affect the character of a nation (visiting property-owning respectablility on the revolution-prone, muttering garret-dweller). It redistributes between estate agent, borrower, lender, and builder. But, repeat, it carries no foreign earnings or export potential.

    A single-issue sugar-daddy will be cut down in two years flat. Banking profits across the sector are down, not because of a Czech Communist regime of price control and party directives, but down because of an economic downturn. Whether there is an upturn really depends upon sensible trade and industrial policy in the United States.

    I agree to a huge degree with the analysis. I see very little future for high-risk specialists that aren't called venture
    capitalists. Or investment banks. And we know how that works. Reinstate Glass-Steagall (and additionally specify the
    regulatory interpretation of it that prevailed pre-1980s). And break up the "too big to fail" operators in domestic finance and retain the takeover rules necessary to compensate for any consequent "digestibility". Place a moratorium on the demutualisation of building societies. Regulate --building society-- executive pay to prevent them becoming infected and possessed by the same conflict of interest between management and owners. And prohibit commercial lending exceeding a certain
    below-industry-average percentage of building society business. This will cost building societies and affect their
    competitive position vis-a-vis banks, but it does create a reserve list of capitalist minutemen which can be relied upon to
    be available and operational when others are not. Begin the forensic auditing on those that can be saved. Do not prioritise
    the hopeless cases. Auditing should ideally be preventive, not newsworthy. Ban the subsequent employment of audit staff in
    the companies they are auditing - a routine practice for decades at this stage - and regulate for a mix of senior and junior
    audit staff in audit teams. Some senior partners in accounting practices have a habit of remaining at a distance from
    lucrative but fishy clients. It is all the easier to tolerate malfeasance. Upon some points, professional association rules can regulate for this in place of a statutory basis, to prevent Parliament from being required to be a collection of money-mad financial wizards too distracted to defend our liberties and its privileges. Where some prescription is deemed "too strict", apply the strictness to special cases (mutual societies, retail banks) and ensure the publication of intelligible risk metrics on the brave remainder (partnerhips, investment specialists) and ban the participation of special classes of firms (super-private entities who close their books and ownership lists, offshore hedge funds) in specified markets and exchanges (as well as State schemes such as TARP and Mortgage Guarantee Schemes), as well as banning their participation in mixed-character buy-out consortia for listed companies, etc.. We could sink into this enterprise to a degree that is highly
    involving in order to protect the public investment...

    If we must revisit this question, expect an unprecedented degree of acuity and aggression. When we are done with this long list, remember that we still run a trade deficit.

    And remember that the largest bank in the world is Chinese because finance follows industry and, particularly, net export
    earnings. The only rules and measures to observe are the current account deficit and the trade deficit. Equating a dim vision
    of a local building society with a paradigm shift, as some private sector people are, is unnecessary. I don't think it a coincidence that the Austrian School economists which were brought to our attention on this blog came from the world of Freud and the Creditanstalt bank collapse.

    Recall that the Austrians carried on an exquisite post-Imperial existence until the Creditanstalt banking collapse finished
    their political independence until the end of the Second World War and triggered secondary waves of the global banking
    crisis. The Austrian school had a vivid experience of lingering decadence and precipitate collapse.

    Are we buying up losses? Check rising default rates - entailing very present losses - and model for imminent losses. What is the return on three million unemployed and 90% mortgages in a property market that could be 20% further down? As well as making our own imprudent loans which will similarly incur losses. Admittedly, this type of loss, however eye-poppingly large,
    will never come to matter financially because if we buy up outstanding loans, or buy up institutions holding outstanding
    loans, or insure or guarantee outstanding mortgages, we will already have been wiped out by the losses due on yesterday's
    loans. Loans from the dusty, black-ribboned ledger we are now invited by City insiders to scoop up from the private sector and bring home like a drunken aunt from a house party.

    The losses are not disappearing.

    Nationalisation and/or the even more damaging Fannie Mae-style underwriting of tonnes of private mortgage debt could deal a killer blow to public finances already deranged by IT projects (50% of one tranche of the Blair Years increase in the "NHS" budget), PFI, and the rental (??) of miscellaneous defense labs, military bases, and satellite radio communications. Floor mopping, book-keeping, filing, exam marking, traffic cameras, and thinking (consultancy) have all been expensively privatised.

    Attaching a profit margin onto floor mopping, or any margin above simple wages, was an ingenious way of simultaneously legalising Jim Crow-era graft and Dickensian-era worker protection. Unless it truly is to encourage innovation and risk-taking in the field of mopping.

    Nationalise the tottering loan-book? Rather than a solution, nationalisation would more resemble standing under a tiring elephant.

  • Comment number 10.

    Martin, you need to get out more.

    Paul, I thought of you while reading about Shriti in the FT this morning, glad job I kept a tab open. :)

    I seem to recall saying much the same thing in response to your, "5 things to fix the financial system" request.

    What I think is likely to be more interesting, is what happens to the nature of consumption in the West. Everyone is banging on about credit, as if it was every man's right and duty to borrow in order to spend. The Asian's have never understood that, and the deeper I've gotten into the underbelly of the Western Financial system, neither do I.

    Personally I think that this is going to be a hundred year storm, just as as was the Great depression. I think 2009 will be seared across the memories of those currently living for a long while, and saddled with debts they cannot easily repay they will be in no hurry to resume spending on luxury tat.

    You can see this in the Chinese import figures, They fell off a cliff, largely as I understand it to do with import of raw materials, the feed stock of the products they export to us. Only we're not buying.

    I think China is going to key to all this, luckily we have Brad Setser, and of course you.

    You're doing a great job, keep it up, blessings of the season to you and yours.

  • Comment number 11.

    I agree praxis. I would like to see some mention of long wave theory in all this. The 50-60 year theoretical amplitude of the wave is pretty well precisely in accord with what is happening. We had the primary short recession in the late 70s, early 80'safter the long upward wave and after that an asset bubble supported autumnal boom in the 90s and early noughties which has now crashed into the traditional winter recession. My reckoning is that this will last some time, pulling down the economy until about 2020 (with the usual ups and downs of the business cycle taking place during that period) before we see another long upward boom like that from 1949-1979. Of course there are similarities with the last time this happened. The 1929 crash didn't really clear until 1949 but we had a massive war which provided the basis for recapitalisation that time. The shake-out of asset prices and reductions in wages will have to be similar this time but of course also the technological base of the economy has also changed, making it difficult to predict where the next boom might come from, but it will probably be some 4th wave of technological and informational innovation not yet fully developed. It's just a question of what happens between now and then really. But it's batten down the hatches time for now.

  • Comment number 12.

    To be honest with you I think TA is voodoo. I know some people will try to fit exceptional historic events, WW1, 911, etc. into a wave like narrative, but I don't think you can really apply that to human behaviour and psychology.

    But each to their own :)

  • Comment number 13.

    Interesting, Paul, but I'm afraid that waht you've written here ...

    "The more capital they hold, the less profitable their operations - because the rate of profit is calculated against the size of your capital"

    ... is not a very good explanation.

    The reason that providing more by way of capital adequacy impacts on profitability, is because the pot of money called for by the adequacy rules must be held in the form of liquid and risk-free assets (like government Treasury bonds). These, of course, yield a very low rate of interest (the so-called 'risk-free rate') - much lower than the 'cost of capital' to the bank (i.e. the rate of return shareholders expect to get on their equity).

    So greater capital adequacy - either through greater risk-taking, or greater regulatory requirements - ties up more of the shareholders' equity in this unappealing manner.

  • Comment number 14.

    #13 Citizen Thompson

    "but it will probably be some 4th wave of technological and informational innovation not yet fully developed. "

    The technology is to generate the next wave. There is historically a resistance to new technology. Herein lies the problem of the present.

    The 4th wave may be incompatible with a culture which has generated the present crisis.

    The technology and ability to generate the 4th wave exists.

    Celtic Lion

  • Comment number 15.

    #10 I know. And I'm doing it again. I blame it on the cold snaps discouraging me from venturing out from my survivalist log-cabin (built out of beaver-tails, you know).

    That, and the sky falling, discourages me from inattention to detail...

    Regarding capital adequacy rules, what is the overall financial difference between Scenario No. 1 (trillion-pound bailouts and utterly mindless Basel-I and Basel-II and the putative Basel-III rules)? And, on the other hand, Rooseveltian regulations?

    Basel-I, Basel-II and Basel-III need mainframe computers, real-time data being piped into quants devised by Paris-based collectives of mathematicians and information technology management frameworks like COBIT, ITIL, CMMI, Prince II (I think the SEC in the United States favours this variation), COSO (the EU pick), ISO17799. Ringing phrases like "Focus, execute and enforce"...

    And they don't work. Because substituting a leverage ratio of 10 for one of 25 still means "game over" when you lose your bets or your financial backer. Being bankrupt to the tune of 700 billion dollars instead of 1750 billion dollars is practically meaningless. Newsflash: Beyond the value of the desk furniture, the modest to enviable share portfolio in sensibly managed companies, and the expensive breed of albino goldfish on display in the lobby area, no-one is getting paid. But the capital adequacy ratio in Basel is not based on a straight leverage ratio. And it is not based on "Risk", but on how relatively risky an oil future in Brent Crude is compared to a pork belly future in Chicago. Does anyone know what the risk triangle says about the conditional expectation as between a refinery fire and an outbreak of swine fever in the next twelve months? And they bin and basket thousands and thousands of these distinct products, instruments and circumstances into risk categories? Measured with their own specialist industry models? And cover with --international treaty-type law -- evolving and multiplying financial instruments P.T. Barnum hadn't thought of?

    While Rooseveltian regulations can be summarised as 'If you are a retail bank, don't do it. If you do do it, don't come crying to me'. Which would we have preferred to have had over the past decade? A marginal cost attached to properly regulated economic activity and the odd shallow recession? Or cheap action in the business world, a world depression and a trillion pound bailout bill? Which is more efficient and pro-business? World depression or line item expenditure?

    By all means, publish where they stand in respect of these measures. But, in my view, if you want to lend your money to something so highly leveraged, go ahead. Caveat numbnut.

    Basel wasn't worth anything in the run-up to this crisis. And it won't be worth anything long-term, either. Why do we now apply it though?

    Because it is a feedback mechanism. Particularly, just as has been so well-described here, money that goes in must then go out again. Precisely.

    It's called control. A positive feedback mechanism is where you constantly make inputs and watch the output rise and rise out of bounds. A classical example of a positive feedback mechanism from medicine and physiology? Cancer. Let's blow away the requirement to study 150 years' worth of control theory. Positive feedback mechanisms are bad.

    Life is a negative feedback mechanism. These banks have been placed in a negative feedback mechanism.

    A business can be profitable over a set period. We'll pick a year. Profit is a net positive at year-end. Going cashflow negative at any point within that period --without credit-- will sink you before you collect your overall net profit.

    That is why the "contradiction" of borrowing after a borrowing binge makes a hint of sense. On these narrow, academic terms. Expect a wild-eyed, long-term borrowing facility to be abused senseless. That will need to be shut down. But lending on a short-term basis to a potentially profitable, cashflow-negative business can make sense.

    And that is what is happening. A large amount of money has been moved in. The "contradiction" is that a significant fraction is being repaid at regular intervals. You can call the injection dramatically loosened collateral terms, inter-bank lending guarantees, preference share capital. You can call the payout in installments "contradictory", "negative", an "outflow", whatever. It is just a re-payment of a --proportion-- of what is being poured in. On arbitrary, flexible terms. And, in a crisis, I think banks should appreciate arbitrary, because they won't like the textbook approach (which would have left them as roadkill months back).

    The payment marked "In" has a thousand bases. Terms. Mechanisms. There must be fifty different schemes operating in parallel, all put in place by the authorities. Put the annual/monthly/etc. repayment of a fraction of this under whatever rubric you want.

    And, for this, the Basel "brand" is being used. That has turned an outgoing expense - an unavoidable outgoing expense - into a conferral of soundness and propriety. Helpful if you would still like a credit rating worth spit in the big, bad world.

    Does the industry really want to argue against this? That might have influenced the choice of Basel as the broad operating label for closing the loop. Liquidity push. Liquidity pull. Loop closed. You have to hand it to them in the H.M.G. base-camp. Smartly done.

    When you marry cashflow considerations with profit considerations, that explains some of the "contradiction". For the rest of the "contradiction", consider: What is the textbook time-lag on oil-price shocks? 18 months? When did oil creep above 60 and start paddling over the big 1-hundred line? There is no way that the responsible authorities were going to stake the kind of shuffle games that can be played with client deposits and stagnant cash pools. Asking for regular liquidations complicates certain classes of dealing, there is no doubt - dealing which was complicating everyone's way of life.

    Preference share capital isn't the half of it. 12%. On the face of it. Based on a principal sum owed to the State of what size? And do we account for the myriad of supports and favours? For their economic value? Assuming we faced any kind of a loan guarantee scheme put out and struck at a 100% level, and including fees, I seriously doubt if we could keep the net overall return on the capital injected up in the positive single-digit realm. Well, you know what will happen. You will sigh for the days of a 100-billion pound deficit.

    50% chaps? A Nobel Prize in the 1990s was handed out for explaining - a little unnecessarily, I think - why the insurance industry converged on a practice of insuring only up to a certain percentage of all that was placed at risk.

    That way, when Ministers of the Crown are tramping around in wellies canvassing at the doorsteps, all the credibility and respect the Chancellor and his team garnered in October won't have been carried away in a flood of business "liquidations" after collecting their Government- guaranteed "investment" loans.

    Do you like your Minister? Do you know he needs to land on a mat marked business loan support? And you --know-- he needs to back this up with results-down-the-line? The Germans have shown you how fast this can turn. Gilt sales have shown you how fast this can turn. You need more than anything the credibility, the authority, and the respect that comes from being scarily proficient and kung-fu prescient. Not having a string of itsy, bitsy "bathroom fittings" shell companies indiscriminately burning through a cashpile (and, for all we know, snowglobes paid for with these loans) and just winding themselves up at cash-call time?

    You want to get results for your country. And a measure that will get "today" tidied away and keep "tomorrow" on-track (for when "tomorrow" will turn up as today).

    You've been doing this for a long time. You've seen it all. You also want to land on a mat that says no "Tax Hikes to Pay For Billion-Dollar Dud Bailouts" to chat about at PMQs? Guarantee someone handing out up and down the country what they in, say, Manchester will know better than you are dud loans? But you still collect Social Insurance and VAT in Manchester? You still want small business to keep decent, hard-working people in the jobs they have put a lifetime into getting good at?

    Solution? Do both. Hit both mats. Drag one on top of the other. And make the financial landing softer and safer.

    The average business in the free-wheeling U.S. takes three years to break even. The average American business owner has been bankrupt how many times in his working life? Three times?

    Either drop it and realise that the dole might be cheaper than a 150,000 pound gamble on every plumber in the Cotswolds. Or refine a loan guarantee scheme to crystalline perfection:

    (1) Guarantee 50% of the business loan that the bank hands out. It (and those well-connected, clued-in private shareholders you have strapped to the bonnet like a stunned moose) carry the rest of the risk for all the loans that the bank will decide get handed out.


    (2) Require the registration of each company that receives these Govt. blessed loans with the brand-new "Employers Business Support Directory".

    50% of the --outstanding-- value of the loan. That way the bank's exposure (relative to your own) doesn't wind down over time as the re-payments come in.

    Put out an emergency Amendment Bill that stipulates that in the the event of bankruptcy, liquidation, administration, examinership etc. for companies registered with such a scheme, a quarter of the loan principal - OK, 25% of the outstanding value of the loan - attaches to the company directors as a personal guarantee.

    12.5% - half - can be reclaimed by the BoE directly. 12.5% - half - goes to the bank. Authorise small-claims courts to handle the matter in the extremity of directors being pursued.

    Vary the percentages, but be very careful overall to enforce the principle of shared responsibility. I doubt that laying waste to the Government credit rating appears anywhere on the Govt. agenda. Keep the economy ticking, stymie the "loan freeze", by all means, but damp down being gamed out of the national wealth. Being a First World country is kind of nice. The alternatives are intimidating...

    Oh, let's use some exciting, illustrative fantasy figures. Does the laxer leverage ratio of Basel-II-pre-sort-of-Basel-III mean that unpaid creditors could lose lose out on an additional 1 trillion dollars for the case of an institution with 70 billion dollars in assets going bankrupt having observed this quasi-Basel at or near the acceptable limits it prescribes? But it's only money! 4%, 10%. I'm throwing in the 10% instead of the 9%, firstly, to hit a fun marker level and, secondly, on the understanding that these guys are of undimmed genius and still know how to massage a balance sheet into a dreamy insouciance.

  • Comment number 16.

    praxis, yes, I must admit I have been resistant to patterning and wave theory in economic history, but the stats (though maybe they are selective too) do seem to stack up. Human intervention can and will, of course, make a difference to how it pans out but the basic need to shake out the generalised crisis of over-production and asset bubble inflation will lead to a long down-turn. Whether you wish to see it as a general theory of fixed waves or just a contingent reality which happens to follow a pattern is, as you say, a matter of taste. I am beginning to move towards the former and a lot of the predictions of those following Long Wave theory do seem to have been correct on the basis of the theory. Anyway, whatever, we are in deep shit.

  • Comment number 17.

    As you say ...

    "The British government imposed a 9% limit (tier 1 capital minimum) by agreement during the 13 October "second version" of the bank bailout."

    However, at the last Treasury Select Committee the Governor of the B of E said that the FSA had not increased the required tier i capital ratio and so banks were free to lend lots more.

    There seems to be a major disagreement between the FSA and the B of E about what the required tier 1 capital ratio is; and also what it should be.

    PAUL - Can you ask the FSA whether they have increased the minimum required tier 1 capital ratio or not. If the Governor of the B of E is right and the minimum tier 1 has not been increased then why were the banks forced to have rights issues to raise more capital?

    If the Governor of the B of E is wrong and the minimum capital ratio has been increased, can you point this out to him so he understands the impact on bank lending.

  • Comment number 18.

    How do demographic trends influence the trajectory of this recession? Only the FT has commented on the prospects for middle age & income Britain. But, current demographics and its trends will certainly guide some of the socio-economic scenarios that Paul Mason and Robert Peston are describing at the moment. Could they elaborate, for us please?


  • Comment number 19.

    Paul, the crisis has only just started.

    Why don't you make a program about the $500 TRILLION + derivatives black hole and explain that this is 10 times larger than the GDP of the whole planet and will not, cannot ever be repaid/ honoured.

    The sub-prime problem that everyone seems to blame for the crises, is only worth less than $2trillion, I believe. It was just a trigger. The real avalanche is still in front of us. As companies and banks go under, the various derivative contracts will be triggered, causing further bankruptcies.

    The true villains of the peace are those POLITICIANS (such as Bush and Brown) who allowed banking restraints to be lifted and who did not outlaw the fraudulent practices of off-book accounting and the creation of a pseudo-insurance markets with virtually no backing for the bets taken.

    The bankers have simply taken advantage of the lack of rules and lack of enforcement of rules, just like most players would do in any game.

    Not that I want to excuse the bas..bankers.
    Perhaps they should be treated in the same way as drug pushers and confiscate any gains by companies or individuals aided by these practices.

    Even more fundamental cause was the wide availability of 'almost free' energy to whole system, which has driven growth for the past century. Now that energy is becoming scarce and expensive, we have a century of decline to look forward to. For more info see and the rest of the website

    The End of Growth combined with human population something like nine times larger than a sustainable population and combined with our complete dependence on cheap energy which is almost gone, is resulting in our system of civilisation crashing. Banking just happens to be the first major casualty.

    I have seen all this and more coming some 4 years ago. So, not only have I not lost anything, but have in fact greatly improved our financial and existential situation. Just shows you, it does not take a genius.

  • Comment number 20.

    The package you did on the exchange rate on Friday night - the one that seemed to be hurriedly edited and then had no discussion afterwards - it was a bit timid I think. The pound had a terrible week last week but picked up a little on Friday, so perhaps you felt the urgency had lessened and watered it down a bit. You certainly gave great prominence to the well-spoken older chappie who was trying to convince us that the euro is about to hit choppy water and sterling is the currency to be in. Glad I don't have him as my fund manager.

    The pound is almost at parity with the euro and falling; it is still slipping against the dollar. It now looks very likely that it will fall below parity. People all over the country are quietly putting their cash into euro-denominated accounts, or buying gold, in order to protect the purchasing power of their savings. No one in their right mind would buy sterling or sterling denominated assets right now. Everyone is selling pounds. Consumer prices may dip in the new year in *some* sectors, but make no mistake, with a delinquent pound inflation is coming. Energy costs in particular - which have risen enormously in the last couple of years - will soon be going up even more.

    Never mind the finer points of whether or not Britain should join the euro, there is a more fundamental issue - there is a real risk of a sterling collapse. Preventing *that* should be a top priority. The only feasible way to do that is to lock the pound to the euro somehow. The government must do this. It is too dangerous for us to retain an independent currency in these conditions.

  • Comment number 21.

    This comment was removed because the moderators found it broke the house rules. Explain.

  • Comment number 22.

    How's the economy being doing since Dec 8?

    Nothing to report, I guess.

  • Comment number 23.


    Limited fractional reserve, the 1294 'credit crunch' and backlash under Edward I (BBC Today, 7th Jan 2009, 06:54am).

  • Comment number 24.

    Hello Paul....are you still there?

    You seem to have been keeping your head down very low lately!

    I don't blame you now that the economy has seriously started to tank.

    I remember during the Recession of the early 80's the News at Ten programme used to do a piece on how many thousands of job losses had been announced throughout the week (in total). Every Friday they used to do the piece. It was terrible, the total just got bigger and bigger. All those poor families blighted through no fault of their own. And now its happening all over again.

    Next time you interview a Labour minister about this complete and utter economic mess they have made for us, please make sure you give them a damn good kicking....figuretively speaking of course.

    Still, from a selfish point of view, I wouldn't mind some of your job security right now.

  • Comment number 25.

    BankSlickerminustheR (#24) "Next time you interview a Labour minister about this complete and utter economic mess they have made for us".

    But New Labour didn't implement Labour policies, they continued to implement the core neo-Conservative policy of de-regulation and selling off of the state to the private sector. Just look to how their funding was raised. What happens if the cosmopolitan/globalist beneficiaries decide to cut their losses and move to their Med homes or elsewhere in Eastern Europe where labour is cheaper but still in the EU?

  • Comment number 26.

    Hello Paul? Still alive i see from thursday's piece as Samuel Pepys. No longer blogging tho? Pity. Hope you pick up your quill again soon. Or are you writing a new musical set in the City?!?!?


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