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Archives for January 2009

Everything will change

Robert Peston | 01:00 UK time, Saturday, 31 January 2009

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Do you want to know how bad the recession will be and what kind of global economy will be built from the rubble?

Here are a few clues. It's a short discussion I chaired for Radio 4's PM programme with Roger Carr, the chairman of Centrica and Cadbury, Richard Lambert, director general of the CBI, and Martin Wolf, the Financial Times's chief economic comentator.


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Bankers and responsibility

Robert Peston | 10:02 UK time, Friday, 30 January 2009

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A heavy burden is on the shoulders of Jamie Dimon - as probably the only American banker of seniority whose reputation has not been smashed to smithereens by the crash of '08.

Jamie DimonUnlike so many of his battered peers, the chairman of JP Morgan has had the courage (or chutzpah?) to show his mug in Davos. And, by all accounts, he's been saying worryingly sensible things in those private bankers' meetings that are being held to provide finance ministers and government heads with the financial industry's view on how to save the global economy.

I am told that at the World Economic Forum's so-called governors' meeting yesterday - in which the banks, brokers, private equity firms and hedge funds tried to draw up a common agenda for reform - he warned against placing too much faith in the possible creation of a central clearing system for financial transactions between banks.

The proponents of such a system believe that it would restore confidence to inter-bank lending - which has been sadly lacking for most of the past 18 months and has been a massive contributor to the implosion of the global machine for creating credit.

The reason it could restore confidence is that it would involve the establishment of what's known as a central counterparty, which would in effect insure banks against loss if another bank was unable to honour commitments.

If there were a central counterparty, fnancial institutions that lend to each other would have less reason to fear that - in extremis - they could not get their money back.

Which would appeal to most bankers (as if you needed telling), especially in this era of high anxiety.

Except that Dimon posed the question whether it would really be sensible to reduce the requirement for bankers to think long and hard about who they're lending to and why.

After all, the mess we're in stems from bankers placing too much faith in computer models and the opinion of third-party credit-rating agencies when deciding where to make their loans and investments.

The debt bubble that precipitated the current debt drought and global recession was caused in large part by bankers abdicating their very basic responsibility to know their borrowers properly and to assess whether these borrowers had the remotest chance of being able to repay their debts.

So if we're going to try to prevent bankers messing up our economy again, do we want them to take greater responsibility for their actions, or less?

Surely in the new world economic order which will be built - though Davos has been disappointingly short of coherent visions of what will be constructed from the rubble - we need bankers to know their customers and to propely evaluate the risks of lending.

But the more that they're insured against losses on lending, the less incentive they will have to lend responsibly.

Which brings us to the Great Paradox (capital "G", capital "P") of our government's measures to restore the flow of credit to real businesses and households.

All of these schemes involve taxpayers' insuring away some of the risks for banks and financial institutions of lending and investing.

In respect of new lending, this is the effect of the Bank of England's new asset purchase scheme, the proposed state guarantee for asset-backed securities, and assorted guarantees for bank lending to businesses.

Taxpayers are even taking on the liability for banks' dodgy old loans and investments, through the establishment of the new public sector insurer of banks' toxic debts, which should probably be christened "The Imprudential".

In other words it is explicit government policy to reduce bankers' responsibility for their actions, their lending, even more than was already the pernicious case.

We're in this mess because too much was lent by too many in a wholly irresponsible way.

And ministers are now encouraging more of this lending by further reducing the responsibility of the lenders for their actions.

It's the economic policy equivalent of curing a drug addict by giving the addict a prescription for the drug of choice.

It might work. Or it might just make our economy's dependence on unsustainably high levels of debt even worse - and thus cause us even more pain when we're ultimately weaned off the addiction.

UPDATE: Here are some thoughts of mine from today's The World at One on how banks could become "good" again.

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Blubbing bankers

Robert Peston | 10:21 UK time, Thursday, 29 January 2009

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Want to wow friends and colleagues by pretending you've been hobnobbing with global business and political leaders in Davos over the past 24 hours? Here's what you need to know:

1) Prime Minister Putin was conciliatory towards the West in a speech devoid of specific commitments on anything of substance. There was an audible "phew" from the global uber-elite.

Wen Jiabao2) The Chinese Premier, Wen Jiabao, both reassured and humiliated the western bankers. He reassured them with his account of how the supply of credit is rising again in China, which gives him confidence that the Chinese economy will grow by a more-than-respectable 8% in 2009. He embarrassed them with this manifestation of the strength of Chinese banks compared with their US, UK and eurozone peers (a strength that is the direct consequence of Chinese government policy).

It's very irksome for the Americans in particular that the Chinese version of what they see as their business model is holding up so well. And as if to rub their noses in it, the Chinese premier confided that he re-read Adam Smith over the summer (note "re-read") to reassure himself that the founder of modern economics wasn't the dogmatic opponent of government intervention that liberal market ideologues contend.

3) As I write, the chief executives of many of the world's big banks are meeting in top-secret, private session - to discuss what to say in their also top-secret meeting with finance ministers on Saturday morning. Here's the scoop on what the bankers will say: "Help!!!!!" (roughly translated as "only the further generosity of taxpayers can prevent us falling over as a consequence of the big losses we're incurring on our imprudent lending").

4) The Mayor of London, Boris Johnson, had the depressed plutocrats in stitches at Barclays' swanky dinner last night. They loved Boris's refusal to acknowledge that the City is in something of a pickle. Meanwhile, at Standard Chartered's restrained celebration of the Chinese new year, hardened bankers were moist-eyed as the legendary Welsh bass-baritone, Bryn Terfel, led a sing-a-long of "You take the high road, and I'll take the low road". I guess for the first time in their careers the star bankers can empathise with the soon-to-be-executed tragic hero of Loch Lomond.

Soros and Roubini cheer me up

Robert Peston | 16:57 UK time, Wednesday, 28 January 2009

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According to the IMF's latest forecast, there will be just 0.5% growth in the global economy this year.

Which is so close to zero that we can see it as total stagnation - a phenomenon we haven't experienced since the World War II.

According to the IMF, the prize for worst performer among the big economies goes to you-know-which: our proud land, the UK.

It forecasts the UK will contract by 2.8% in 2009, a steeper decline than the US (predicted to contract by 1.6%), the euro area (minus 2%) and Japan (minus 2.6%).

Our combination of massive debts, an over-valued housing market and excessive economic dependence on financial services (the City) has been toxic.

Here's some mildly encouraging news however. I interviewed George Soros, the hedge-fund legend, this afternoon - and he thinks most of the bad stuff about the UK is in the price.

Or, as he put it, he thinks that sterling may have fallen enough, for now (which is something of a contrast with that mega-bear of the UK, Jim Rogers, who used to work with Soros).

That said, Soros had no qualms about using the "D" word: he says a full scale depression remains a very real risk.

As does Nouriel Roubini, who I also interviewed. Roubini is the economist who probably shouted loudest and earliest about the looming financial disaster.

And what he said cheered me up a bit (and I needed it) - in that he believes governments at last acknowledge the scale of the problem, even if (in his view) they haven't yet sufficiently co-ordinated their policies to create money, use taxes and public spending to stimulate demand, and fix banking systems.

Davos and trust

Robert Peston | 09:38 UK time, Wednesday, 28 January 2009

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The blanket of snow covering Davos, the Alpine resort that hosts the World Economic Forum, is normally a comforting blanket.

DavosThis year it's almost sinister.

Because for the bankers, financiers and business leaders who feel able to leave the day-to-day crisis of managing their businesses through this painful recession for a few days of jaw-jaw and endless canapes, the big question is "what horrors still lurk beneath the surface".

They are sombre and anxious - such a contrast with their confidence of previous years that globalisation and financial innovation were enriching the world (and, as luck would have it, making them particularly prosperous). . .
What really cast a pall in the preceding weeks was the fall from a state of banking grace of Bank of America and its chairman Ken Lewis.

The biggest US lender seemed to have done most things right, till its takeover of Merrill Lynch in the autumn that now looks the very epitome of hubris.

On the top of this mountain, all bankers and traders have wanted to talk to me about is the colossal losses at Merrill, the spat between Lewis and John Thain (Merrill's now departed boss), and BofA's humiliating government rescue.

"What happened to Ken Lewis killed all of us", said a banker. "Investors rightly took the view that if you can't trust BofA, who can you trust?"

This is not an ideal backdrop for the formal business of Davos, which is to come up with proposals to pull the global economy through the painful downturn and make global capitalism safe for the future.

Many of those here see themselves (still perhaps a touch hubristically?) as helping to shape the agenda for April's meeting in London of the G20 group of leading nations.

That will be when the politicians of the rich developed nations, in which the economic mess was cooked up, come together with Brazil, India, China and Russia to save the world.

I have to say that bankers are rather less optimistic about what the politicians can achieve than the politicians themselves.

There's a fatalism among the uber-capitalist class: that the economy won't turn till 2010 at the earliest; and that they've been cast into the unglamorous underworld of bonus-less toil for as long as the mind can contemplate.

If business leaders needed telling that they're less loved than ever (they didn't), the annual poll of how much they're trusted by citizens around the world was a bad start to the day.

Edelman has been polling what we think of business for a decade. This year's result, if translated into a well-known colloquial phrase, would be unprintable Anglo-Saxon.

But here's what really shocked me: Bob Diamond, the de facto creator and head of Barclays' investment bank, isn't here. That's almost the equivalent of the Queen not showing up for Royal Ascot (well not quite - but you know what I mean).

Diamond, understandably, feels he needs to stay in London, where his troops are battling away in the war against financial pessimism. And there are plenty of other Davos banking regulars who've stayed away.

But even in the absence of Diamond - and of John Varley, the bank's chief executive - Barclays is pressing ahead with its lavish annual dinner for corporate clients.

They'll be treated to a rollicking address from Boris Johnson, the Mayor of London. Let's hope he cheers them up.

UPDATE, 12:13PM: The gloom here from business leaders, private-equity specialists, hedgies, bankers, management consultants and economists is deep and unrelenting.

They are immensely pessimistic about the economic outlook and about the ability of governments to lessen the pain.

I'd be tempted to come home immediately and climb under the duvet, except for one thing: when the herd is charging in a particular direction, the herd is normally wrong.

So on the basis that the best time to buy (metaphorically speaking) is when everyone else is selling, just maybe we're near the darkest hour for the global economy.

Refuelling the motor industry

Robert Peston | 12:44 UK time, Tuesday, 27 January 2009

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What Peter Mandelson will announce this afternoon is guarantees for borrowings by manufacturers of cars and construction vehicles, as well as their suppliers.

Peter MandelsonMany of these companies were too big to qualify for the guarantees from taxpayers made available to small and medium size companies by the Business department earlier this month.

But these substantial employers are having terrible difficulty borrowing from banks and financial markets. So the taxpayer will now stand behind a portion of their debts.

These new guarantees are expected to underpin several billion pounds of fresh bank loans for the industry.

The state support is expected to be directed towards investment by the motor industry in low-carbon technologies - which may prevent the measures falling foul of a European Union prohibition on state support for particular industries.

The motor industry has been desperate for help with research and development into a new generation of "green" cars.

The funds for all this will involve some new money from the Treasury and some re-allocation for other elements of the Business department's budget.

The Business secretary is also expected to announce support for the retraining of motor-industry employees who have been made idle in recent weeks as the big carmakers have temporarily shut down production lines.

The measures are likely to be seen as a particular boon for Jaguar Land Rover, the subsidiary of India Tata Motors, which has been anxious about whether it would be able to refinance a huge loan when it falls due in June.

What will probably be announced at a later date is the use of government guarantees for the issue of bonds created out of personal loans to car-buyers - which would be a way of ending the drought of credit for those wanting to buy a motor.

UPDATE, 16:05PM: The scale of the support for the motor industry announced by Peter Mandelson this afternoon is not enormous, but is pretty green.

When taxpayers buy business debt

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Robert Peston | 09:55 UK time, Tuesday, 27 January 2009

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Can the Bank of England's autonomy over monetary policy, its independence from political interference, be sustained as the Bank Rate approaches zero?

At a time of painful recession, this question may sound of interest only to the clashing egos of central bankers and Treasury ministers.

But the answer probably does have implications for all of us, because it would have a bearing on the all-important credibility of the institutions that shape economic policy, especially that of the Bank of England.

This issue has arisen because the Bank of England is about to start using measures other than movements in its policy interest rate to influence the interest rates actually paid by businesses and households and to increase the stock of money in the economy.

These measures have been given the label "quantitative easing". But this seems a very unhelpful badge, since economists seem divided - in a theological kind of way - over precisely what it means.

Better then to describe what the Bank of England is about to start doing.

Within a few short weeks, it will start exchanging high quality Treasury bills for various forms of corporate debt, both bonds and commercial paper (the main difference between bonds and commercial paper is that bonds have a longer maturity and commercial paper is short-term debt).

We'll know a bit more about this tomorrow, when the chancellor and the governor of the Bank of England send letters to each other setting out the scope and operation of this scheme.

But this is what we know so far. The Bank of England will have about £50bn of Treasury bills to disburse and this fund will be underwritten by taxpayers. So any losses incurred by the Bank of England from its investments in companies' debts will ultimately be borne by all of us.

Now the reason why the Treasury and Bank of England have decided to set up what they call an "Asset Purchase Facility" is because they believe big companies are finding it too difficult and too expensive to borrow in the form of bonds and commercial paper.

The logic is that if the Bank of England were to buy these bonds and commercial paper, the market would become deeper and more liquid - which in turn could persuade other investors to buy these forms of corporate debt.

There's a hope on the part of the authorities that the price of bonds and commercial paper would rise (over time), which in turn would lead to a fall in the interest rates actually paid by companies. In other words, big companies would find it easier and cheaper to borrow.

Now the governor of the Bank of England insists that what's going on here does not represent formal monetary policy. But that's surely a nice distinction, because the Bank of England would be influencing both the supply and price of credit - which seems to me to have the distinctive quack of monetary policy.

However, Mervyn King feels able to describe this as something other than monetary policy because this debt is not being bought for cash but for interest-bearing Treasury bills, or government debt.

That said, those bills are highly liquid. The recipients of them would treat them as the equivalent of low-risk money.

Oh dear. I am in danger of slipping into the kind of obsessive theological economic debate that gives me the willies. So let's move on.

SHAUN CURRY/AFP/Getty Images / Oli Scarff/Getty ImagesPerhaps the important point is that Mervyn King and the chancellor have both made clear that it won't be long before the Bank of England starts to use money, rather then Treasury bills, to buy corporate debt and other financial assets. At that point, even the governor would call that monetary policy.

It would be the moment when - for the purists - quantitative easing would begin (you knew I'd break my word not to use this ghastly expression). To reiterate, the Bank of England would start to buy financial assets - low-risk government bonds and higher risk corporate debt - from banks and for money.

There would be two reasons for doing this.

First, the stock of money in the banking system would increase. The hope would be that the banks would lend this out - though if they were still feeling very averse to risk, they might lend it only to the Exchequer, by purchasing more government bonds. In fact, if they were feeling really frightened about the world, they could just sit on the cash.

That is why it would make sense for the Bank of England to buy riskier business debt, corporate bonds, from banks: doing so would liberate precious capital for banks, under capital adequacy rules, and would give them an incentive to provide new loans to companies and to households.

You'll notice, of course, that what we're talking about here is taxpayers paying cash for corporate debt. In a way, we'd all be lending to companies.

And because we'd be lending to companies - which brings with it the risk of loss for the Exchequer and thus for us - the chancellor feels he can't stand idly by and give the Bank of England free rein to invest as much as it likes and in whatever way it likes.

So Alistair Darling will, I am told, set limits on how much the Bank of England could disburse when buying financial assets from banks. And he may also set guidelines on how much the Bank can spend on individual categories of debt that carry different kinds of risk (thus there'd be a maximum allocation set by the Treasury for purchasing corporate debt, another allocation for government bonds, and so on).

He feels unable to dodge doing this, because taxpayers' money would be on the line.

However, it would mean that he would be impinging on the operation of monetary policy, as and when it takes the form of purchases of financial assets (oh yes, the infamous quantitative easing again).

Many would see this as undermining the independence of the Bank of England - almost an abandonment of the economic reform upon which Gordon Brown built his early reputation for success as chancellor more than ten years ago.

Would that matter?

Hmmm.

If this new form of monetary policy were to fail, blame would be shared with the Treasury - so perhaps the credibility of the Bank of England would be less damaged.

But it may represent a slippery slope back towards a muddying of how macroeconomic decisions are made. And some would say that the UK's mediocre economic performance through most of the post-war years stemmed from a failure to properly delineate the responsibilities of the Treasury and the Bank of England.

Or, to put it another way: when politicians were intimately involved in setting monetary policy, Britain was something of an economic loser.

Lloyds to convert?

Robert Peston | 14:47 UK time, Monday, 26 January 2009

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It's slightly odd that the penny should at last have dropped for investors - that if Barclays says it's profitable and doesn't need to raise new capital, then that's to be believed.

For a bank to have to give this reassurance in the form of an open letter from the chairman and chief executive is highly unusual. And the message they delivered wasn't new.

The bank has been shouting that it's in reasonable nick for 10 days, ever since the steep slide in its share price began.

Only belatedly have investors realised that Barclays could not make such confident statements without the approval of its auditors and also that of the City watchdog, the Financial Services Authority - and that surely they can't all be wrong.

Lloyds logoWhat's good for Barclays' share price has also had a more modest positive effect on shares in Lloyds.

As for Lloyds, I'm hearing that it may yet follow the lead of Royal Bank of Scotland by converting £4bn of preference shares held by the government into ordinary shares.

That would save it just under £500m a year in dividend payments, but would see taxpayers' stake in Lloyds rise to well over 50%.

Lloyds has been signalling that it does not want to be nationalised to that extent. If it's so desperate to prevent public ownership going through the 50% threshold, it could try to persuade UK Financial Investments, which holds the investment on behalf of the Treasury, that the new shares should not carry any votes.

China's moment

Robert Peston | 09:25 UK time, Monday, 26 January 2009

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We've known for some weeks that the developed economies of the world are collectively in recession for the first time since the World War II.

Chinese textile workerBut there has been a residual hope that emerging-market economies, led by China, India and Brazil, would still provide momentum to global growth.

That residual hope is quite close to evaporating.

At the end of last week, official figures indicated there was no growth in China at all between the third and fourth quarters, according to analysts (published year-on-year growth was 6.8%, the lowest rate in seven years).

And yesterday, a senior official of the International Monetary Fund told Reuters that the IMF's forecast of global economic growth in 2009 would be revised down sharply later this week to between 1 and 1.5% - which would be the worst economic performance since the early 1980s and is perilously close to zero.

As for international trade, that's shrinking in an alarming fashion. The World Bank expects trade volumes in 2009 to contract for the first time since 1982.

What's at work here is a vicious interaction between the financial crisis, which has led to a massive reduction in credit to finance trade, and a slump in real demand for real goods and services.

All of which is to highlight the limits of what the rescue packages for any individual economy - Gordon Brown's or even President Obama's - can hope to achieve.

If the Treasury's proposals to stimulate loans to households and businesses succeeds, that could lessen our economic pain.

In that context, the Treasury will be encouraged by the positive tone of Barclays' unusual open letter this morning, in which its chairman and chief executive say they are looking to procure insurance from the taxpayer against future losses on dodgy loans - and that doing so would allow them to increase lending in the UK (as a brief digression, it must be a great relief to them that Barclays' share price has at last responded positively to this latest and most theatrical declaration that the bank really isn't in dire need of new capital).

That said, if there's no demand from other countries for the stuff made by British businesses, all the credit in the world isn't going to create revenues for them.

Which is why the likes of Corus, GKN, almost every carmaker you can name and pretty much every exporter is cutting costs and laying off staff.

In fact, as I've been arguing for weeks, the repatriation of credit - the demand from national government's like ours that banks concentrate their lending on domestic customers - may actually worsen the net availability of credit around the world, especially the all-important finance for lubricating the levers and pulleys of cross-border trade.

What's required is the co-ordination of measures taken by the world's biggest economies to revive the ability of banks to lend - and explicit encouragement of banks and other financial institutions to fund business and commerce outside of their home countries (as I say, the reverse is happening - with potentially devastating consequences).

It has also got to be fervently hoped that the likes of China and the other great exporting nations recognise that their future wealth requires them to reconfigure their economies in a substantial way - and it's not just the debt-addicted US, UK and other developed economies in the West that face tough decisions in reconstructing themselves.

If the Asian and South American emerging economies were to import more and export less, thus helping to reduce the scale of the contraction in economies like ours, their longer term prospects would surely be that much better.

This is not to berate them for making us in the West feel so much richer over the past decade, by selling us cheaper and cheaper goods and by recycling their financial surpluses to us in the form of low-interest loans. It's just to say that we've bought all we can afford for now. And that if they don't buy a bit more of what we produce, well then we're going to represent a pretty anaemic market for them in years to come.

Which is why Obama has already signalled - in perhaps too blunt a manner - that he believes the Chinese authorities are holding down the value of China's currency to obtain unfair trading advantage.

How China reacts, with a defiant devaluation or a statesmanlike confident revaluation, will have a bearing on the prosperity of us all.

PS: If you're interested in how we'll know when we're through the worst of this economic mess, you might want to take a look at the short film I made for Friday's News At Ten.

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Steelmaker to cut 2500 in UK

Robert Peston | 13:48 UK time, Sunday, 25 January 2009

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Corus is poised to announce job cuts of 3,500 from its global workforce of 42,000.

A majority of these, more than 2000, will come from the British workforce of 24,000 (see below for update, saying that job cuts in the UK will be about 2,500 in total).

The formal announcement could come as soon as tomorrow morning.

If there's good news here, it's that (as the Sunday Times points out today) the Anglo-Dutch steelmaker is not planning to close any of its substantial manufacturing or processing plants.

Its main sites in the UK are at Port Talbot, in South Wales, Scunthorpe and Teesside.

Corus - which was acquired in 2007 by Tata Steel of India - has been hit hard by the recession. Its order book has fallen a third, global demand for steel has dropped 40 per cent from its peak of last year and steel prices have plunged a staggering 50 per cent since last September.

That said, these cost-cutting measures might well have taken place whatever the economic climate.

They are the result of a substantial review of the efficiency of the business by its soon-to-retire chief executive, Philippe Varin, for the business's Indian owner.

I understand that the cuts at Europe's second largest steelmaker have been brought forward as a result of the downturn, but it was clear to Mr Varin that Corus needed to become more efficient in any case.

Corus has started to temporarily reduce its output to cope with a massive decline in demand from the construction, automotive and assorted manufacturing industries.

This means there isn't full-time work for the majority of the UK workforce who are not being made redundant.

The company wants to use this semi-idle period - which it expects to last for six months - to retrain its employees.

It has requested financial help from the British government for a rolling programme of providing new skills to its entire workforce. This would take the form of a state top-up for the wages of employees.

Corus feels it will have to reduce the pay of employees for six months or so, until demand for steel recovers. The company feels it's fair to request support from taxpayers for an increment to staff pay, because the alternative of making more employees redundant would lead to a rise in social security payments.

A wage subsidy along these lines is provided by the government of the Netherlands, where Corus has substantial operations.

Ministers have not yet decided whether to provide a retraining subsidy of this sort.

UPDATE 17:54 Job cuts in the UK will represent about 10 per cent of the workforce, so around 2,500.

The long and short of banks

Robert Peston | 08:46 UK time, Friday, 23 January 2009

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When the ban on short-selling was introduced last year, the chancellor basked in the general approbation of this crackdown on financial speculation that was supposedly destroying confidence in our banks.

The impression was created that the Treasury was in part responsible for the prohibition on the practice of borrowing bank shares to sell them (with the speculator hoping to buy them back later at a lower price to trouser the difference).

FSA HQWhich now puts the government in something of a pickle. Because it's very unhappy that the City watchdog, the Financial Services Authority, lifted the ban last Friday on these transactions that generate profits from falling share prices.

But ministers can't easily express their disapproval in public - to do so would imply that they didn't really have much say in the imposition of the ban in the first place.

The thing is that the FSA is an independent regulatory body. And at least part of its role is to promote liquid markets that set prices in an efficient way.

The FSA believes that short-selling enhances the process of setting prices, by capturing the available supply and demand for securities and also relevant information.

As we surely must now appreciate, as we live with the bitter consequences of the popping of the debt bubble, the euphoric buying of assets by manic investors is highly dangerous - so it can be very helpful that the market contains short-sellers expressing a contrary, negative view.

So the FSA would only ban short-selling, or any other similar orthodox and longstanding trading practice, when it detected palpable, significant damage to companies or to the economy that outweighed the market benefits.

There was evidence of such damage last spring and summer. A vicious interaction of malicious rumour and speculative sales was devastating bank share prices, and this in turn affected the confidence of banks' creditors and depositors.

When these creditors and depositors withdrew their funds, banks came perilously close to collapse, which transformed the rumours into self-fulfilling propositions.

The ban on short-selling was therefore a circuit-breaker between rumour and the undermining of banks' ability to fund themselves in the wholesale money markets and from retail deposits.

However, since the ban was imposed last autumn, the funding of banks - their borrowing - has become much more stable, thanks to the forced largesse of taxpayers.

The Treasury has committed around £800bn of taxpayers' money to underpin banks' ability to borrow what they need. A run on a bank that would bring it down is almost impossible today, because banks can secure what they need from us, the taxpayers.

Which is why the FSA felt comfortable about allowing short-selling to re-commence.

To put it in stark terms, thanks to taxpayers' largesse, short-selling bank stocks is no longer a potentially lethal activity.

Even so, many - including ministers - argue that the FSA was crackers to allow short-selling to start again.

They point to the collapse in the share prices of Royal Bank of Scotland, Lloyds Banking Group and Barclays as evidence that hedge funds and other short-sellers are up to their old tricks of destroying the infrastructure of the British economy for private profit.

There's only one problem with this thesis: it's not supported by the facts.

Since the ban was lifted, there has been a negligible amount of short selling.

And although some will be revolted by the disclosure in this morning's Guardian that Landsdowne has made a few millions in profit from shorting Barclays, it's laughable to think that Landsdowne's miniscule short position could have contributed to the billions wiped off Barclays' value since last Friday.

Most of the share price movements in the big banks have been caused by conventional selling of shares by the normal gamut of investment institutions.

Some of these investors may have sold because of their conviction that the shorts were selling the stock down to zero. In fact a number have told me precisely that. But this turns out to be dangerous hysteria, disconnected from the trading facts.

There is an argument that the FSA should have anticipated this irrational depression on the part of pension funds and others - and should have delayed the lifting of the ban until a bit more common-sense returned to the market.

But the main cause of the recent falls in bank shares was the Treasury's massive new package to stimulate lending - which spooked the City for reasons discussed in earlier notes - and a worldwide escalation in fears about the health of banks.

The short-sellers are the convenient whipping boys, not the prime malefactors (if you think it's a crime that the share prices have fallen, which is moot).

As of now, no irredeemable damage appears to have been done. And although it may jar to say so, shares can rise as well as fall - even bank shares.

Insurance, not nationalisation

Robert Peston | 09:50 UK time, Thursday, 22 January 2009

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The government really really really doesn't want to nationalise Royal Bank of Scotland or any of the other big banks.

That was the thrust both of Adair Turner's interview on the Today Programme this morning and of Paul Myners's article in this morning's Financial Times.

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As if you needed telling, Turner is the silken-tongued chairman of the City watchdog, the Financial Services Authority, and Myners is the big-booted City minister who made a modest pile building up a fund management business in the boom years. We can safely assume they speak with authority on this issue.

Turner said that losses being incurred by banks right now are "not dramatically worse" than the FSA expected in October when it forced the big banks to raise £50bn of new capital - with £37bn coming from us, from taxpayers.

That was an unambiguous re-affirmation that they're not bust, in the FSA's view - which matters, since it's the FSA which has the power to determine whether a bank is fit enough to continue taking deposits.

However that's not the end of the story, because the banks could of course suffer losses that would muller them in a fundamental sense - and would of course prompt yet more financial support from taxpayers to prop them up.

Lord TurnerIn that context, it's striking that Turner was dismissive of demands that the banks must "come clean" about the extent of their dodgy loans and investments - which if memory serves me right has been something of clarion call by the prime minister in recent days (is it plausible that the head of the FSA would contradict Gordon Brown?).

Turner said that the banks and the FSA have a detailed understanding of what's on their balance sheets.

However only a soothsayer would claim to be able to predict with certainty how markets will move in the coming weeks or the precise course of our recession.

That's got nothing to do with whether the banks are hiding stuff. It just means that no one can know with certainty the future market value of banks' investments or the degree to which businesses and householders will have difficulty keeping up the payments on their debts.

These are, to use the Rumsfeldian cliché, "known unknowns".

And it's because there are these "known unknowns" that the Treasury announced on Monday its scheme to insure the banks against losses on loans and investments that could destroy their balance sheets and cause them to collapse.

Or, as Turner makes crystal clear, the insurance scheme is a way of staving off nationalisation of the big banks.

In other words, the government has decided that it would be better for you and me as taxpayers to take on the liability for the potential future losses of the banks, while preserving their semi-detachment from state control, than for us to own them and control them outright.

That said, Royal Bank and Lloyds Bank can only be semi-detached from the Treasury, because we as taxpayers own 70% of Royal Bank (or at least we shortly will do) and 43% of Lloyds.

But this is what you need to know and what investors in general appear to have missed in an outbreak of mass-hysteria that nationalisation looms: the prime minister and chancellor have made an unambiguous judgement that the general good would be better served by the semi-autonomy of the banks than by making them instruments of the state.

Why?

This is what Myners says in the FT: "The capacity for soundly managed banks and markets to support the generation of wealth in the economy could never be matched by the public sector...British banks are best managed and owned commercially".

Hmmm. On that basis, let's hope that the past, in the form of the banks' grotesquely inadequate management of risks during the last few years, isn't a guide to the future.

All this means that a very heavy burden rests on those at the Treasury who are frantically trying to make a success of the insurance scheme.

The guinea pig is Royal Bank of Scotland. It hopes that by the time of annual results on 26 February it will have made significant progress in identifying loans and investments whose losses above a certain level will be insured away by you and me.

This is a pretty tall order, because the bankers and Treasury officials will be trying to put a price on "known unknowns": it won't easy to agree the fee that RBS will pay us for being relieved of liability for losses whose certainty simply can't be measured in a scientific way.

But, as by now you'll have worked out, the Treasury will be pulling out the stops to make the insurance scheme work. Because if they can't get it to work, it's difficult to see how the 100% nationalisation of Royal Bank of Scotland - and even perhaps of Lloyds Banking Group - can be avoided.

Mervyn and leverage

Robert Peston | 08:56 UK time, Wednesday, 21 January 2009

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The Governor of the Bank of England didn't pull out the stops to cheer us up in his speech last night.

What was particularly striking were his closing remarks, when he said that he was sure an economic recovery would come and that there would certainly be a positive outcome from all those interest rate cuts and the hundreds of billions of taxpayers' cash allocated to pumping up the wilting banking system and stimulating demand.

Mervyn KingBut - and it's an important qualification - he couldn't be sure when the economy would turn. He said: "No one can know at what point the impact of all this stimulus will have a visible effect on activity; the lags in economy policy are notoriously long and unpredictable".

Oh dear. If the economists we trust to steer us through this mess ever had a torch, the battery appears to be flat.

Nor did I feel particularly reassured by his assessment of when the great cause of our woes will be fixed, the reduction in borrowing and lending by banks and other financial institutions.

To remind those who don't live and breathe bankers' jargon, when Mervyn King talks about "leverage ratios" he means the relationship between a bank's debts and its capital resources. He said that the "leverage ratios of large banks remain at remarkably high levels and the required adjustment will not happen quickly... With fresh capital from the private sector difficult to obtain, banks have opted to reduce their lending and that is why the flow of credit to all parts of the economy, here and abroad, has been heavily disrupted."

It's that stress on the leverage ratios of banks still being "remarkably high" that slightly surprises me. Not because it's wrong. But the Treasury and the Financial Services Authority have frantically been trying to reassure the banks that they have ample capital resources to finance their balance sheets - and Mr King does seem to be saying something different.

Mr King went on to say that "banks are encouraged to run down their capital to enable them to absorb losses while continuing to lend, but in the long run they will need more capital".

Again, this is not quite what the FSA is saying. The City watchdog's message - which it repeated loudly on Monday - is that our banks currently have enough capital to absorb the losses they'll incur as the recession causes increasing difficulties for borrowers. It says that their capital ratios will still be at acceptable levels even after the losses have been absorbed.

But if the Governor is right that banks have inadequate capital for the long term, the markets will price that in today, in the form of lower share prices for banks and much more demanding terms for the credit they require.

Considering the mullering of bank share prices in the past couple of days, it looks as though the Governor is right. But I doubt the Treasury or the FSA will thank him for pointing it out.

It's not all gloomy news, according to King. He says that because so much of banks' excessive lending and borrowing has been with other financial institutions, there is "scope for a reduction in the leverage of banks without restricting lending to the 'real' economy".

There are two things to say about this.

First, as John Gieve, the Deputy Governor of the Bank of England, told me in an interview for my Panorama documentary before Christmas, the Bank of England was too sanguine during the boom years that there was some kind of cordon sanitaire around the debt and asset bubble, such that when the bubble was pricked it wouldn't infect the real economy too much.

That turned out to be spectacularly wrong. It's therefore reasonable to question whether the non-financial sector (that's you and me, and "real" businesses) can be protected from the massive reduction of lending between financial institutions.

Also, the way the Treasury is trying to protect the non-financial sector is by imposing formal quantitative targets for lending to businesses and households on those banks in receipt of financial support from taxpayers. As you've noticed, it's instructing the banks to lend considerably more to all of us.

Which is all very well.

But as I've pointed out before, if all countries forced their banks to concentrate their lending on domestic markets, that would lead to an even sharper fall in cross-border flows of funds and capital than is already taking place.

It would amount to a kind of financial protectionism, a beggar-my-neighbour policy, that could impoverish us a lot more than would otherwise be the case.

So the Treasury should tread a little warily, I think, before forcing all our banks to do nothing but their patriotic duty.

PS: Mervyn King is at pains to point out that he hasn't run out of all tools to revive lending and the economy.

He confirmed that we're probably about to enter the relatively uncharted wilderness of "unconventional measures" to stimulate the flow of credit and money: what's called quantitative easing, or the creation of reserves at commercial banks by the Bank of England buying all manner of financial assets, in the hope that the banks won't just sit on these reserves but will convert them into loans to the private sector.

It's reasonable to see this as the creation of new money. The big question is whether it would circulate and stimulate transactions - which is what the Bank of England would want - or would be hoarded.

In fact, within a matter of weeks, we'll see the Bank take an imaginative first step in that direction, when it starts to buy up corporate debt (not for cash, but in exchange for Treasury Bills), in the hope that the liquidity of the market for corporate debt will be significantly improved and thus make it cheaper and easier for big companies to borrow.

This may sound tediously technical. But it is big stuff. It represents the public sector, us as taxpayers, lending directly to companies (even though the Bank will be buying this stuff on the secondary market).

Faith in banks

Robert Peston | 09:55 UK time, Tuesday, 20 January 2009

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It's more than a little local difficulty that Royal Bank of Scotland yesterday suffered the indignity of becoming a penny stock (though it's bounced a bit this morning).

RBS logoBecause of the plans for global domination of its previous chief executive, Sir Fred Goodwin, this bank is known from Wall Street to Shanghai.

It's big in America. It had till recently a symbolically important stake in Bank of China. It was the victor in the world's biggest ever cross-border banking takeover battle, when it acquired the poisonous rump of ABN Amro (but not "ANB Ambro," as Gordon Brown put it, when scolding Royal Bank yesterday).

Whether we like it or not, the collapse in its value from more than £70bn a couple of years ago to £4.6bn represents unfortunate worldwide advertising about the perceived frailties of our financial system and our economy.

In the context of how others see us, here are remarks made overnight by Jim Rogers, the well-known investor, to Bloomberg: "I would urge you to sell any sterling you might have...It's finished. I hate to say it, but I would not put any money in the UK."

Errr, say what you mean Jim.

Inevitably, sterling has fallen - to its lowest level against the Yen since 1971 and to its lowest against the US dollar since March 2002. For what it's worth, Rogers believes sterling will approach parity with the dollar.

The connection between sterling and the health of our banking system goes like this.

Our banks have colossal overseas liabilities; they've borrowed huge sums abroad. According to Bank of England figures, the gross foreign currency liabilities of British banks are around £4,400bn (having quadrupled over a decade).

Of course the banks all have matching assets. But the problem is that the assets tend to be illiquid, hard to sell. Whereas the lenders to the banks can often ask for their money back at relatively short notice.

The reason that Royal Bank of Scotland and HBOS - now part of Lloyds - were semi-nationalised in October was that lenders to them were demanding their money back. They were hours from collapse and it was therefore vital that the British state should be seen to be standing firmly behind them, to reassure all lenders to them that their funds were safe.

But when the Treasury acquired big stakes in Royal Bank and what's now called Lloyds Banking Group - and when it committed £500bn of loans and guarantees to make sure that all the big banks could repay providers of wholesale loans that could demand their money back - at that point the liabilities of the banks increasingly came to be seen as the liabilities of the state.

This is not an accounting issue of whether Royal Bank's £1,900bn of liabilities is on the public-sector balance sheet.

It's about whether, when it comes to the crunch, the state would honour those liabilities.

And, of course, we all know that the Treasury would honour those liabilities. The damage to the British economy of allowing a bank like Royal Bank to renege on what it owes would be unthinkably huge.

So it matters, in the first instance, that our banks are perceived as viable, profitable businesses - able to pay their way.

And it also matters, in the second instance, that the UK state is viewed as being able to honour the liabilities of its banks, in the unlikely event that a mob of overseas lenders to the banks all asked the teller one day for their money back.

What this means is that if you put any kind of probability on a recurrence of the collapse in confidence in our banks that we saw in October, then some portion of banks' overseas liabilities should be counted as an increment to the ballooning debts of the government - which is why there's a link between the perceived weakness of the banks and a fall in sterling.

Although - as you'll have spotted - there's a dreadful paradox: a fall in sterling actually makes the problem worse. Because, as Royal Bank of Scotland helpfully pointed out in its trading update yesterday, a fall in the pound increases the sterling value of banks' overseas assets and liabilities.

All of which is to explain why, in these febrile circumstances, something as nebulous as "confidence" in our banks really matters.

In that context, what may count is that investors yesterday believed that short-sellers were once again driving down the value of bank shares - even though I am reliably told there was very little short-selling.

That fear of short-selling may have persuaded other investors to dump bank shares, or given them a further reason to do so. Which is why the lifting of the ban on short-selling of financial stocks last Friday may have been unfortunately timed.

Also, as I said last night on the Ten O'Clock News, the prime minister' may have meant well when giving a stern instruction to the banks that they must come clean about the scale of their dodgy assets. But it unnerved shareholders, who wondered on what basis they could value banks, if even the most powerful man in the country didn't know what horrors lurk inside them.

As for the lack of detail in the multi-hundred-billion pounds plans announced by the Treasury to stimulate lending, that was an invitation to the City to fear the worst - to conclude that the banks would become profitless instruments of the state.

Where does all this lead?

Well if the world's investors already see Royal Bank as a de facto part of the state, if the constant noise about its future in the City and the media is damaging to wider confidence in the financial system, then the government may conclude that full nationalisation of Royal Bank of Scotland isn't necessarily worse than the status quo.

Collapse of confidence in banks

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Robert Peston | 13:46 UK time, Monday, 19 January 2009

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As I said this morning, this is not a bank rescue plan. But if it had been, it would have failed miserably.

Barclays' share price has fallen again today. At the current price of 90p, this bank's entire market value is £7.5bn. And remember, this is a bank that said on Friday night that its profits for 2008 were considerably more than £5.3bn.

In other words, investors currently value this giant international bank at a little over one year's profits. Which is little short of extraordinary.

And let's not even mention that Royal Bank of Scotland's shares are down by more than 50%, on the supposedly reassuring news that taxpayers will be sharing in its future pain.

Confidence has drained from the banking system. And to state the obvious, today's myriad announcements from the Treasury have not succeeded in rebuilding that confidence, which is so vital to a functioning economy.

UPDATE, 04:20 PM: What's going on? Why have shares in RBS, Lloyds TSB and Barclays all been knocked?

Well investors have been well and truly spooked by the sheer size of losses at Royal Bank - especially since these have been incurred before the recession really starts to bite on the ability of households and companies in the UK to pay their debts.

But the other concern is that the banks are - in a way - in the process of being nationalised, without the bother of the government taking control of the shares.

The fear of investors is that with taxpayers providing so much support to the banks, any spoils would go to the state in the form of fees, and to UK households and companies in the form of lending mandated by the Treasury at uncommercial interest rates

As for shareholders they would receive the slimmest possible returns for years to come.

Rescuing the economy, not banks

Robert Peston | 09:33 UK time, Monday, 19 January 2009

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Our big banks aren't bust. They were recapitalised in the autumn - with £50bn of cash from taxpayers and external investors - and they remain solvent.

And if you wish to ring up the Financial Services Authority, the City watchdog, for assurance on this point, I'm sure you'll be told that the big banks have a sufficient cushion of capital to weather all but the most cataclysmic storms that may lie ahead.

However the impression has somehow been created over the past few days that they are being rescued again.

I'm not sure whether that's the result of media hysteria, bankers' neurosis or government spin.

RBS logoAnd Royal Bank of Scotland hasn't exactly soothed nerves this morning with its historic announcement that it will report losses for 2008 of between £7bn and £8bn.

But even Royal Bank has very substantial capital resources - the more so after it converts the government's holding of preference shares into ordinary shares (when taxpayers' stake in the bank rises to 70%).

What's been announced by the Treasury and Bank of England this morning is not a survival plan for the banking system: we've already had that.

If it's anything, it's a survival plan for the British economy.

Now, as it happens, the giant insurance scheme announced today - which would see taxpayers becoming liable for all sorts of ill-judged lending by the banks - would reduce the likelihood that the banks will need rescuing again in a few months time.

It's what it says on the tin: "insurance".

But as of now, the government's primary motive for providing this protection is to stimulate lending.

The logic is that if banks can evaluate how much they'll lose in this painful recession, which is what they'll be able to do when taxpayers have the dubious privilege of insuring away the uncertainties for them, they will be less reluctant to provide new credit.

In fact, in return for providing the insurance, the Treasury will mandate banks to make new loans to households and businesses.

Why all this stress on credit? Well as I've pointed out so often as to send most of you to sleep, the withdrawal of credit from the UK and global economies is what's precipitated these dreadful economic conditions.

That's why the Treasury will guarantee bonds created out of mortgages, car loans, and other assets - to provide funding for the housing market and elsewhere.

That's why the Bank of England will swap corporate loans and other forms of credit for Treasury bills, which can easily be turned into cash (by the way, this new facility is a part of the preparations for quantitative easing, for printing money when Bank Rate is nearer to zero).

That's why Northern Rock, the nationalised bank, is starting to lend again.

All of this represents the last chance saloon for Treasury initiatives to revive lending that fall short of direct government control of lending by banks.

If credit doesn't become more readily available, the recession will deepen - and one consequence will be that bank losses will escalate even beyond the current alarming forecasts.

At that point, a new rescue plan for the banks would have to be launched. And there would be full-scale nationalisation of our biggest banks.

Lend, lend, lend

Robert Peston | 15:59 UK time, Sunday, 18 January 2009

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A dizzying number of banking initiatives is likely be announced by the Treasury tomorrow morning.

But they'll all have two things in common.

They are designed to improve the supply of credit to the economy, to prevent this recession turning into something even more prolonged and painful.

And they'll involve yet more commitments of taxpayers' money, of our money (we could be talking as much as several hundred billion pounds of additional help from taxpayers, to add to the £600bn of our wonga that has been provided to the banks in the form of guarantees, loans, and capital).

Also, they are way outside of most people's experience, so they may seem complicated.

For example the government will - for a price - provide a guarantee that bonds created out of mortgages or out of loans to companies won't go bad.

The point of this is to encourage investors with billions in cash, such as pension funds or hedge funds, to buy these bonds.

Think of it as investors lending to us as taxpayers, and taxpayers then passing the cash on as loans to credit-starved housebuyers and to big companies.

You may think it odd that investors would rather lend to taxpayers rather than directly to businesses and households. But, rightly or wrongly, they think that we are very unlikely to default (and when I say "we", I of course mean the United Kingdom, the state, as a sovereign borrower).

So the device should increase the supply of precious credit to the real economy - although some will worry about whether taxpayers should be taking on the risk of financing the housing market and companies in this way.

Also - as I pointed out yesterday - we as taxpayers will be insuring some of the bad loans made by our biggest banks, to limit their future losses from their reckless lending.

The aim of this would be to give banks greater confidence about their prospects - with the intention of assuring the banks that they have sufficient resources to lend more to all of us.

Yesterday I disclosed two other Treasury wheezes: to reduce the massive cash drain for Royal Bank of Scotland, HBOS and Lloyds TSB from the dividends payable on preference shares held by the Treasury; and to staunch the massive contraction of lending by nationalised Northern Rock.

What's more, there'll be a new Bank of England scheme to allow banks to swap assorted loans for Treasury bills - which in effect gives them access to a vast pool of cash to facilitate the provision of more credit.

I hope that by now you spot the pattern. It's all about making sure that enough loans are being made to keep afloat viable businesses and to prevent the contraction of the housing market becoming devastatingly savage.

But you'll also identify an apparent injustice and a paradox.

The seeming unfairness is that banks are being sheltered from the full consequences of their own fecklessness - for the supposed wider good.

And the paradox is that the government wants to make more credit available to reduce the severity of a recession that was caused by a decade-long, crazy lending binge.

Update 19:32: Royal Bank of Scotland will convert the £5bn of preference shares it has sold to the Treasury into ordinary shares - which means that taxpayers' stake in this enormous bank will rise to more than 70% (again, see yesterday's note for more on this).

A bank insurer, not a toxic bank

Robert Peston | 12:04 UK time, Saturday, 17 January 2009

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I don't know why the government hasn't knocked on the head the idea that it's working on the creation of a bad or toxic bank that would buy our biggest banks' dodgy loans and investments.

What I expect it to announce on Monday (although the timetable could slip a day or so) is the creation of the mother of all bank insurance schemes.

By the way, the Treasury is also considering making an offer to Lloyds/HBOS and RBS to convert the expensive preference shares they've sold to the government into ordinary shares.

If this happens, I would expect RBS to say yes and Lloyds to say no. And the conversion would see the state's holding in Royal Bank rising from 57.9% to around 70%, or a good step nearer full nationalisation (see below for more on this).

But back to this insurance scheme to give banks and their investors a bit more certainty about the losses they would face as the recession undermines the ability of many borrowers to repay their debts.

Our biggest banks would identify their bad loans and foolish investments. And they would then pay a fee to a new state-backed insurer to protect themselves from losses over a certain level on these stinky assets.

But the banks would retain these bad assets on their balance sheets. They would not be transferred to a new toxic bank. We as taxpayers wouldn't own the stinky loans - though we would be liable for losses on them over a certain level.

Why the urgency of doing this?

Well, in just a few weeks we'll see results for 2008 from our biggest banks. As I've already pointed out, Royal Bank of Scotland and HBOS will announce unprecedented, horrible losses.

And the HBOS losses would represent a massive drain on its new owner, Lloyds TSB.

There's a fear that unless the Government has developed some kind of safety net for them by then, there could be an alarming loss of confidence in the banking system of the sort we witnessed in September and October.

So next week we'll get the announcement that just such a safety net, in the form of the insurance scheme for toxic loans, is in the process of being designed and built.

In a way, it can be seen as a way of getting capital into RBS and Lloyds/HBOS in particular without fully nationalising them.

That said, the scheme will be open to all our very biggest banks. So Barclays too could insure away future losses on certain of its loans and investments if that suited it - although on Friday night it insisted that it had made stonking profits of well over £5.3bn in 2008.

However, I don't expect a long and detailed statement on the institutional mechanism by which we as taxpayers will pick up part of the bill for the longest banking blow-out in history.

Nor do I expect, as this stage, the government to put a number on the likely cost to all of us as taxpayers of putting a floor under banks' losses - although the potential liability would run to tens of billions.

Of course it's entirely possible that if the new state insurer values the assets properly, taxpayers could end up over the years of the scheme with a profit.

But it seems unlikely that this will be a very popular policy. Readers of this blog have repeatedly asked why we as taxpayers should bail out the banks for the consequences of their greed and recklessness. The question I'm always asked is: whatever happened to the old-fashioned idea that we should pay for our mistakes?

For those working around the clock this weekend at the Treasury, in Downing Street, at the Bank of England and at the Financial Services Authority, the priority is to restore the strength of the banking and financial systems, to stem the remorseless contraction of credit that's caused our awful recession.

In that context, the Treasury and UK Financial Investments (the institution created by the Treasury to manage its investments in banks) have been preparing to make an offer to Lloyds/HBOS and Royal Bank, to convert £9bn of their preference shares (owned by the Treasury) into ordinary shares.

The reason for doing this would be to remove from them the heavy financial burden of paying the 12% dividend of the preference shares.

In the case of RBS, for example, the dividend represents an annual cash outflow of £600m and for Lloyds/HBOS the outflow is £480m.

In theory, if the two banks didn't have to pay this dividend they could lend £27bn more every year (because under FSA guidelines, if the £1080m of dividends were retained by the banks as equity capital, the banks would be able to lend a multiple of that core Tier 1 capital).

My strong sense is that RBS would love to convert the prefs, which it regards as costly debt, into ordinary shares - even though that would see it owned 70% or so by the state.

However Lloyds TSB is less keen, because it's 43.4%-owned by the public sector and doesn't want to see state-ownership rising above 50%, which would be the result of converting the prefs.

It will be interesting to see whether Lloyds' shareholders would agree that it's worth paying out £480m of cash each year to taxpayers to prevent that creeping nationalisation of the bank.

Anyway, as readers of this blog know, there'll be plenty of other initiatives announced next week by the Treasury, most of which can be seen as deploying taxpayers' resources to encourage lending.

One of these will be an extension of the timetable for Northern Rock, the fully-nationalised mortgage bank, to repay what it's borrowed from the Bank of England and the Treasury. This would put less pressure on the Rock to shrink the amount that it is prepared to lend.

Which, at a time when the problem for the economy is a shortage of credit, sounds a bit like an outbreak of common sense at the Treasury.

Hampton for RBS

Robert Peston | 16:09 UK time, Friday, 16 January 2009

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hampton_203pa.jpgI have learned that Sir Philip Hampton, the chairman of Sainsbury, is to be the new chairman of Royal Bank of Scotland.

After a few days of negotiating, Sir Philip has agreed to take the post - which became available after RBS's woes led to the resignations of its senior management. He will replace Sir Tom McKillop.

His appointment to head the partly-nationalised bank comes as ministers and officials are working frantically to put in place measures to improve the provision of funds to banks and to limit their losses from the bad loans they have made.

First Septic Bank (revisited)

Robert Peston | 10:40 UK time, Friday, 16 January 2009

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Bank of America did the world a favour by acquiring Merrill Lynch last autumn, at the height of the global financial terror about whether any bulge-bracket Wall Street firm could survive.

So the US government was never going to cut up too rough when the biggest lender in America asked for a bit of additional help in absorbing the losses incurred on Merrill's holding of poisonous assets.

But the overnight announcement on the bailout of B of A would have been viewed as the stuff of public-finance nightmares a year ago. Today, it's almost par for the course that US taxpayers are injecting $20bn of new capital into the bank and promising to absorb most of the future losses on $118bn of radioactive investments.

Those financial commitments are peanuts of course in the context of $14,000bn-and-rising of financial support that taxpayers have provided to banks all over the world. What's gone wrong with our banks is without historical precedent - but then, you knew that.

One manifestation is banks' results for 2008. What till recently was the world's biggest bank, Citigroup, will disclose horrible losses later today. And next month, we'll see unprecedented losses from Royal Bank of Scotland and from HBOS.

At those banks that have managed to remain in the black, profits have collapsed.

But have no fear. They can't collapse - because we as taxpayers are implicitly underwriting the lot of them. Full nationalisation remains the economic insurance policy of last resort (as shown by Ireland's nationalisation of Anglo Irish Bank).

So what are the interim measures that governments can take, to keep banks afloat and stave off full nationalisation?

One element - but only an element - is to take further steps to improve the flow of funding to them.

We'll probably see some of that announced by the Treasury and the Bank of England next week - partly because there's a deadline set by the end-of-January closure of the Bank of England's Special Liquidity Scheme, which allows banks to swap hard-to-sell mortgages for easy-to-sell Treasury bills.

A new scheme will be put in place that is likely to permit banks and other financial institutions - probably to include the finance arms of motor manufacturers - to exchange all manner of loans to homeowners and consumers and businesses for Treasury bills.

In simple terms, you can see it as taxpayers lending to individuals and companies, or taxpayers financing the real economy.

And on top of that, a sovereign wrap is expected to be put around certain categories of bond - including debt issued by certain big companies (see "Taxpayer support for big companies") and bonds created by packaging together mortgages.

You should view that initiative as taxpayers providing an insurance policy to purchasers of those bonds that they won't lose out if the borrowers can't pay or won't pay.

The details should be nailed down in the coming days. But the broad thrust, bankers tell me, is useful.

That said, as we've seen with the Bank of America debacle, there are two other issues confronting all banks.

Have they got enough capital to absorb the losses being incurred on loans that are going bad?

And can they be remotely confident that they can estimate quite how many loans will go bad, and how big the consequential losses will be?

The arrival of a painful recession, of uncertain length and depth, makes that calculation almost impossible.

Guess what? We as taxpayers are going to have to ride to the rescue yet again.

As I've been saying for the past few weeks, one option under consideration is the creation of a state-owned toxic bank, into which our banks would transfer their stinky assets.

As a concept, some City chums and I branded it last autumn as the First Septic Bank.

septic432.jpg

It was top of the US Treasury Secretary's agenda in September, but was never implemented in the US because the technical obstacles are huge.

As it happens, Obama's team is having another go at creating the First Septic Bank, and a British version - the Royal Septic Bank - is also under consideration.

But the First Septic Bank of America and the Royal Septic Bank of Great Britain may yet fail to be born.

Because there are huge difficulties in valuing the assets to be placed in them and in defining the assets that may be placed in them.

If you put too high a price on the stinky assets, taxpayers end up massively out of pocket.

If you undervalue the assets, banks are mullered.

It's a nightmare.

There are other ways of exploiting taxpayers' deep pockets to achieve the same outcome - such as the guarantee being provided to Bank of America (which had already been given to Citigroup) that taxpayers would underwrite a proportion of losses on toxic assets retained by the bank.

The most creative solution I've come across has been made by Sir Peter Burt, the veteran Scottish banker who was chief executive of Bank of Scotland in its glory days but recently failed in a campaign to keep HBOS out of the clutches of Lloyds TSB.

Burt is proposing a sale-and-leaseback of toxic assets. Which probably sounds like gobbledegook to you. So I'll address it in more detail in a forthcoming note.

Suffice to say for now that a sale-and-leaseback between the banks and the state has two supreme advantages: there's no need to value the poisonous assets; and losses on those stinky assets would be absorbed by the banks in manageable chunks over about 10 years.

The Treasury is reviewing the options and I would not expect it to opt for one or t'other for some time.

But the bad news or good news (depending on whether you're a taxpayer or a banker) is that we as taxpayers will end up in some way paying for the stupid loans and investments made by smart bankers.

(Note from BBC blog admin: apologies for the hiccups in publishing this post this morning.)

Taxpayer support for big companies

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Robert Peston | 18:50 UK time, Thursday, 15 January 2009

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What would you think about lending a few bob to a giant FTSE-100 company?

And when I say "you", I mean all of us, as taxpayers.

Because the next phase in the government's attempt to stem the contraction of credit - that pernicious trend that's driven us into recession - will probably be to put a "sovereign wrap" around bonds and tradable paper issued by big companies.

treasury_sign203.jpgIt's the unfinished business of the Treasury and the Business Department, likely to be unveiled later this month, following the £11bn package of guarantees for bank loans to smaller businesses unveiled yesterday.

Broadly, taxpayers would be guaranteeing loans made to companies by pension funds, mutual funds, insurers and other financial institutions.

And the idea would be to funnel the cash in these funds to the biggest 350 or so British companies.

One reason for doing this is that we're about to see a big bulge in the maturing of loans to companies. As I pointed out in the post "2009 is payback year", for European companies in aggregate there's a trillion dollars of bonds that have to be repaid or rolled over during the coming 12 months.

And although the corporate bond markets have recovered a bit in the past few weeks (the putative "green shoots" which Shrita Vadera now wishes she hadn't pointed out), we as taxpayers are probably going to have to lease our creditworthiness to companies, in order to persuade big investors to back those companies in sufficient size and at the right price.

Which means that the £600bn of loans, guarantees and capital provided to date by British taxpayers directly to our banks would be augmented by substantial guarantees from us for borrowing by giant businesses.

In this instance, we'd be following where that recent convert to the alleged benefits of massive state intervention, George Bush's America, has been leading. In the US, there's already colossal support from taxpayers for corporate borrowing from investors in the form of commercial paper - with the US central bank, the Federal Reserve, buying the stuff and acting as de facto market maker.

As I noted in "The New Capitalism", the social, cultural, political and economic implications of the growing dependence of the private sector on the state and on taxpayers will be profound.

If you knew that you were lending to the vendor of your knickers, or the provider of your broadband service, would that change your attitude to them?

As swathes of the private sector receive vital financial support from taxpayers, the balance of power between citizen and big business will change. But for better, or for worse?

The cost of bringing banks home

Robert Peston | 08:50 UK time, Wednesday, 14 January 2009

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Mervyn Davies is almost the only banker to emerge from the mayhem of the past few years with his reputation enhanced.

Mervyn DaviesHe revived Standard Chartered as chief executive and latterly as chairman. And this British-based international bank has avoided the horrendous mistakes of its bigger, prouder peers, such as Royal Bank of Scotland and HBOS.

So some will say that Gordon Brown is fortunate to have recruited the lively Welshman as trade minister, in succession to the sometimes controversial Digby Jones.

However Davies's appointment only reinforces the paradox that a prime minister who claims to be a great democrat is relying to an extent unprecedented since perhaps the 19th Century on unelected ministers in the Upper House to fix his biggest problems.

Unlike Digby Jones, Davies will join the Labour Party.

And he'll endeavour to avoid the inevitable sniping about financial conflicts of interests by putting all his assets into a blind trust. He won't be taking a salary.

So what's in it for Davies?

Well the day job is trying to promote trade and inward investment - which he sees as proper public service.

Given his expertise, he'll also have a useful sideline in the war against the credit crunch, the contraction of lending, as yet more imaginative uses of taxpayers' money are found to reverse the crippling contraction of credit available to households and businesses.

In that context, probably the most significant feature of today's announcement that something over £11bn of our money is being pledged as loan guarantees and investments in small companies is that ministers believe it'll generate some £10bn of additional lending to small and medium size businesses (that is lending on top of the £21.3bn being guaranteed).

They're stipulating that banks can only take our financial help if they pledge to use the resources that are then released to provide new loans to companies with a turnover of less than £500m.

Which is useful.

But, of course, ministers can have no control over whether banks simultaneously cut their lending to households, or big businesses.

And £10bn is - in any case - small beer in the context of the vast quantities of credit that have been removed from the economy as a whole by the collapse of a range of financial institutions and the scaling down of lending here by a raft of overseas banks.

Banks all over the world are repatriating the focus of their operations. They are concentrating their resources on their domestic markets, because of the intense political and popular pressure they face to support their home economies.

What we're seeing is reversal of the financial globalisation that was such a feature of the past 20 plus years.

In that context, there was inevitability about this morning's announcement that semi-nationalised, cash-strapped Royal Bank of Scotland has flogged its 4.26% stake in Bank of China for £1.6bn net.

It's a case of needs must - although it's a resonant manifestation of the utter collapse of Royal Bank's ambitions to rule the world (in a banking sense).

But don't assume that the widespread return by banks to national banking is all for the good.

The internationalisation of banking, the growth of cross-border flows of capital, generated huge incremental increases in the wealth of most of the world.

A long halt to the process of distributing capital to any place on the planet where its most needed and could be most productively used would impoverish rich countries and - perhaps more importantly - poor countries.

Taxpayers' short-term loans to business

Robert Peston | 12:30 UK time, Tuesday, 13 January 2009

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The government will tomorrow announce three kinds of financial support for small and medium-sized businesses.

And the first thing to point out is that the potential cost to the government of the measures in respect of public spending is just a few hundred million pounds - even though taxpayer guarantees for loans will be at least £10bn. So it would be wrong to get carried away with the significance of all this.

But if the schemes work, they would help small and medium-sized companies to refinance some £20bn of debt that falls due for repayment this year.

They are designed to reduce the risk that large numbers of companies will collapse as a result of the reluctance of banks to extend credit.

The government wants to persuade banks, for as little cost as possible to taxpayers, to keep afloat, through the current recession, those businesses that are fundamentally sound.

Help will be targeted at companies of a middling size, with turnover of up to several hundred million pounds a year: not the very smallest businesses and not those big enough to be able to raise funds directly on capital markets.

And it's all quite technical, involving financial engineering that some may see as too complicated.

Probably the most eye-catching of the measures will be the provision of perhaps £10bn of taxpayer guarantees for short-term corporate loans provided by banks. These loans would cover medium-size companies' working capital requirements, or their day-to-day financing needs.

These loans aren't particularly risky. And although they have become harder for companies to retain, the withdrawal of working-capital finance by banks isn't the biggest problem faced by most businesses.

So some may see it as odd that the government is providing substantial working-capital finance. But here's where the financial engineering comes in.

Taxpayers would guarantee around 50% of these working-capital facilities, so they would support around £20bn of credit to companies.

hm_treasury_bbc203.jpgThe tit-for-tat that the Business Department and the Treasury is imposing on banks is that if they take advantage of these taxpayer-backed facilities, they will then be obliged to provide longer-term loans to sound, relevant, needy businesses.

Or, to put it another way: ministers hope that by reducing the requirement of banks to finance companies' working capital, the banks will be prepared to take a few more risks in financing companies' investment and longer-term needs.

We'll see.

Some will argue that the scheme does the opposite of what the public sector should do. They would say that only the public sector and taxpayers have the stomach for taking serious amounts of credit risk right now - so we as taxpayers should do this, rather than providing these relatively risk-free loans.

That said, the Business Department will enlarge a separate scheme, called the Small Firms Enterprise Guarantee, which will involve the public sector taking quite significant risks in financing firms regarded as vital to the long-term needs of the economy.

These would be companies involved in developing products and services with what's known as a high "knowledge" content - or those with the potential to generate significant exports and to underpin the competitiveness of the UK.

Right now, these businesses are having extreme difficulty raising finance. So the government will guarantee up to 80% of loans to them.

These would be riskier loans, which could total several billion pounds in total over time. And therefore the eventual cost to the taxpayers from providing them will run to several hundred million pounds, because some of the loans will go bad.

Finally, the Business Department is making available a few tens of millions of pounds of equity capital to help the survival of strategically important small businesses that foolishly borrowed too much during the years of the debt bubble.

And in the coming few days, there will be an announcement that the government will co-insure trade credit - which is another vital component in companies' financing needs.

Because it's all pretty complicated, there may not be many big headlines out of all this.

It's a lot less easy to understand and possibly less ambitious than the Tory proposal to guarantee up to £50bn of loans to companies. (See also Friday's post, Nationalising Tories.)

But ministers would argue that they are targeting help where it's most needed - and that the Tory plan could result in credit being provided either to big businesses that don't really need it or will generate big losses for taxpayers on loans that companies won't be able to afford.

There is a philosophical difference here, between a Tory Party that would trust the banks to use very substantial taxpayer guarantees wisely and a Labour government that would be much more prescriptive in the deployment of much smaller guarantees.

Vulnerable small firms

Robert Peston | 09:55 UK time, Tuesday, 13 January 2009

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There are two ways of looking at Tesco's figures this morning: as a bit worse than some of its close competitors, particularly those perceived to offer better value for money; and massively better than most retailers.

TescoTesco is far too big to be dismissed as an interesting exception. Its sales in the UK alone (and it has big overseas operations) are over £40bn.

So it matters - and not just to Tesco's shareholders - that in the seven weeks to 10 January Tesco's like-for-like sales (or sales per unit of selling space) were 3.5% higher than in the previous year.

And the resilience of Tesco's sales extended wider than relatively recession-proof food. Tesco says this morning that non-food sales rose a bit - and that it captured market share in electricals, clothing and entertainment.

That said, Tesco's performance appears to have been less robust than its closest competitors, Sainsbury, Asda and Morrison. And smaller retailers that position themselves as offering the cheapest food around, such as Aldi, have enjoyed much stronger sales increments (this morning's FT says Aldi sales rose 22.2% in December).

But Tesco is incomparably bigger than all of them. Aldi's UK sales are almost the equivalent of a rounding error in Tesco's profit-and-loss account. Tesco is as big as Sainsbury and Asda combined.

So it would be unrealistic to assume that Tesco could escape unscathed from the end of the longest, strongest consumer boom in British history.

But nor are its figures exactly consistent with the screaming headline this morning from the British Retail Consortium, which says "Worst December in survey's history" when summarising its members' trading performance in December.

The store groups that belong to the BRC suffered a 1.4% drop in total sales in December and a 3.3% fall in like-for-like sales.

Meanwhile the British Chambers of Commerce, representing a much wider range of businesses - some 6,000 of them - says that its survey of economic conditions in the last three months of 2008 discloses "a frightening deterioration" in the health of the British economy.

The BCC says that domestic demand is collapsing, exports are falling and confidence is through the floor.

So who do we believe, Tesco - which talks of a "steady UK performance - or the BCC and the BRC?

To reiterate, it would be wrong to dismiss Tesco as just one firm. In the UK alone it employs more than 280,000 people - compared with 680,000 people for all BCC members.

However, although Tesco, the BCC and the BRC may seem to be saying contradictory things, they are all telling the truth.

Tesco does have the advantage of being in food, which we have to buy even when the economic going gets tough. But it has two other enormous advantages.

It has a massive and fantastically strong balance sheet - so it is not constrained by the shortage of credit that's mullering smaller businesses.

And as a business it's so big that it can cut prices to win customers, and then share the pain of those lower prices with suppliers.

In other words, the most exposed business right now are smaller ones, with limited buying power and a dependence on credit that's harder and more expensive to maintain.

Some of these will fail because they borrowed imprudently during the boom years, or because they are badly managed or because they are in industries or markets in terminal decline.

Although there is a human cost to such failures, we shouldn't weep too much or try to prop them up. The fastest route to long-term economic decline is to put lame ducks on life support.

What should worry us however is that many fundamentally sound companies may fail, simply because some international banks have massively reduced their presence in the UK corporate-lending market and British banks have perhaps become excessively averse to taking risks.

These vicious trends have been conspicuous for months. And, after months of evaluating how to maximise the therapeutic bang for the taxpayers' buck, the government will tomorrow unveil measures that it hopes will correct some of those market failures.

To state the bloomin' obvious, even Tesco couldn't thrive if the productive capacity of Britain's small and medium sized firms were wiped out in the coming months.

Insurance that worsens crunch

Robert Peston | 00:01 UK time, Monday, 12 January 2009

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An essential element in the government's forthcoming package to stem the pernicious shrinkage of credit in the economy will be measures to compensate for the devastating impact on many companies of the withdrawal of trade credit insurance.

That probably sounds deeply dull and technical. But please read on, because this stuff matters to all of us.

For smaller companies, the importance of trade credit insurance is often that they can't borrow from banks, unless they've insured their sales to corporate customers.

The banks make this stipulation because it absolves them from having to assess the credit-worthiness of their borrowers in detail - because at least part of the credit risk has been laid off to an insurance company.

So the availability of such insurance is literally a matter of life and death for many businesses.

Woolworths is one of the more extreme examples.

When insurers would no longer provide cover to Woolies' suppliers in the autumn, that was the penultimate nail in the coffin of the ailing general retailer - because suppliers insisted that Woolworths pay cash upfront to them for orders, which meant that Woolies was forced to draw on its borrowing facilities, which in turn took the retailer up to the limit of what its bankers were prepared to lend.

And the rest is the sorry story you know: the demise of a historic high street name that was forced to liquidate everything so that the bankers could get their money back.

The point is that trade credit insurance is central to hundreds of billions of pounds in trade and the provision of finance to companies of all sizes.

When it's withdrawn, as has been happening for months, small companies are unable to fulfil valuable orders placed by big companies and those bigger companies lose access to vital supplies.

So a rational decision by insurers to scale back their cover on sales to companies perceived as vulnerable to our economic contraction is rippling through the economy in a damaging way: cover is being withdrawn because we appear to be in a sharp recession, and its withdrawal is making that recession significantly worse.

Part of the problem is that the insurers seem to me to have massively underpriced the cover they provide. Just as banks charged ludicrously low rates of interest during the years of the credit bubble, so the trade credit insurers insured hundreds of billions of pounds of trade for tiny premiums.

According to statistics from the Association of British Insurers, there were £334m of premiums written by the insurers in 2007, covering £282bn of sales by British companies.

Or, to put it another way: insurers were receiving premiums equivalent to the turnover of a medium-size business to protect more than 20% of the output of the entire British economy.

Scary or what?

Those aggregated premiums were equivalent to a minute 0.1% of the sum insured - down from 0.26% in 1995. Which would only make economic sense in a world where there are never recessions.

One illustration that the premium was too low is that claims received by insurers in 2008 are likely to have been rather more than total aggregated gross premiums received in the previous year, extrapolating from trends in the first nine months of the year.

But the insurers have been protecting themselves from the worst losses by simply withdrawing cover for new orders to companies seen as weak. In other words, unlike insurance provided to you and me on our homes, for example, the trade credit insurers have been able to withhold protection as soon as they detected stormy conditions.

To restate the painful paradox: insurance designed to give confidence to companies that they would be paid by corporate customers is being scaled back in a way that's magnifying the woes of businesses big and small.

What's to be done?

Well, in France, a new system is being implemented whereby taxpayers are sharing the insurance risk with private-sector insurers on supplies to viable companies.

And I would expect the Business Department and the Treasury to implement a similar system of co-insurance by taxpayers.

But that can only be a short-term solution.

In the longer term, the supply of finance to small and medium-size businesses has to be overhauled, so that the viability of those businesses is no longer dependent on insurance that's only available when the sun is shining.

Nationalising Tories

Robert Peston | 13:33 UK time, Friday, 9 January 2009

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If there was even a scintilla of doubt that we're in a very painful recession, that doubt must be eliminated by the release today of statistics on manufacturing output and industrial production in November.

These were truly shocking.

The seasonally-adjusted output of all UK production industry in the penultimate month of last year was a staggering 7% lower than in the same month of 2007.

For the smaller group classified as manufacturers, the fall was even worse, at 8% year on year.

Brand new Nissan vehicles are parked up awaiting loading onto ferries to be distributed worldwide from Tyne Dock, South Shields, Friday Jan 9 2009Of course it's true that industry is not as big a proportion of the British economy as many would like it to be. But it contributes around a fifth of our entire economic output.

And that fifth of the economy is contracting at an annual rate of 8%.

The picture is even more alarming when examining the manufacturing figures in more detail, and looking at output in the three months to the end of November compared with the previous quarter.

There were falls in 12 of the 13 manufacturing sectors. Worst hit were wood and wood products, which was 6.7% lower in that quarter; transport equipment, down 5.7%; and basic metals, also 5.7% lower.

Only the relatively recession-immune food, drink and tobacco sector recorded an increase - though its rise was an anaemic and statistically insignificant 0.4%.

As for the 77% of our economy that's represented by assorted services: well, many of those - such as our banking and financial businesses - are in a conspicuous mess.

That said, the pre-Christmas hysteria about the meltdown of retailing was overstated (though the shopkeepers have themselves to blame for this hysteria, with their characteristically neurotic seasonal gloom about their prospects).

The true story of non-food retailing is that it was generally bad in the run-up to Christmas, but lethally bad only for a few. Those stores perceived to offer staggeringly good value performed better than the rest (yesterday's figures from cheap-and-cheerful Peacocks were particularly impressive). And food retailing was the exception to the generalised fall in sales.

However, forecasters who have been estimating that the UK economy contracted by an unpleasant 1% in the final quarter of last year may turn out to have been optimistic.

But to return to manufacturing for a second, this country will pay a heavy price for years to come if this economic contraction leads to a permanent loss of firms and productive capacity.

We've learned to our cost the perils of being exceedingly dependent on growth from the City, from financial services. It would be a double indignity if an economic crisis created in the financial sector should wreak the most harm on manufacturers - and make our economy, and our prosperity, even more dependent on services.

So it's more than a small mercy that those horrible job cuts announced yesterday by Nissan are being implemented in a way that should not lead to an irreversible loss of skills and shrinkage of its manufacturing potential.

Even so, there's a role for government, to prevent the chronic shortage of credit in the economy - which is the precipitator of our misery - from wreaking devastating harm on viable firms.

The Treasury has already announced taxpayer guarantees to support £1bn of bank lending to small businesses and a further £1bn of working-capital finance for small exporters. And it's working on a more substantial scheme that would involve taxpayers sharing in the risk of much more lending to companies.

What's finally announced won't be trivial. But the Tories complain that the government has been too slow and unambitious in providing such succour.

The shadow chancellor, George Osborne, today called for a three-pronged strategy to stimulate the flow of credit: state insurance for £50bn of lending to business; a cut in the cost of the capital that's been provided by the Treasury to banks and also a reduction in the fees levied for guaranteeing interbank lending; and a new Bank of England facility to swap corporate loans for cash.

This would amount to a substantial extension of the nationalisation of the credit-creation process - and Osborne acknowledges that more draconian nationalisation may yet be necessary.

It's quite something when the Tories complain that a Labour-controlled Treasury is being too cautious in rolling back the boundaries of the private sector and too feeble when pumping up the role of the state.

Update: Apparently I was the only person in the UK who had never heard of Sportacus. My shameful ignorance ended yesterday when I met this rock-solid pillar of the crumbling Icelandic economy on Simon Mayo's 5 live show. Click below to see me going to LazyTown.

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Does the Bank Rate matter?

Robert Peston | 09:37 UK time, Thursday, 8 January 2009

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There is a good deal in Evan Davis's remarks this morning on Today that all the fuss about whether the Bank of England should cut interest rates may be the equivalent of bald men arguing over who should have the comb - and his apology to my old friend Roger Bootle, a follicularly challenged economist, was priceless.

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To return to my boring refrain of the past 18 months, the biggest problem for our economy is not the price of money but the availability of it. Banks are contracting the amount they lend. So the question is whether a cut in the Bank of England's policy rate to a historic low would increase the supply of credit.

In normal times, a cut in the Bank Rate would help to boost the flow of new lending. But right now it's not clear that a reduction would have much positive impact

The reason is that the main headache for the banks is that both regulators and markets are forcing them to hold more capital relative to their loans, their assets.

The risks of lending are perceived to have increased. So lenders to banks and also the FSA officials paid to stop banks falling over want them to hold more capital as a cushion against future credit losses.

Capital is scarce. The main source of it right now is us, taxpayers. Banks aren't keen to be nationalised to any greater extent than happened last year. So the route the banks are taking to boost the ratio of their capital to assets is to lend less, to deleverage (to use that ghastly euphemism).

Here's the good news. When interest rates are cut, that provides an opportunity for banks to generate capital. How so?

Well if banks fail to pass on the reduced cost of funds to borrowers, such as companies and those with mortgages, banks' profits increase, which in turn boosts capital (so long as banks don't pay out the profits as dividends). To put it another way, if banks make greater profits from lending that's one of the best incentives for them to lend more.

Here's the less good news. With interest rates so low, banks are under intense and understandable political and populist pressure to maintain interest rates for savers while still passing on the rate cut to borrowers.

In other words, they are under massive pressure to generate reduced profits from lending - which of course serves as a disincentive to lend.

And as the Bank of England's Bank Rate moves closer to zero, the louder is the clamour for the banks to keep rewarding savers while charging next-to-nothing for loans.

Which would squeeze profit margins till the pips squeak.

And there's a further drain on their profit margin as interest rates fall, which is that there's an unstoppable shrinkage in the margin between their average lending rate and the 0% rate banks always pay to the millions of us who keep some of our money in current accounts that never pay interest.

All of which is to say that cutting the Bank Rate now that rates are so low won't cure the disease that's afflicting the economy - the shortage of credit. And there's a risk that cutting rates to almost zero could make the illness worse.

Which is why it won't be too many weeks before we see policies that would be the equivalent of giving a comb to a hairy economist.

These, as I've been saying for some time, would involve taxpayers lending more to businesses and households, the further nationalisation of the credit-creation system.

What's still unclear is what form this nationalisation will take.

It could involve taxpayer guarantees for some bank loans. It could involve extracting loss-making assets or toxic loans from banks, to give the banks greater confidence that their capital won't be eroded. It could involve the state taking direct control of the provision of some credit to the real economy.

There's a massive amount of work on all this going on in the Treasury. And ministers are doing a great deal of agonizing about it all. The results of that agonising matter a great deal more than whatever decision is taken today by the Bank of England on interest rates.

Rose on pay and VAT

Robert Peston | 15:37 UK time, Wednesday, 7 January 2009

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What should happen to business leaders' remuneration in this downturn?

Sir Stuart RoseWell Sir Stuart Rose, the chairman of Marks & Spencer, was characteristically blunt when I interviewed him earlier today.

"I certainly won't be taking a pay rise" he told me. "It would be inappropriate for me to do so...I am 99.99% certain there won't be a bonus. I certainly won't be getting anything over and above what my staff will enjoy."

As for the example that should be set by Britain's executive class in general, Rose said there must be absolutely "no payments for failure."

Which most of you may well say is common sense, at a time when almost every company tells me that it's either reducing job numbers or is about to do so.

But as we've seen over many years, common sense doesn't always rule in the board room when remuneration is being decided

I also asked Rose whether he agreed with Simon Wolfson, the chief executive of Next, that the government's emergency VAT reduction had been a waste of time and money (see my note this morning, "M&S: no ordinary downturn").

Rose, who is a member of the prime minister's Business Council, started by saying that he "doesn't do politics". But he then added that the VAT decrease has "not made a material difference to our sales."

Which some will see as a criticism of the Treasury, although Rose was at pains to point out that he felt the government was acting with the best of motives.

As for the Treasury and Number 10, they believe that criticisms of the VAT cut miss the point.

They say that the point of the reduction in the VAT rate from 17.5% to 15% - which lasts a year and will lead to a £12bn reduction in tax revenues - was not to boost the sales of M&S or any other individual retailer.

It was to put money into the pockets of consumers and businesses, at a time when households are feeling strapped for cash and when companies' profit margins are under pressure.

The VAT reduction has done that - but, perhaps, only as an uninteresting matter of definition.

Where retailers pass on the VAT cut in the form of lower prices, that represents an increase in the real value of our disposable income. And where firms have maintained their VAT-inclusive prices (and loads of restaurants and leisure groups haven't passed on the cut), that's a boost to their profitability.

Either way, there are cash benefits to households and businesses from the VAT reduction.

But what's much more interesting - and what's hotly debated - is whether the VAT cut is the best possible use of that precious £12bn for the purpose of dampening the magnitude of the economic contraction we're experiencing.

And that's where the remarks of Wolfson and Rose are relevant.

The Treasury cut VAT partly to stimulate economic activity in the private sector. It hoped that the £12bn of foregone revenues for the Exchequer - and the corresponding increase in public-sector debt - would generate incremental revenues for business and would therefore protect jobs.

If substantial retailers like Marks and Next say the VAT cut hasn't stimulated trade to any noticeable extent, that matters (although it is not beyond the realms of possibility that Marks and Next are wrong).

M&S: no ordinary downturn

Robert Peston | 07:58 UK time, Wednesday, 7 January 2009

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Is Marks & Spencer the true story on the high street or a bit worse?

The story it tells is certainly pretty dire.

The famous like-for-like sales, which show sales per square foot in older stores, are truly horrible - with general merchandise 8.9% lower in the 13 weeks to December 27.

However, it's probably the trend to unadjusted, overall sales that's more disturbing.

For the group as a whole, these were 1.2% lower, thanks to a particularly strong performance outside the UK and on the internet.

But here's the ghastly bit: overall UK sales were down 3.4%, including the benefit of Marks' well-publicised and unprecedented promotional days.

Clothing was the worst performer, with sales 6.5% lower. Food was just 1.1% down - which represents a modest recovery.

Also, the profit margin of Britain's largest clothing retailer was significantly lower, because Marks has been forced to slash prices.

Sir Stuart Rose, Marks's chairman, expects the bad times to last at least a year.

So he's closing 27 less profitable stores, shedding 1,230 jobs and making the pension scheme less generous. He's also taking a knife to investment, with capital spending falling from £700m this year to no more than £400m next year.

This is pretty savage stuff, designed to keep the group profitable during the worst high street downturn for almost 30 years.

Marks' profits this year are expected to slump around 45% to a bit over £600m.

So the days of laurels and awards for Marks' well-known executive chairman probably feel to him like a lovely distant memory.

Update 0839: It's rare that Simon Wolfson, the chief executive of Next, makes public utterances. And perhaps today we know why, because he certainly stirred things up a bit this morning in his Today interview, when he criticised the government's emergency cut in VAT.

This reduction for a year in the VAT rate, from 17.5% to 15%, will cost £12bn. It's supposed to help groups like Next, Britain's second biggest fashion chain, by encouraging all of us to spend a bit more.

But Wolfson said that the expensive VAT reduction was a mistake, that it was a waste of taxpayers' money, and that the Treasury would have been far better to cut income taxes if it wanted to encourage spending.

A well-known Conservative supporter, Wolfson also raised serious concerns about the government's central economic policy, of spending more and cutting taxes to combat the contraction in our economy. He's very worried about the consequential ballooning of public-sector debt - and he believes that, like Next, Gordon Brown could do more to make the public sector more efficient.

Quite rightly, he was at pains to point out that the difficulties on the high street are a recession, but not Armageddon - and that groups like his and like M&S remain solidly profitable.

In which context it's as well to point out that Marks has managed expectations among its investors of what to expect from its results in a characteristically astute way.

Although its trading update was hardly uplifting stuff, its shares have risen a smidgeon this morning.

Sterling challenge for UK shops

Robert Peston | 09:15 UK time, Tuesday, 6 January 2009

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Sales in a typical Next store, so called like-for-like sales, have fallen 7%.

To put it another way, the UK's second biggest fashion retailer is selling one in twenty fewer skirts and shirts in shops unaffected by new openings.

This sounds disastrous.

But investors in its shares may actually breathe a small sigh of relief that its performance in the last five months of 2008 wasn't even worse, given the gloom that's engulfed the High Street.

Also there's comfort to be had from Next's announcement that it's on course to make profits in line with City forecasts of more than £415m before tax.

At Debenhams too the theme is that it could all have been a lot worse, as the leading department store chain reported like-for-like sales down 3.5% in the 18 weeks to the beginning of January.

Although Debenhams is widely viewed as having too much debt, barring an unexpected calamity both it and Next will still be standing after the downturn in consumer spending which has exterminated weaker rivals.

What will particularly impress Debenhams' creditors is that the gross value of its transactions and profits have risen, the business is generating cash, and net debt has fallen

But it won't be easy.

Next warns that the coming headache will be a massive increase in costs caused by the sharp devaluation of sterling.

In Next's case this doesn't bite until the autumn and winter of this year, because it has hedged its currency exposure until then. For most big retailers, including Marks & Spencer, the big impact of the weakened pound will come in the middle of the year.

There will be a horrible choice for Next, M&S, Primark and the rest, who buy most of their stock outside the UK.

Should they absorb an estimated 20% currency-related increase in the cost of clothing and other goods manufactured for them in China, India, Hungary and so on?

That, of course, would mean that their profits - which are already on a crash diet - would be squeezed further.

Or, in a period of feeble consumer demand, is there any chance they'll be able to pass on the cost increases to cash-strapped consumers?

Their ability to pass on the costs to us will depend on the intensity of competition at the time.

Right now, with Tesco announcing yet another round of price cuts, there's no sign of an easing up in the competitive assault.

In fact, one of the reasons that the sales of Debs and Next weren't even worse was the significant discounting that took place in the Christmas fortnight.

Anyone who made the mistake - as I did - of venturing to a mall or shopping centre in late December will know that we haven't been wholly weaned off our spend-spend-spend habits.

There was a mob, frantically looking for bargains.

But we're all back at work now, the last Woolworths have shut their doors forever, and a chill wind is blowing through the economy.

Those who run our biggest stores tell me they're braced for the worst of winters.

Update 1243: The Times is, of course, correct that M&S is poised to announce around 1,000 job cuts. Details will be announced tomorrow in its trading update and the statutory consultation period will commence. But this shouldn't be seen as a savage and massive redundancy programme. M&S is the largest fashion retailer in the UK and employs more than 70,000. These job reductions represent less than 2% of the workforce.

Also, I didn't mean to imply, as some have suggested, that Next's figures include the post-Christmas sale (its trading update relates to the period up to and including Christmas Eve). What I thought I was saying was that it and Debs (and lots of other big store groups) benefited from a shopping surge in the holiday season (which is in Debs' announced figures, but not Next's).

Bull in a china shop

Robert Peston | 09:36 UK time, Monday, 5 January 2009

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Companies burdened with debt and dependent on discretionary spending by consumers are currently as fragile as the finest crystal or bone china. So, sadly, there's no surprise that Waterford Wedgwood - which had net debt around £470m last spring - has called in the receiver in Ireland and has gone into administration under insolvency procedures in the UK.

Almost everything that Waterford Wedgwood manufactures is a nice-to-have rather than a must-have. And most of us are thinking twice about shelling out on nice-to-haves.

wedgwood_pa203.jpgWW's collapse is a resonant event that speaks of a noxious global squeeze on consumer spending. But although it has more history than most of the FTSE-100 companies combined - Waterford, Royal Doulton and Wedgwood are great names from Britain and Ireland's industrial past - WW is not a huge company.

Global sales are £650m. In the UK, it employs 1,900. Of these, around 600 work in manufacturing at Barlaston.

There are 5,800 employees outside the UK. And (lest you've forgotten that we live in a globalised world where production gravitates to low-cost economies) the biggest manufacturing centre is Indonesia, where there are 1,500 staff.

The brands will surely survive under new owners. And my understanding is that there have already been expressions of interest from possible buyers of the brands.

However, what happens to its manufacturing plant - and that of many other companies like it - is what matters. Even if in WW's case there are just a few hundred British manufacturing jobs at stake, the UK can ill afford to see yet more precious exporting capacity relocated to more productive competitor economies.

That said, for biggish British companies this morning, there's some good news on this, the first proper business day of the new year.

What I mean by this is that there's no news of any significance from them - and that's good news.

If trading by retailers over Christmas had been even worse than investors had been led to expect, there would have been emergency announcements by those retailers (under Stock Exchange rules).

So in the coming few days we can expect the likes of Marks & Spencer, Next and Debenhams to say - in their scheduled trading updates - that turnover per square foot of selling space is falling pretty sharply and that profit margins have been squeezed by heavy discounting and promotions. But we knew that.

And we can be fairly confident that they remain on course to meet much reduced expectations for their profits this year (a bit over £600m in the case of Marks & Spencer, down from £1.1bn last year, or an eye-watering drop of around 45%).

More generally, the question to be asked is whether most of the bad stuff that could happen to companies is already discounted in stock market prices.

Analysts are forecasting that the earnings of European companies will fall fairly sharply this year and that those of US businesses will drop in the first half before recovering. The outlook is more mixed in Asia.

Against that ostensibly gloomy background, stock markets have been rising fairly generally over the past two or three weeks. The FTSE-100 is now more than 20% above its low point of last year. The S&P 500 is 26% off its 2008 bottom. Asian stocks have been rising solidly for the past eight days.

Shome mishtake, shurely?

Not at all.

Stock markets are looking at the prospects for 2010 and 2011. And however rotten 2009 will turn out to be, in the form of companies going kaput and unemployment rising sharply, investors are increasingly confident that armageddon has been avoided.

They look at the way that central banks have slashed interest rates and are - in effect - dropping money from helicopters. They look at Barack Obama's plan to pump something over $700bn into the US economy in the form of tax cuts and public spending. And they conclude that an economic turn for the better must surely come towards the end of 2009.

Here are a couple of almost needless words of caution.

Stock markets aren't always right (we've all learned that painful lesson in the past couple of years, haven't we?).

And, as and when we see the green shoots, they may be fragile, stunted and spotted with a disease called inflation.

Our banks 'have to lend more'

Robert Peston | 13:09 UK time, Sunday, 4 January 2009

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Those of you of a puritan nature may have come close to fainting this morning when the Prime Minister told Andrew Marr that our biggest banks may have to lend more than they did in the boom years rather than less.

"Is he totally bonkers?" you may have found yourself asking. "Surely it was excessive borrowing by companies and households that got us into this mess. So how can it make sense for the banks to lend even more?"

The answer, which Gordon Brown hinted at in a characteristic mumble, is that our biggest banks provided only a proportion of loans during the era when the debt bubble was created. And lots of the other providers of credit in that time of crazy lending are now out of the market altogether or have become much smaller players.

That's one of the major reasons why there has been a sharp reduction in the availability of debt-finance even for creditworthy businesses and prudent households.

And, to state what you all know too painfully well, it is the main reason why our economy is contracting so painfully.

Here's an incomplete list of banks that were major providers of loans that - for a variety of different reasons - are no longer the aggressive providers of credit in the UK that they once were: the Icelandic banks (you know why); Northern Rock and Bradford & Bingley (ditto); the finance arms of major motor manufacturers; Citigroup/Egg; Alliance & Leicester (absorbed by Santander); many of the Irish banks and their subsidiaries; the smaller building societies; the specialist mortgage lenders.

The collapse of Woolies told this story. Among the big lenders who demanded their money back in November, only one - Barclays - was British. And Barclays' exposure was smaller than most. The big lenders - GMAC, Burdale (part of Bank of Ireland) and GE Capital - have overseas parents.

So how much capacity has been taken out of the British lending market? Well that's what the Treasury and the Bank of England are desperately trying to evaluate - because it will determine the next phase in the Government's commitment of taxpayers' money to ensure that sufficient credit is available to viable businesses and households.

My strong sense is that the Treasury is moving towards a plan that looks awfully like the Tories' proposal for taxpayers' to guarantee a proportion of lending to business.

What's under consideration is an insurance scheme, whereby banks would pay a fee to the Treasury to reduce the potential losses they would face on lending to companies and also possibly to households.

Here's how such a scheme could work - though it's early days, so don't assume that the numbers I quote will be the ones the emerge as and when a scheme is announced.

The banks would retain liability for - say - the first 5 per cent of the loss on a loan. So they would retain a strong incentive to lend prudently. But the banks would be able to purchase insurance from taxpayers to cover the next 10 per cent or so of any losses on loans that went bad (and, in a severe recession, many loans would go bad).

Why would this encourage banks to lend more than they are doing at present?

There are two reasons.

First, the banks could take a bit more risk when lending, because the loss to them in the unlikely case that all the stinky stuff hit the fan at the same time would be knowable and manageable.

Second, with the state sharing the risk, the banks' capital ratios would look much healthier as their balance sheets expanded, because the formal regulatory risk-weighting of lending would be significantly reduced.

Of course, the corollary of all this would be a significant increase in the risks and potential losses carried by taxpayers. And as I said in my Christmas Eve note ("We are the banks") the line between the public and private sectors would become even more blurred.

As for the banks, if they took advantage of such a scheme, they would be under an unavoidable obligation to direct their incremental lending at the UK: they would have to massively increase the credit they provide here, and shrink the credit they provide in other countries.

To be clear, there's a lot of this going on anyway. Royal Bank of Scotland, for example, is scaling back its global ambitions and is rebalancing its business towards the UK.

And there, as they say, is the rub.

RBS's shift towards its home market is a microcosm of what most banks are doing all over the world. And as banks do their patriotic duty and direct their increasingly precious and scare capital resources towards their domestic markets, the amount of credit available in the world as a whole is being compressed.

What's going on can be seen as a partial retreat from globalisation in the financial economy. The scale and longevity of that retreat in this new year will determine all our economic fortunes, wherever we may be in the world.

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