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Archives for July 2009

Who'll be shot when banks misbehave?

Robert Peston | 10:25 UK time, Friday, 31 July 2009


As the Treasury select committee says, the "who-gets-fired" test is a pretty good way of ascertaining whether there are clear lines of responsibility in any organisation or group of organisations.

That said, most of our personal experience would indicate that surprisingly few institutions - in either the public sector or private sector - pass this test with flying colours.

However, as and when the system for preventing our banks and financial institutions from making a terrible mess of it all again is finally perfected, it would - as the MPs point out - be sensible to have some clarity about who is in charge.

They think that the Council for Financial Stability - the new body for co-ordinating the financial-oversight work of the Treasury, Financial Services Authority and Bank of England - is a "cosmetic change", a "rebranding" that "will achieve little by itself".

That's a knee to the tender parts of the Chancellor of the Exchequer.

On the other hand, there's no endorsement of the Tories' plan to make the Bank of England the all-powerful super-regulator-cum-central-bank.

As it happens, George Osborne, the shadow chancellor, can answer the question "who gets fired?" in his utopian regulatory world. As and when we're all covered in ordure generated by the banks again, it would be the governor of the Bank of England who would get the bullet.

Lucky old Mervyn.

However, the Treasury select committee implies that it may be a bit previous to go nap on Mr King as the potential fall guy.

It wants decisions taken first on the "macro-prudential" tools that are needed to prevent banks lending too much during an economic boom.

Only when it's clear how best to prevent a generalised lending binge (those were the days) can there be a judgement on whether it's the Bank of England or the Financial Services Authority that should be lead party-pooper, say the MPs.

In this context, it's worth pointing out that there's something of a nuanced assessment of the FSA.

The report says that the FSA has "failed dreadfully in its supervision of the banking sector" but compliments the regulator for its "speed of progress" in recruiting better staff and enhanced training.

For me, however, the most important parts of the report relate to stuff I've been boring on about here for months and months: viz, the best ways of shrinking banks individually and collectively so that they can no longer hold the taxpayer to ransom.

The big question is how to break the link between the creditworthiness of British banks and the creditworthiness of the UK as a whole - or how to reduce state-protected banks' dependence on massive, unreliable wholesale funding from abroad that turned out to have been underwritten by us, by taxpayers (though no-one ever asked us if we wanted to be the guarantors of the banks' reckless borrowing).

Like the authorities, the MPs are still feeling their way towards a long-term solution, and there's no immediate prospect of ending the destructive mutual dependence between a bloated banking sector and an over-stretched public-sector balance sheet.

That said, the MPs - like the Treasury and the FSA - believe that, in the many years to come, the banks can be taxed down to size, or incentivised to slim down and simplified by imposing substantial additional capital requirements on banks that are big or complex or engage in a good deal of speculative trading.

Against that background, if you're in a mood to fume once more at the way that individual bankers enriched themselves at taxpayers' expense, I commend to you a report published yesterday by the New York State attorney general on fat bonuses paid last year by US banks that were kept alive by public money.

The once-mighty Citigroup, for example, received hundreds of billions of dollars in investment and guarantees from American taxpayers, but still paid out $609.1m in bonuses to its top 124 bonus recipients: three individuals received bonuses of $10m or more; 13 pocketed bonuses of $8m or more; 44 individuals trousered bonuses of $5m or more.

Merrill Lynch, which was rescued by Bank of America and generated losses last year of $27.6bn, paid its top four bonus recipients in 2008 a combined $121m and the next four received $62m. The top 149 bonus recipients at Merrill received a combined $858m.

This spectacle of bankers' snouts in the trough feasting thanks to the emergency succour provided by taxpayers was also to be seen at Goldman Sachs, Morgan Stanley and JP Morgan.

And all the while a painful global recession - partly caused by bankers' excess - was depriving less fortunate citizens of their livelihoods.

We don't have an equivalent report into the bonuses paid last year by British banks.

And perhaps that's just as well.

We tend to pride ourselves at being an imperturbable, unrevolutionary nation. Not for us the defenestrations and guillotinings of continental popular uprisings.

But the vision of bankers gorging on the carcass of the economy like bloated ancien regime aristocrats might upset a few, I suppose.

BT: A blacker pension hole

Robert Peston | 11:23 UK time, Thursday, 30 July 2009


BT seems to me to have been a bit disingenuous this morning in the way it has presented its first quarter results.

The impression it creates is of steady-as-she goes in its retail and wholesale broadband and telephony businesses. And that the troubled global services divisions - which provides services to big institutions - is now looking sick rather than a basket case.

Which is presumably why its share price bounced an impressive 11% this morning.

BT sign

So it comes as something of a surprise to discover, buried in a note some way into the press release, that at the end of June its net liabilities exceeded its net assets by a substantial £3.2bn.

Now I can't remember the last time that a putative blue chip like BT, a semi-utility that's supposed to generate buckets of cash, had a net deficit on its balance sheet.

This is a non-trivial occurrence.

Intriguingly, BT insists that:

"this does not affect the distributable reserves and dividend paying capacity of BT group plc, the parent company".

Which is a bit odd - in that some might argue that the prudent course would be to strengthen the balance sheet by conserving cash and abandoning the dividend (which was slashed 59% only 10 weeks ago).

So what's created this hole?

Well the deficit before tax in its pension fund has doubled from £4bn to £8bn in just three months.

And, under legislation passed by this government, this is an unavoidable debt.

To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn.

The cause of the huge increase in this debt is not a collapse in the value of the pension scheme's assets. In fact these have risen 3.8% to £30.4bn.

What's ballooned are the liabilities, from £33.1bn to £38.3bn.

And some will say that BT has been hoist on its own petard - in that pensions analysts such as John Ralfe have been arguing that for months the company has been understating the size of its pension liabilities through the so-called discount rate it uses.

Explaining this is a bit complicated, so please bear with me.

The way that any pension fund values its liabilities is to evaluate the numbers of people in its scheme and how long the current and future pensioners are likely to live.

Then it adds together the payments it is likely to have to make to those current and future pensioners over the many decades till the last pensioner is dead.

And then the fund calculates the present-day value of all those payments, in order to ascertain the value of the assets it should be holding today such that it can be confident of paying out all those pensions over all those years.

Now this is the tricky bit.

Under accounting rules, what's known as IAS 19, a pension fund "discounts" those future payments - or puts them into today's money - at the prevailing rate of interest on high quality corporate bonds.

Perhaps the best way to think of this is that the fund is assuming that its assets - its investments - will increase in value at the rate of interest paid by big sound companies for borrowing from investors.

And the important point to grasp is that the higher the yield on corporate bonds (or the higher the rate of interest that companies have to pay to borrow) the lower the current value of a pension fund's liabilities.

So BT's pension fund looks in much better shape when big companies are paying much more to borrow.

Here comes the paradox.

Because of the credit crunch, this corporate bond yield surged to a record 7.72% last October. And the yield increased simply because investors took fright and didn't want to lend to companies.

So the credit crunch - which has been doing so much damage to the health of businesses - created the illusion that weak pension funds, like BT's, were in better shape than was actually the case.

The point is that corporate bond yields were temporarily inflated and distorted by panic in the markets: that 7.72 rate of return wasn't remotely a return that any fund should have expected to earn over the decades to come; it was an unrealistic discount rate.

Now as economies have started to show signs of recovery, investors have become less reluctant to lend to companies.

So the yield on corporate bonds - and the relevant yield for BT is AA-rated corporate bonds - has fallen.

Since March, the yield on AA corporate bonds has fallen from 6.85% to 6.2%.

Hey presto: the economic outlook looks less bleak; the price of credit for companies has fallen; but the value of pension fund liabilities at BT has gone through the roof.


What's worse, the pension regulator thinks that BT is still not using prudent enough assumptions in measuring its pension-fund hole.

It doesn't like the use of the AA corporate bond yield to measure liabilities and - as part of the rigorous three-yearly actuarial evaluation that all schemes have to go through - the regulator has asked an outside expert to advise on what a sounder discount rate would be.

Ralfe believes the deficit on more sensible conservative assumptions would be about £11bn, more than BT's stock-market value.

And if BT were forced to value its pension liabilities on the basis of the yield on gilts - which is how schemes are valued when companies want to get shot of them to an outside insurer - well then the deficit would be well over £20bn.

Which is broadly a way of saying that BT's managers under the chief executive Ian Livingston are not any longer working first and foremost for the company's shareholders, but that their more important and burdensome obligation is to the pension fund.

As a start, BT in May agreed with the regulator that it would put £525m each year into the scheme for the next three years - consuming half of all the cash generated by the business.

What it's now negotiating is the contributions for succeeding years. And there is little reason to believe that these substantial payments will fall for almost as far as the eye can see.

Arguably, in an economic sense, BT's current and future pensioners own this totemic business.

Why men are to blame for the crunch

Robert Peston | 09:44 UK time, Wednesday, 29 July 2009


I routinely characterise the credit crunch as "men behaving badly" - because it's almost impossible to find a woman to blame.

The reckless chief executives of banks who went on a borrowing and lending binge: all men.

SuitedThe financial engineers who packaged up poisonous subprime debt and mis-sold it as AAA solid gold: they were long of Y chromosomes.

The central bankers and regulators who slept while the dangerous financial party was in full swing: blokes.

The finance ministers who didn't want to recognise that the surge in house prices was perilous, for fear of alienating voters: yup, it's my gender again.

Now there are two ways of looking at the culpability of men for the economic and financial mess we're in.

The conventional explanation is that it's a manifestation of the glass ceiling, of sexism in the City (and in politics, and in the public sector).

Which is to say that women had a lucky escape: they are only innocent of this particular crime against global prosperity because men unfairly elbowed them out of the way in the unseemly race to the top.

And there must be some truth in the notion that we'll only be a fair society when we can heap opprobrium on women for a banking crisis (of course they had their moment in the sun in respect of responsibility for a recession with Margaret Thatcher's economic contraction of almost 30 years ago).

As today's report from the Women and Work Commission shows, there's still considerable discrimination against women at most levels of most workplaces.

But I think there may be a sense (and here I'm on very dangerous territory) in which masculine vices played a dominant role in fomenting the crunch.

And, I suppose, the simplest way of putting this is that I know very few women who measure their success in life by the size of their respective bank balances, whereas I know an astonishing number of men for whom the only thing that matters is "the score", as determined by the heft of their salaries, or bonuses or capital gain.

We've descended into the uncomfortable realm of hack psychology, so we're not going to stay here long.

But I would observe that - in my experience - men are more prone than women to simply run like a train at the goal, and never mind who's flattened along the way.

And the kind of complex mathematical modelling that underpinned so many of the toxic financial products - and of flawed systems for controlling risk - is also a peculiarly male practice. It's the equivalent of an obsession with computer games, or cricket scores or railway timetables: little worlds detached from the real world.

A top male banker (that tautology), the chairman of HSBC, Stephen Green, strays into this dangerous territory in his new book, Good Value. He says:

"If men were to be unchanged by the full participation of women in public life, if women were to participate in public life on the basis of adoption of traditional male modes of interaction, then humankind would have missed a profoundly important opportunity for growth. All the evidence is that something far better is achievable".

His presumption that there will be such full participation by women will be seen by some as naively optimistic.

But if we're looking to prevent a repetition of the kind of financial calamity we've just endured, it mightn't be a bad start to appoint a woman as chief executive of Citigroup (or HSBC), or as chancellor of the exchequer or even (heaven forfend) as governor of the Bank of England (and, by the way, if you have any ideas about how the City of London's male closed shop can be smashed, the Treasury Select Committee is conducting an enquiry and would love to hear from you).

Who'll boss our banks?

Robert Peston | 11:00 UK time, Tuesday, 28 July 2009


John Kingman is to quit as chief executive of UK Financial Investments, the arm of the Treasury that manages taxpayers' huge holdings in Royal Bank of Scotland and Lloyds.

Some would say that Kingman is the most powerful public official in the UK, in that UKFI is also taking over responsibility for Northern Rock.

There'll be some surprise that he is choosing to stand down. But he's wanted to move into the private sector for a couple of years - and said as much to the Treasury's permanent secretary, Nick Macpherson, last summer.

Kingman felt unable to leave UKFI till it was properly established. That, in his view, is now done, with today's announcement that David Cooksey is to become chairman of UKFI.

Cooksey is a private-equity pioneer (he founded Advent and worked there for 25 years) who knows Gordon Brown well, but is not regarded as a ministerial patsy.

His first task will be to find a replacement for Kingman. Although Kingman himself worked at the Treasury for many years and was latterly the number two there, the successful candidate is unlikely to come from the public sector, since Kingman's financial skills are not widespread in Whitehall.

Kingman however is paid as a senior civil servant. Any private-sector replacement would receive many hundreds of thousand pounds more.

His departure is bound to be seen as part of a trend of individuals close to the prime minister who are leaving government and the public sector.

If markets don't work, what will?

Robert Peston | 09:24 UK time, Tuesday, 28 July 2009


The following seemingly unconnected events of the past 24 hours all have a big thing in common:

a) the chancellor of the exchequer warning big banks that he fears they may be overcharging companies for credit and withholding vital loans from credit-worthy borrowers;

b) the Commodities Futures Trading Commission in the US raising serious concerns that gyrations in the oil price do not reflect actual or perceived changes in fundamental supply and demand, but are the consequence of financial speculation (see today's Wall Street Journal);

c) the media regulator, Ofcom, pointing out that internet service providers systematically overstate the speed of their broadband services (to which my colleague Rory Cellan-Jones would probably say "duh!", in that he has been banging on about this for months).

Well, these are all examples of public authorities - regulators or elected politicians - claiming that markets aren't working properly.

In other words - if these state authorities are correct - the market clearing price for small business loans, or energy or broadband are not the "right" prices. They are not the prices that would be set if there was healthy competition and if buyers and sellers had relevant information.

Which, in these cases, means that customers are being overcharged. And also that decisions on how and where to invest - how to allocate capital - are probably being taken in an inefficient way, with negative implications for growth and prosperity.

We're going to see a good deal more of the state interfering in markets - largely because we're enduring a painful recession caused by what many would see as the most serious market failure since the late 1920's.

In that more grave case, what happened was that banks and other financial institutions systematically under-priced loans - or, to use the jargon, mis-priced risk - for the reasons I've been boring on about here for a couple of years (defective risk-control systems in banks and regulators, judgements distorted by self interest in firms, finance ministries, and central banks, and so on).

So we seem to be moving away from the Anglo-American political consensus of the past 20 years that the markets are normally right, reversing the Thatcherite/Reaganite movement of rolling back the state and expanding the domain of the private sector (to be pretentious for a moment).

But what we are heading towards?

If markets are routinely wrong, what does that mean for how we organise our economies?

The influential chairman of HSBC, Stephen Green - in his new book, Good Value - defends market-based economies as simply the least bad of the available options.

Trader on floor of New York Stock Exchange

And that may well turn out to be the view of the majority.

But, many would say, it's not a very inspiring view of how we live now.

Does it mean, inevitably, that the role of the regulator, the public inspector, will inevitably become more and more powerful?

What about our attitudes to wealth creators, how will they change?

Right now, it's become almost an article of faith among the current generation of regulators and central bankers that markets almost always overshoot (replacing the previous religious conviction of market perfection).

Behavioural economics, a hybrid of psychology, is in. The efficient market hypothesis is widely viewed as an embarrassing example of primitive fundamentalism.

According to the new ideology, participants in markets who accumulate the biggest personal fortunes are merely those most adept at predicting the irrational behaviour of the herd.

Which probably shouldn't be seen as any more noble or as a more socially useful form of wealth creation than betting on the 3.30 at Kempton Park.

And yet we have a tax system, introduced by this government, that disproportionately rewards capital gains generated in financial markets.

So the differential rates of income tax and capital gains tax probably aren't sustainable.

There is a much more fundamental dilemma for this government and the next one.

Which is that public faith in markets and the private sector is being tested at a time when many would argue that the relative size of the public sector has grown disproportionately.

The public sector is heading towards a size - not far off 50% of our economic output or GDP - we haven't seen since the 1970's.

To state the bloomin' obvious, unless the private sector expands to create jobs and generate tax revenues, we're going to be considerably poorer for years.

But how on earth can that happen if the state has to employ a growing army of officials to prevent the private sector ripping us off?

And if we've fallen out of love with unfettered markets, does that mean the end of privatisation and the abandonment of the attempt to introduce market structures into public services.

Interestingly the Tories have work in progress on this in their fledgling policies for what they call the "post bureaucratic" society.

Broadly, this is about providing households with as much relevant information as possible via the internet to make informed choices about which financial services to buy or which state school to choose.

The theory is that Google-style algorithmic data sorting replaces state-funded watchdogs and nannies.

A worthwhile ambition? Most would probably say so.

But implementation won't be cheap and would take years and years to touch even a slim majority of the population.

Business still being crunched by banks

Robert Peston | 09:31 UK time, Thursday, 23 July 2009


The chief executives of our biggest banks have been summoned to the headmaster's study on Monday morning.

Alistair Darling, Peter Mandelson, Shriti Vadera and Paul Myners will grill the bosses of Royal Bank of Scotland, Lloyds, Barclays, HSBC, Santander and Nationwide about whether they are lending enough to support an economic recovery - and, in the case of Royal Bank of Scotland and Lloyds, whether they are lending what they promised when kept alive by a massive injection of public funds.

Those who run our banks tell me that they're doing their bit, that they're supplying the credit to businesses and households which is being demanded. And if the official and unofficial statistics show that there hasn't been a great surge in lending, well that's because (in case we hadn't noticed) there's a recession on and there isn't a great demand for new loans.


Here's an extract from the Bank of England's summary of business conditions compiled by its agents, which was published yesterday:

"The Agents' sense was that contacts' experience was becoming increasingly polarised as lenders sought to focus their activities on the least risky credits. That would be consistent with ongoing reports of tight limits being applied to banks' exposures to some sectors - notably, the property and construction sectors and some retail activities. There were further widespread reports that spreads and fees were being increased sharply on renewal or review of facilities."

To translate: there's less credit for business and it's more expensive.

And this anecdotal evidence was supported by the Bank of England's statistical analysis of lending by our biggest banks (published on Monday), which showed that net lending to British businesses remained negative in May: the three month annualised contraction in the provision of loans was a non-trivial 5.4% (or growth of minus 5.4%, for those who think in that way).

Bank of England

In fact for business, the statistics show that 2009 has been the year of the credit crunch rather than 2008. Last year, lending to business continued to grow, albeit at a much reduced pace. It's only this year that there has an actual shrinkage in lending.

The other absolutely vital point is that in 2007, well over half the growth in lending came from foreign-owned and specialist lenders - which have disappeared from the market completely. So companies are now wholly reliant on the old-established British banks, which are - or so the Bank of England reports - lending considerably less.

To state the obvious, there isn't a great sense of common cause or national purpose between the banks on the one hand and the government and Bank of England on the other on how to revive the economy.

There remains tension in the relationship, reflecting the banks' need to return to what they see as a sustainable level of profits and the authorities' fears that any recovery - as and when it comes - could be choked off either by the inadequate provision of credit or by the excessive cost of borrowing.

You might well ask (as Stephanie Flanders has been doing so eloquently in her recent notes) what all this tells us about whether the Bank of England's ambitious quantitative easing programme to inject new money into the economy - by buying gilt-edged stock - has had any significant positive effect other than to help the Treasury finance its yawning public-sector deficit.

That said, it would be wrong to say that there are serious credit constraints on all businesses. Big companies have been by-passing the banks and raising billions in new equity and loans - in the form of bonds - from institutional investors. And the very smallest companies also seem to be treading water reasonably well in choppy conditions.

It's the medium size businesses - those with a few tens or a few hundreds of employees - for whom the credit crunch remains a very harsh reality.

They are too small to disintermediate the banks and go directly for finance to investors. And they are too big to be considered by banks as a relatively modest risk.

Anyway, I would imagine that Darling and Mandelson will bellow at the banks that they have to do more for the important bedrock of our economy, those middling size companies - by at least advertising a little bit more effectively that they remain open for lending.

That said, there are some huge intractable problems here, which Monday's meeting won't go anywhere near to solving.

The first is whether the price of credit matters.

Mervyn KingAs I understand it, the governor of the Bank of England thinks it does, and is tearing his hair out that banks have taken advantage of the fall in funding costs that he's engineered by widening the gap between what they pay for money and what they charge for it.

The Banks think he's exaggerating the problem and misunderstanding what's going on.

They would argue that the cost for them of raising funds - from retail depositors or in the form of state-guaranteed finance - hasn't fallen by nearly as much as the reduction in the Bank's policy rate.

Also, they'd point out that they were charging far too little for finance during the boom years; that, as Mervyn King has pointed out many times, that they stupidly underpriced the risks of lending, and that all they're doing now is trying to put a proper price on risk.

But what if the Treasury mandated those banks wholly or partly owned by the state - Royal Bank, Lloyds and Northern Rock - to cut the cost of loans?

Well, the banks' disheartening reply is that if the independent banks, the likes of HSBC, Barclays and Nationwide, were being undercut, they'd simply quit the marketplace, and then we'd really know the meaning of a credit crunch.

Then there are the final, final points, which I've been belly-aching about for two years and are the most troubling of the lot.

Which are: first, that households, business and the public-sector have borrowed far too much; and, second, that the banks themselves became far too dependent on unreliable wholesale credit which - when that disappeared - was replaced by loans and other forms of support from taxpayers.

Just take households for a moment. They (we) have borrowed a record-smashing sum equivalent to around 175% of our disposable income, up from 100% in 2000.

We'd had eight years of continuous economic growth in 2000 - a long stretch by any standards - so a one-to-one ratio of debt to disposal income might well be a sensible, sustainable ratio.

But just think what that implies about how much more households will have to save over the coming few years, and how much less they (we) should borrow, if we're going to return to some kind of stable equilibrium.

In that context, what we should be hoping for from the banks - in the case of mortgage finance, for example - is not that the banks massively increase net lending, but that they provide what little credit there may be to those widely perceived to be in most need (first-time buyers, for example).

What's more, if we were to take the contrary view, that current levels of lending to households and businesses are perfectly reasonable and in fact should be increased, there is only one potential source of incremental lending: that's us, taxpayers.

Here's why.

Much of the growth in lending to households and businesses in the three or four years before the credit crunch began in 2007 came not from the accumulation of stable retail deposits but from the repackaging of debt into bonds plus other wholesale sources.

After securitised bond markets closed down almost two years ago and other sources of wholesale funds became difficult to procure, we the taxpayer filled the breach - with a mixture of direct loans and guarantees for borrowing by banks.

The Bank of England estimates that the gap between customer loans and deposits reached £800bn in 2008. It has also confirmed that the increase in taxpayer support for our banks since the crisis began has been £1.26 trillion or 88% of our economic output, GDP (compared with 73% in the US).

As I've said many times before, if we want to our banks to be weaned off the life-support machine provided by us, by taxpayers, then banks have to borrow less - and that means the amount they lend will shrink, very significantly.

Right now we appear to be as far from ever from reconciling the conflict between the short-term imperative that banks lend more, in order that the recession isn't too prolonged, with the equally important long-term imperative that they lend considerably less.

Treasury forecasts £77bn loan losses for Lloyds and RBS

Robert Peston | 10:21 UK time, Wednesday, 22 July 2009


A new measure of the scale of our big banks' recklessness in the boom years has been provided in the Treasury's annual report for the past year.

It says that it expects the public purse to incur a loss of £25bn in respect of the Asset Protection Scheme.

RBS logoThat's the safety net provided by the Treasury for Royal Bank of Scotland and Lloyds, which was announced on 19 January as an alternative to full public ownership of these banks.

It involves taxpayers providing insurance to RBS and Lloyds against possible future losses on £325bn of loans and investments made by RBS and £260bn of credit extended by Lloyds.

Negotiations are still in train on the fine print of this insurance arrangement. But the Treasury says that "on preliminary analysis of a sample of assets initially proposed to be included in the scheme", it estimates it could lose £25bn (as my colleague Stephanie Flanders has written about here).

However it adds that the estimate "could be subject to substantial revision (up or down) as further due diligence reports are completed" and that "altered economic and market conditions would clearly also effect estimated losses" (doh!).

Lloyds logoNow you'll probably find this slightly odd, but I think this statement is more interesting for what it says about RBS and Lloyds than for what it says about potential costs to us, to taxpayers.

The reason is that it's impossible at this stage to forecast with scientific precision the shortfall between the loans provided by these banks and how much they'll ultimately get back from overstretched borrowers.

But here's the important point.

There would be no estimated loss to the Exchequer at all unless the Treasury was confident that the banks would use up the entirety of their excess - their liability to take the first loss - on this insurance scheme.

Or to put it another way, the Treasury would not and will not incur a penny of loss on the Asset Protection Scheme unless and until Royal Bank of Scotland suffers £42.2bn of additional eye-watering losses on those £325bn of loans and investments and Lloyds incurs £35.2bn of losses on its £260bn of insured assets.

It's worth saying that again. Royal Bank and Lloyds - which already reported record losses for 2008 - are expected by the Treasury to suffer further losses on their loans and investments of at least £42.2bn and £35.2bn, or £77.4bn in aggregate.

That's the kind of financial calamity that makes me feel slightly dizzy.

Of course, these losses will be incurred over a period of months and years. And they will be offset to some extent by profits that are being generated from the unpoisoned parts of the two banks.

But to call these losses the toxic fruit of reckless lending doesn't quite capture the magnitude of these banks' departure from sensible prudential standards.

And I ought to add that if the Treasury were right that the loss to the Exchequer turns out to be £25bn on top of these losses for the banks and their shareholders (that us again, of course, since taxpayers are set to own 84% of RBS and 62% of Lloyds), there would be further losses for the two banks of £2.5bn (losses over and above the first loss are shared 90:10 between taxpayers and banks).

As it happens, I can conclude with marginally better news for taxpayers.

Which is that the net loss for the taxpayer on the APS may eventually turn out to be zero.

Here's why.

It's true that there will almost certainly be a substantial gross loss for the public sector as insurer of those ill-judged loans and investments.

But, as with all insurance schemes, the banks are paying substantial fees for the protection. And in the case of Royal Bank, it has also agreed not to claim tax losses or allowances relating to its disastrous loans and investments.

Once those fees and tax benefits are taken into account, the taxpayer may well break even on the deal.

Which, of course, is not to argue that this is good business for the public sector.

We'd all have been better off if the banks' lending binge hadn't been so wild and prolonged.

But small virtue can be extracted from this hideous financial necessity.

Recovery risk for government borrowing

Robert Peston | 08:15 UK time, Tuesday, 21 July 2009


Whenever I find myself in any gathering of bankers, business people or politicians, the question they ask more than any other is whether the government will be able to borrow all it needs from markets - or whether at some point big investors will lose their appetite for gilt-edged stock, the exchequer's IOUs.

A good person to tap on this - though one who is not without a vested interest - is the Treasury's banker, Robert Stheeman, the head of the Debt Management Office, whose job is to raise all those hundreds of billions of pounds to cover the gap between tax revenue and public expenditure.

This year he has to sell an utterly unprecedented £220bn of gilts. That's more than four times the finance that he's typically had to find in recent years. And it would expand the existing stock of gilts - or the size of the market - by more than a third.

And, what's more, with the government refusing to countenance significant spending cuts or tax rises, he'll have to raise a similar amount next year too (even if a new government were to massively reduce public expenditure, there would be a lag before there was an impact on borrowing).

So - I asked him, in an interview for the Today programme - how great is the risk that investors will sit on their hands? Does he lie awake at night fearing a re-run of the 1970's, when a Labour government had to be bailed out with emergency financial support from the International Monetary Fund?

Well, Stheeman doesn't have bags under his eyes and sees a funding crisis as a very remote danger - largely because the market for gilts is much wider and deeper than it was.

For example, it has become much more international, with a record 36% of gilts now held overseas.

Now, you might point out, he would say that, wouldn't he?

That said, he was much less dogmatic about whether the government might end up having to pay a much higher interest rate to borrow - which is hugely important, because an increase of one percentage in the cost of borrowing £200bn would be £2bn that wouldn't be available to spend on public services every single year till the debt is repaid.

If, for example, the UK lost its impeccable AAA debt rating, that would almost certainly push up funding costs - not least because some of those helpful overseas buyers are central banks which aren't permitted to hold sovereign debt rated at less than AAA (though it was striking that Stheeman told me that he didn't think a downgrade of just a notch would make it significantly harder for him to raise what he needs).

But here's one reason why it's so difficult to judge where the cost of borrowing for the government will settle in the coming few months: the Debt Management Office has sold fewer gilts than have been bought by a separate part of the public sector, the Bank of England.

In April, May and June, Stheeman and his team flogged £57.9bn of gilts, while Mervyn King's traders waded into the market to buy £77.7bn of UK government debt.

The Bank of England is buying as part of its so-called Quantitative Easing programme to increase the stock of money in the economy and cut the cost of credit.

But the Bank has almost disbursed the £125bn allocated in total to the scheme - and was somewhat equivocal a couple of weeks ago about whether it will increase its gilt-purchasing budget.

Investors seem persuaded that the Bank of England will buy a bit more - although we'll have the first test in a gilt auction this morning of whether the Bank's equivocation is seriously unsettling investors.

Gilt prices have been falling after the large penny dropped in markets that there may not be many more weeks before the Bank of England transmogrifies from a massive net buyer of gilts into a potential seller.

Where the gilt price settles then is - as Stheeman implied - not something that can be predicted with scientific certainty.

And here's the great and painful paradox.

If the Bank of England stops buying at a moment when investors become a bit more confident about prospects for the global economy and our economy - if they become less averse to risk and more interested in buying assets other than AAA sovereign debt - well, then it might become altogether more tricky and expensive for the government to borrow.

Tory plan to sanitise banks

Robert Peston | 19:10 UK time, Sunday, 19 July 2009


The Conservatives' "plan for sound banking" (as they call their 52-page policy document on reforming the banking system to be published tomorrow) differs from government policy in a number of significant ways.

George Osborne on Andrew Marr Show Sunday 19 JulyFirst, as I've written about here several times in the past few weeks, a Tory administration would transfer to the Bank of England responsibility for preventing banks, building societies and insurers - both individually and collectively - taking excessive financial risks.

A Financial Regulation Division, responsible for regulating and supervising financial institutions, would be created at the Bank and it would be headed by a new Deputy Governor for Financial Regulation.

This would strip from the City watchdog, the Financial Services Authority, one of its most important functions.

What would be left at the FSA would be its consumer protection functions and its responsibilities to ensure that financial institutions conduct business in a fair and proper way.

So the Tories would rename the FSA as the Consumer Protection Agency. And this Consumer Protection Agency would absorb the bit of the Office of Fair Trading which licences and regulates consumer credit businesses.

These institutional changes would be part of a broader initiative to shift the balance of power from banks and insurers to consumers.

Thus the Tories would force credit card companies and banks to provide much more information directly to individual customers about their charges and terms for a variety of products, from credit cards, to mortgages and savings accounts.

George Osborne, the shadow chancellor, wants financial institutions to provide this information in a form that could instantly be uploaded into product comparison websites, so that customers can instantly see whether they are getting a good or bad deal from their banks.

This is an idea that Osborne has borrowed from one of the pioneers of "nudge" behavioural economics, Richard Thaler.

Also, in the event that the Tories win the next election, Osborne would - in the words of the policy paper - "ask the Office of Fair Trading and the Competition Commission to conduct a focussed examination of the effects of consolidation in the retail banking sector".

Such a competition probe would look at whether choice for consumers has been reduced in a seriously damaging way by the takeover of HBOS by Lloyds, the acquisition of Bradford & Bingley and Alliance & Leicester by Santander, and the withdrawal from the UK of various overseas institutions and assorted small firms.

Since the opinion polls indicate that the Tories will form the next government, the likes of Lloyds and Royal Bank of Scotland will doubtless instruct lawyers almost immediately to prepare their cases for why they haven't acquired excessive market power in recent months.

But these banks will note with some trepidation that Osborne says the findings of these competition enquiries would determine his strategy for how to dispose of the government's huge stakes in Royal Bank and Lloyds, together with its 100% ownership of Northern Rock. There is an implication that he would break up RBS and Lloyds.

Finally, the Tories are going further than the government in detailing plans for what's called macro-prudential regulation, which is about preventing the kind of lending binge that took place in the three or four years before the summer of 2007 and precipitated the worst financial and economic crisis since the 1930s.

The paper talks about creating "a powerful new Financial Policy Committee within the Bank of England, working alongside the Monetary Policy Committee", which would have tools - such as varying how much banks can lend relative to their capital resources - to prevent banks in general from taking excessive risks.

However, although the Bank of England's size and power would be massively increased by these reforms, the Tories want to curb the personal power of the governor of the Bank of England.

The paper says that "the new structure will... reduce the institutional reliance on the position of Governor, with a collegiate approach to policy on financial stability and more use of external expertise".

The point is that responsibility for the supervision of banks and for limiting risks in the financial system would be vested in the Financial Policy Committee, which - like the existing Monetary Policy Committee that sets interest rates - would consist of Bank executives and outsiders.

So the governor of the Bank of England could not dictate - as he can in limited areas now - how the bank will act in a financial crisis.

What is striking is that - as a backstop to the powers of this Financial Policy Committee - the Tories are committing themselves to the introduction of a leverage limit, or a simple ceiling on how much banks can lend in gross terms relative to their capital resources.

But what's also conspicuous is something of an internal contradiction in the Tory analysis.

On the one hand, the paper is quite clear that certain banks - such as Royal Bank of Scotland - borrowed and lent far too much and became far too complex for the health of the economy. They became instruments of economic destruction.

The paper says that there are "some valid arguments in favour of some degree of structural separation between the riskiest banking activities and deposit taking institutions [or those that look after individuals' savings]".

However, it thinks that unilateral action to force banks to divest these allegedly dangerous activities would not be feasible and would damage the City as a financial centre.

So it's relying on the Bank of England to impose the equivalent of a punitive tax on banks that do considerable trading for their own account of a speculative kind, by forcing such banks to hold disproportionately higher capital reserves.

And the Tories believe that this approach "would result in the separation of the riskiest activities if retail banks find the additional costs of engaging in them are too great".

Well, we'll see. Interestingly, this is one of the few policy areas where the government and the Tories are somewhat converged in their thinking.

There's a good deal more to say about the Tory paper. And given that most in the City assume - rightly or wrongly - that the Tories will be in power next year, it'll be studied in minute detail in the City over the coming weeks.

But I'll restrict myself to four additional observations.

• First, the Tory paper is vague about what will happen to the FSA's oversight of regulated markets and listed companies, and its powers to investigate market abuse and insider trading. That said, I understand that these roles might well end up - in the longer term - merged with the Takeover Panel and the Financial Reporting Council as part of a new regulatory authority with broader responsibilities for the conduct of publicly listed companies.

• Second, the management of the FSA now faces a nightmare few months: given the high probability that its days are numbered, retaining and recruiting staff will not be easy.

• Third, breaking up the FSA in the way that the Tories want to do is easier said than done, in that recent reforms have created unified teams within the FSA of those who look after consumer protection and those who are responsible for checking that banks and insurers are lending and investing prudently.

• Fourth, on the assumption that Lord Turner, the chairman of the FSA, becomes the new Deputy Governor for Financial Regulation (my sense is that the chief executive of the FSA, Hector Sants, is planning to leave the regulatory fray next year), we'd see the start of a compelling contest to succeed Mervyn King as Governor in 2013.

This would probably be a death match between Turner and the Deputy Governor for Financial Stability, Paul Tucker.

Which, of course, is to trivialise these weighty policy matters, but is not uninteresting.

Curbing bank executives' enthusiasm

Robert Peston | 10:00 UK time, Thursday, 16 July 2009


A Treasury-sponsored review has today recommended substantial reforms to the structure and behaviour of banks' and financial institutions' boards, to restrict the freedom and the incentives for senior executives to take reckless risks.

Sir David WalkerSir David Walker, who is a senior adviser to the US investment bank Morgan Stanley and is a former director of the Bank of England, believes that last year's financial crisis, which helped to precipitate the worst global recession since the 1930s, was in part a consequence of "failures in governance in banks and other financial institutions".

After five months of analysis, he has concluded that:

1) the boards of big banks didn't understand the scale of the risks their organisations were running;

2) that non-executives of big banks did too little to rein in the excesses of the executive directors;

3) that shareholders in banks also failed to curb reckless gambling by financial institutions, that the owners didn't "exercise proper stewardship",

4) and that bankers were paid in a dangerous way which encouraged them to speculate imprudently.

One recommendation which is likely to alarm some banks is that boards' remuneration committees would set the pay not only of executive directors but also of executives below board level whose "total remuneration" might be "expected to exceed the median compensation of executive board members".

In the case of Barclays, for example, which owns a substantial investment bank, this would lead to the board setting the pay of hundreds of bankers paid as many millions each year as those on the Barclays board.

The pay of these so-called "high end" executives would also be disclosed "in bands" in the banks' annual reports, although the executives' names would not be published.

In an interview with me, Sir David said he was fully prepared for protests about this degree of disclosure on pay from the big banks, who are likely to complain that they would be revealing commercially sensitive information that could put them at a competitive disadvantage.

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Like the Financial Services Authority, the City watchdog, Sir David also wants a significant element of bonuses or performance pay to be handed to relevant bankers only after several years have elapsed, up to five years, or enough time to verify that the deals triggering the bonuses aren't toxic.

Other proposals are:

a) new risk committees should be set up on boards, separate from the audit committees, which would be chaired by a non-executive;

b) these risk committee would overseas all substantial transactions and would have the power to block those deemed too dangerous;

c) non-executives would devote 30 to 36 days each year to the affairs of a bank or financial institution, up from 20 to 25 days at present (many of you probably won't believe they earn their fees of £100,000 or so a year for four to five weeks of work);

d) non-executives would be better trained, they would be scrutinised more rigorously by the FSA and they would be encouraged to hold the executives to account, in a way that would probably end the "collegial" nature of bank boards;

e) the chairmen of banks or other financial institutions would commit no less than two-thirds of their time to the business, they would have significant and relevant "financial industry experience", and they would face re-election by shareholders every year;

f) boards would monitor more closely whether their big shareholders were selling shares and would take steps to learn why these shareholders had lost confidence in their businesses;

g) the FSA would also "be ready to contact major selling shareholders to understand their movitation";

h) institutional shareholders would sign up for a new set of "principles of best practice in stewardship", to encourage them to be more actively engaged in the affairs of companies, which would be overseen by the Financial Reporting Council.

When I spoke to Sir David he stressed that he was acting in an independent capacity when making these recommendations and that the Treasury was under no obligation to implement them.

Some may feel that his reforms would lack teeth, because he does not want them enshrined in legislation. Instead he wants them enforced through the Combined Code, the voluntary code on UK boardroom practices that is overseen by the Financial Reporting Council.

Update, 15:35: Barclays has told me two interesting things: first that its board already approves all group pay packages worth more than £500,000 a year; second that it's not worried about disclosing in its annual report how many of its staff receive pay of that magnitude and greater.

Can non-execs cure banks' madness and badness?

Robert Peston | 06:51 UK time, Thursday, 16 July 2009


Sir David Walker, a former regulator and someone who in the past would have been described as a City grandee, will today publish his prescription for how the so-called governance of banks can be improved.

Governance is the sententious word for the structures and rules for institutions that are supposed to prevent them doing the wrong thing.


And since banks all over the world in the years before the credit crunch did the wrong thing on a scale that was without any precedent, there must surely have been a collective failure of governance.

Or to put it another way, the owners and non-executive directors of banks from UBS in Switzerland to Merrill Lynch and Lehman in the US to Royal Bank of Scotland and HBOS in the UK were useless at preventing those banks borrowing and lending in a reckless and dangerous manner.

So presumably that means the owners and non-executives were either under-qualified nitwits, cowards or unhealthily close to greedy manic chief executives.

Which would mean - surely - that new codes of conduct for shareholders and initiatives to improve the quality of those who sit on bank boards would make a world of difference.

That may be so.

But it's worth reminding ourselves what actually happened at Royal Bank of Scotland, for example, before we conclude that accidents can always be prevented if only the right people are in the right jobs.

Because the non-executives at Royal Bank were an impressive bunch - on paper.

They included three former bankers, an erstwhile treasury official whose responsibilities included financial regulation, the one time boss of an insurance giant, and the titular head of Goldman Sachs in Europe.

At the time, these were not individuals who would have been described as either ignorant of finance, shrinking violets or nincompoops.

Some have alleged that the non executives were terrified of the steely chief executive of the time, Sir Fred Goodwin.

This, I have to say, is less than compelling. I know some of these non-execs. And I can tell you that they are materially tougher and less pliable than old boots.

Then there's the question of whether they knew as much as they should have done about what was going on.

That is is a moot point. Some non-execs say they didn't know all the relevant details about RBS's holdings of lower quality housing loans in the US.

But it wasn't non-executive ignorance of those risks - or perhaps of any risk - that led to its collapse into the arms of the state.

What really did for RBS was its record-breaking takeover of the rump of the Dutch bank ABN Amro in the autumn of 2007.

This was the wrong deal, at the wrong price and at the wrong time.

The non-executives were not ignorant of the risks RBS was running in buying ABN. However they thought these risks, which turned out to be suicidal, were worth taking.

All of which simply says that even smart, well-qualified people can be gripped by irrational exuberance - and that therefore we shouldn't get carried away with the idea that governance can be a perfect protection again catastrophe.

How long will China finance America?

Robert Peston | 08:20 UK time, Wednesday, 15 July 2009


China's foreign exchange reserves have soared.

In the second quarter of the current year, they rose by $178bn to $2.132 trillion to exceed $2 trillion for the first time.

According to Bloomberg this is a record increase.

On this occasion, the primary cause is not the great surplus of China's exports over its imports.

It's the result of overseas investors identifying China as the strongest of the world's major economies and pouring money into property and into shares: the Shanghai Composite Index has jumped 74% this year.

Man walking past stock price monitor in Shanghai

To put it another way, if international investors want to take an equity risk in these recessionary conditions, they go to China - because its economic stimulus package seems to be working (the annual growth rate in China in the three months to the end of June is said by forecasters to have been not far off 8%; we'll have the official stats, for what they're worth, tomorrow).

Now, the really interesting question is how much of that increment has been reinvested by the Chinese authorities into US government debt, or holdings of Treasury bonds and bills.

China is the largest foreign lender to the US government. At the end of April, China's holding of Treasury securities was $763.5bn (Japan was the second biggest holder, with $686bn).

However, between March and April there was actually a slight fall in the dollar value of Chinese lending to the American government - though that fall was trivial compared with the $261.5bn increase over just a year in the amount of US government bonds held by China.

Zhou XiaochuanA recent speech by Zhou Xiaochuan, the governor of the Chinese central bank, conceded - in a slightly elliptical way - that China would have to lend more to the US, to see it through the current economic and financial crisis.

He said: "in the short run, the US may need more capital inflows to deal with the financial crisis".

So China will continue to fund the growing gap between America's public expenditure and its tax revenues, by recycling to the US the cash of overseas investors who prefer to invest in China's real assets.

Mr Zhou is clear that allowing America to live beyond its means is profoundly unhealthy for the global economy in the long term.

As he said: "over the long run, large capital inflows are not in its best interest of making adjustments to its economic growth model".

Or to put it another way, the US public, private and financial sectors all have to reduce their indebtedness: Americans have to save more.

But there is huge self-interest on the part of the Chinese in not forcing America to go cold turkey - in breaking its borrowing addiction - too quickly. China's exporters, squeezed savagely over the past year by the global recession, would hardly relish another lurch downward in US demand for their stuff.

The interdependence of China's great production machine and America's army of consumers remains the great fact of the global economy.

So although the Chinese authorities would love to hold their reserves somewhere other than in dollars (and Mr Zhou is a great proponent of enhancing "the status of the SDR" - the IMF's virtual currency - as an alternative to the dollar), it won't be quick or easy for China and America to reform their uncomfortable relationship of dealer and user.

Goldman: Recession? What recession?

Robert Peston | 14:33 UK time, Tuesday, 14 July 2009


I'm in a horrible rush, so have to keep my remarks on Goldman Sachs' second quarter results brief.

I could say "crikey" and leave it at that.

mersey house

But I will translate. Just a few months after Wall Street and the City of London were in meltdown, Goldman has reported record net revenues for a three-month period of $13.8bn, which is a breathtaking 47% higher than those generated in the preceding three months and in the equivalent period of last year.

It's boom time again, especially in the trading of credit and currencies.

And oh how Goldman's 29,400 staff have been rewarded. Compensation for the three months was a handsome $6.65bn or $226,000 per employee.

That brings remuneration per employee for the first half of the year to a none-too-cheap $384,000.

And we're only halfway through the year.

The media and political reaction to Goldman's bounceback will be fascinating to observe.

It's true that the investment bank has consistently performed better than most of its rivals.

But when that cataclysmic storm broke over the financial system last autumn, Goldman - like the rest - had to turn to taxpayers for a crutch in the form of guarantees for its debt, access to central-bank liquidity and capital.

It has recently declared that it can stand on its own feet again without taxpayers to lean on.

But some may well ask whether taxpayers shouldn't have demanded a bit more for their succour, given that Goldman is once again the world's pre-eminent money-making machine.

Has the City learned anything?

Robert Peston | 09:28 UK time, Tuesday, 14 July 2009


What I am about to write will - I suspect - make some of you laugh and some of you cry.

It concerns the attempt by a Guernsey-based investment group, Resolution Limited, to buy the UK life insurer, Friends Provident.

But it's really about the irrepressible financial creativity of the City of London - and whether bankers, investors and financiers have learned anything from the financial debacle of the past couple of years.

Let's start with Friends.

It was created in 1832 to "alleviate the hardship of Quaker families facing misfortune" (its words) and it was demutualised in 2001 to become a listed company.

These days it looks after the savings and financial interests of 2.5m policyholders, it has 739,000 shareholders and it has assets under management (as of 15 June) of £51bn.

Quite a pedigree, you'll agree.

Now let's look at Resolution Limited.

It's a Guernsey-incorporated company created at the end of 2008 for the express purpose of buying life insurance companies, asset management businesses and other financial firms.

According to its prospectus, it is "resident for tax purposes in Guernsey and is subject to the company standard rate of income tax in Guernsey at a rate of 0%".

But it is not an operating company. Again, to quote from the prospectus, Resolution has "outsourced most of its operating functions, including the identification and assessment of acquisition opportunities and the design and execution of the restructuring and disposal process for acquired businesses to Resolution Operations LLP".

John TinerAs for Resolution Operations LLP, that's another new business created and owned by the well-known financial entrepreneur, Clive Cowdery, and John Tiner - whose name may ring a bell, because he used to be the chief executive of the Financial Services Authority - plus three others.

What's in it for them? Well they receive an annual fee of 0.5% of the non-cash value of Resolution Limited, subject to a minimum of £10m per year, plus 10% of any value they create from their management of any financial businesses bought by Resolution Limited.

So the proposal that's been put to Friends Provident's board is that a non-taxpaying Guernsey company would buy this life company, and its £51bn of assets would then be managed by a newly created partnership of five individuals, who would scoop 10% of any value they create over and above the annualised gross redemption yield on three-month UK gilts (not exactly a challenging hurdle right now).

You might think this looks like tax arbitrage and financial engineering, of a sort that is surely out of fashion in a City that wants to win back the hearts and minds of a taxpaying population which feels a bit let down by its excesses of the past few years.

But perhaps that's the wrong way of looking at the proposed takeover.

As it happens, Friends' board rejected the initial proposal from Resolution Limited - but Resolution received what it calls "constructive feedback" and may therefore come back with sweetened terms.

Who'll decide what will happen? The owners of Friends of course. And the most important of these are Lloyds Banking Group, Aviva, Axa, Legal & General and Royal London, which collectively control more than a quarter of the life company.

You may notice that they're all in the life business too.

If it were to turn out that these giants of the life industry think that the skills of Cowdery, Tiner and the remainder of the Resolution quintet are worth 10% of any value created, well that implies something not very positive about the relative skills of their own employees - since their own managers are rewarded rather less handsomely than Resolution's crew.

Is that really a message that Lloyds, Aviva, Axa, L&G and Royal London want to send to their staff and customers?

Has Arsenal borrowed too much?

Robert Peston | 00:00 UK time, Tuesday, 14 July 2009


I've obtained a copy of the financial analysis of Arsenal that was made by the investment bank Lazard Brothers in support of Alisher Usmanov's proposal that the club should raise up to £150m in a rights issue.

It's a chunky 35-page document. But its conclusion can be summed up very simply: Arsenal has too much debt to pose a serious challenge to Europe's biggest clubs; or to use the jargon, it is over-leveraged, too thinly capitalised.

This is a verdict that has been rejected by Arsenal's board, which has been advised by NM Rothschild.

The North London club's directors argue that paying down debt would have only a marginal impact on the availability of financial resources.

Emirates stadium

Of course, as an Arsenal-supporting BBC journalist, I couldn't possible take sides in this dispute between the Uzbekistani plutocrat and Arsenal's directors.

But some of you will be interested in Usmanov's point of view.

Here are a few bullet points from the Lazard document:

1) It believes that Arsenal's earnings before interest, tax, depreciation and amortisation (EBITDA) will fall from between £55m-60m in 2009 to £35-40m in 2010. The most striking contributor to this squeeze that it cites is a 12-14% increase in costs to £179m "as a result of players being compensated for tax changes and a number of step-ups in wages for individual players".

2) It predicts that cash flow will fall by more than that because of some pre-payments on assorted deals that were taken in 2007.

3) It says that Arsenal's fans are already paying 40% more than the average for the big four English clubs for match tickets and 24% more for season tickets - implying there's little scope to increase gate revenues, especially in a recession.

4) It calculates Arsenal's gross average annual spend on new players as £18m, compared with £37m for the big four; and the net annual spend, including sales, as precisely zero, compared with a £20.2m big four average

5) Perhaps most germanely of all, it fears that redevelopment of Arsenal's former Highbury stadium into luxury apartments may not turn out to be profitable - and that refinancing £140m of property-related debt over the next couple of years will be neither cheap or easy.

So Usmanov - the second-biggest shareholder in Arsenal with a 25 per cent stake - suggests that investors stump up a maximum of £150m via a rights issue of new shares.

This would provide additional funds for Arsene Wenger to augment the playing squad, and/or pay off some of the property debt, and/or pay down a substantial portion of the £242m of separate debt incurred to fund the development of the new Emirates stadium.

As I say, Arsenal's board has said no to all this, following detailed scrutiny by bankers from Rothschild - which included those bankers sounding out the most important individual at the club, Arsene Wenger.

The advice to the board from Rothschild was;

a) paying down the Emirates-related debt would save a maximum of £5m a year;

b) there are better ways to rehabilitate the Highbury redevelopment, including a putative cunning plan under negotiation right now - and even if the worst came to the worst, there should be no direct financial contagion to the club, since the providers of the property loans have no recourse to the footballing assets;

c) perhaps most controversially, the chaps from Rothschild don't believe Arsene Wenger is seriously constrained by lack of finance in his ability to develop the playing squad - and, more importantly, they don't believe that he feels fettered (if you see what I mean).

All of which would be described by some as a courageous blocking tackle: turning down equity finance during a sharp recession, and while the worst conditions in living memory for property developers prevail, well that's quite ballsy.

No quick sale of RBS and Lloyds

Robert Peston | 08:35 UK time, Monday, 13 July 2009


UK Financial Investments' first annual report, which has just been published, captures the idiosyncratic and perhaps surprising relationship between the government and the two giant banks rescued by taxpayers, Royal Bank of Scotland and Lloyds Banking Group.

As is implied by the data in the report, these two - or rather Royal Bank of Scotland and HBOS, which was bought by Lloyds - escaped full nationalisation only by the very fine skin of their teeth.

RBS and Lloyds banks logosBy the time the Treasury's scheme to insure them against losses on £585bn of their loans - what's known as the Asset Protection Scheme or APS - is put into effect, taxpayers are likely to own 84% of Royal Bank and 62% of Lloyds.

These banks belong to us, to taxpayers. And the monetary value of our investment in this duo is huge, though putting a precise number on it isn't easy - in that the losses we'll incur on the insurance scheme or APS should be seen as a de facto investment, and we won't know the scale of that for years.

If the losses turned out to be no greater than the insurance fees paid in shares by the banks, than taxpayers' total capital at risk could be "as little" as £53.5bn.

But if RBS's and Lloyds' lending and investment portfolio turns out to be considerably worse than feared, well then we might have to realise a staggering £100bn from the sale of our holdings in the two banks in order to get our money back.

The only thing that can be safely concluded is that taxpayers have invested a colossal and unprecedented sum in keeping these banks alive.

The annual report puts it like this:

"Following the issue of B shares in connection with the Asset Protection Scheme, the value of the UKFI-managed investments in these banks will be around £60bn at current market prices".

And, for the avoidance of doubt, if we sold at £60bn we would be selling at a loss - because the market value of taxpayers' initial stake in the two banks is about £11bn less than we paid for those first holdings.

In other words, there's going to be an absolutely enormous asset to sell, as and when these stakes are privatised.

Now what's really striking is how little influence the government wants over these banks in return for the unprecedented support that taxpayers have provided to them.

Yes, the two banks have promised to make more credit available to UK businesses and households, as a condition of transferring potential losses to the public sector under the APS.

Monitoring that the banks honour those lending agreements is a responsibility for the Treasury, not for UKFI.

But apart that lending tit for insurance tat - whose scale is not sufficient to make good the perceived credit deficiency in the UK - these banks have not become explicit instruments of government policy.

Some would say that having been more-or-less nationalised, the duty of the government is now to turn them into directly controlled credit-creation machines, an alternative perhaps to the less predictable initiative to ease lending conditions which goes by the name of quantitative easing.

However, the chancellor and prime minister have set up UKFI with an explicit mandate to make sure that doesn't happen.

UKFI's overarching objective, as explicitly agreed by government is to "develop and execute an investment strategy for disposing of the investments in an orderly and active way through sale, redemption, buy-back or other means".

And in order to do that, it and the government believe that the banks have to remain autonomous commercial entities, and not tools of macro-economic policy.

This is how UKFI chief executive, John Kingman, puts it in the annual report:

"We operate like any other active and engaged shareholder, on a commercial basis and at arm's-length from government...We work closely with our investee banks, for example through strengthening their boards.

Our investee banks continue to be separate economic units with independent powers of decision and, in particular, will continue to have their own independent boards and management teams, determining their own strategies and commercial policies".

So page after page of the annual report is about three things:

• how the government will not micro-manage the banks;
• how UKFI will attempt to help the banks improve the quality of their boards, their governance and risk controls (there'll be a lot more on this in a government-sponsored report by Sir David Walker to be published on Thursday);
• and how UKFI intends to flog those enormous holdings in the banks.

Here's the paradox.

As the annual report makes clear, flogging perhaps £100bn of stock in Lloyds and RBS - which is what the holdings may easily be worth in a couple of year - can't be done overnight.

That's just too big a mouthful for investors to swallow quickly.

How can I be certain? Well in the entire history of Europe, there have only been three occasions when banks (or indeed any companies) have sold shares worth more than £10bn to commercial investors in a single exercise (they were the share sales by HSBC, RBS and UBS all carried out in 2008 and 2009).

Which is not to say that the RBS and Lloyds stakes can't be flogged, but just that it could take quite a few years.

Now that'll be quite a few years during which protests aren't likely to subside that the banks aren't doing their civic duty of supporting the economy.

So UKFI's role as the human shield of the independence of RBS and Lloyds may become increasingly fraught.

Update, 10:18 AM: My favourite bit of the UKFI report is its stern warning to the City that it won't give highly profitable mandates to sell its stakes in the big banks to any investment bank it regards as leaky. It says:

"we need to be especially careful that our dealings with intermediaries - including our selection processes for investment banking advisers - do not create undue risks of leaking our intentions to the market".

There will be no "pre-soundings" of investor appetite, it says.

Crikey. Them investment bankers won't like the idea of flogging this stuff into a market that hasn't been "conditioned".

Update, 10:50 AM: Perhaps the most striking disclosure in the report is that the annual remuneration of UKFI's chief executive, John Kingman, is £143,000.

Of course, that's a lot of money by almost all standards - but not, of course, by the standards of those he employs to run Royal Bank and Lloyds.

Their annual remuneration, including incentives, is as much as 20 times as great.

It's also about half as much as the remuneration of some local authority chief executives.

Since Kingman is arguably the most powerful individual in the British banking scene, perhaps his pay will set the new norm for the industry.

If it does, he'll be barred from the City for life.

News of the World bugged Sun editor

Robert Peston | 09:57 UK time, Friday, 10 July 2009


I have learned that the News of the World was apparently eavesdropping on the phone messages of Rebekah Wade, who at the time was the editor of its sister paper, the Sun (she still is - although she will soon become chief executive of the Sun's parent, News International).

Rebekah WadeShe was one of 75 individuals identified by police as having their phone messages monitored by the private investigator, Glenn Mulcaire - who was jailed in 2007 for phone hacking, together with Clive Goodman, the News of the World's royal reporter.

The police informed her that she was on Mulcaire's list of those whose mobile-phone voicemails were being tracked and was asked whether she wanted to press charges. She declined.

It's not unusual for newspapers to spy on each other, even newspapers within the same organisation.

The disclosure may be particularly embarrassing for Andy Coulson, who was then editor of the News of the World and is now the director of communications for the Conservative Party.

He denies that he knew that Mr Goodman was hacking into the mobile phones of celebrities, politicians and others.

Update, 10:45: For anyone running more-or-less any substantial news organisation, it'll be difficult to know whether to welcome or dread the Guardian's investigation into the use of allegedly improper techniques by News International to obtain private information about individuals.

Some will see it as an incentive for journalists to clean up the way they carry out investigations.

Others will fear that it will restrict the ability of journalists to uncover genuine wrongdoing, that legitimate investigations will become harder as a result of apparent misbehaviour by those hacks pursuing celebrity tittle-tattle.

But over-riding all other thought and emotions will be one terrifying question: "is my news organisation going to be seriously tainted by this?"

Because more-or-less every newspaper employed journalists whose specific skill was to obtain private phone records, or ex-directory telephone numbers or other confidential personal information.

And these specialist hacks in turn got hold of the valuable data through their relationships with private investigators.

A good deal of this trade in personal confidential information has already been exposed by Richard Thomas, who has just retired as information commissioner.

In a series of reports and in evidence to the House of Commons culture, media and sport committee, he made a series of disclosures about newspaper activities that he regarded as "prima facie" illegal.

Here's a statement from him to MPs that he gave in March 2007, which refers to the results of an investigation he carried out into the business relationship between the press and a firm of private investigators (the investigation was given the codename Operation Motorman):

"The first thing I would need to share is that the 3,000 or 4,000 transactions identified... came from a total of 13,000 transactions in this one operation alone. We were careful only to put forward those where there was some sort of hard evidence of the transaction being positively identified as involving a journalist for a newspaper".

And this is what he cited as the evidence of payments being made by journalists for the information:

"We did have, and we do have still, the statements, the bank statements, the invoices - some of these well-known proprietors were including information such as 'payment for confidential information', payment for 'blagging' [obtaining information by deception] in some cases - so there was what I might call hard 'prima facie' evidence."

But although successful prosecutions were brought against the detectives (who were given a conditional discharge), there were no charges brought against journalists - because Thomas was advised that, in the climate of the time, the courts would not wish to punish journalists, even if there were evidence of wrongdoing.

However the degree of detail obtained by him about this trade was startling.

He said the market price for obtaining the phone records of an individual was £750. Criminal records could be had for £500. The name of the owner of a car cost up to £200. And to break the barrier of secrecy of the ex-directory phone system cost up to £75 per number.

Where did the money end up? Well, a flow-chart produced by the office of the information commissioner shows the press employing private detectives who in turn deal with phone companies, call centres, the DVLA and what's described as "police source".

Also striking is Richard Thomas's list of the most enthusiastic customers of the particular detectives under investigation [pdf link].

The Daily Mail was listed as the top customer, with 952 transactions "positively indentified" (in the words of a report by the Information Commissioner's Office).

Then came the Sunday People, with 802, and the Daily Mirror with 681 trades.

The Mail on Sunday was in fourth spot with 266 deals. And the News of the World was one place below, with 182 transactions.

Even the Observer, sister paper of the Guardian, was a customer - with 103 transactions.

I would imagine none of those papers will be watching the current humiliation of the News of the World and its owner, News International, with much relish.

Update, 13:10: To state the obvious, my story says that the News of the World appears to have been eavesdropping on Rebekah Wade, editor of its sister paper, the Sun.

And - according to my sources - that is what she believes.

However, it has been brought to my attention, by a Tory spokesman and some commenters here, that on 29 November 2006 the Guardian reported that Mulcaire had intercepted her voicemail messages.

So the Conservatives are saying this is old news.

But the original Guardian story also says that no-one at the News of the World had a clue that there was eavesdropping of Ms Wade. There's an implication in that Guardian article that Mr Mulcaire may have been tracking the messages she received for someone else.

So, to repeat, what I'm saying is that News International is convinced Mr Mulcaire was operating for the News of the World - though I am not saying that the editor of the News of the World, Andy Coulson, knew this was going on.

Sorry if this is a bit complicated.

Does Europe need hedge funds?

Robert Peston | 09:54 UK time, Thursday, 9 July 2009


Boris Johnson has just been on the Today Programme on the latest phase of his "Save Europe's Hedge Funds" campaign.
Boris JohnsonHe fears that proposed new EU legislation will drive hedge funds - and perhaps private equity - to relocate to the US and Switzerland.
And he's probably right. Hedge fund managers tell me they hate the combination of the additional bureaucracy and the probable restrictions on how much they can borrow that's contained in the legislative draft.
So does the Europe Union need hedge funds? And, since most of them are here in the UK, does London need hedge funds and private equity?
Many of you, I know, think this is a fatuous question. You hate the lot of them.
But the arguments are more nuanced than you might think.
The case for the defence goes like this.
1) They help the distribution of capital to those who can use it most productively. This is importantly true of private-equity and venture capital firms that back start-ups and growing companies. It's also true of the smarter hedge funds. It's almost certainly not true of private-equity funds that borrow to buy big mature businesses (see below).
2) They contribute to the liquidity of markets.
3) Over many years, their investment performance has tended to be rather better than that of conventional fund managers. So they provide a useful investment alternative for the pension funds on which millions of us rely. However the performance of better and worse funds varies enormously and they do not represent a homogeneous asset class. So this argument should not be over-stated.
4) They've created a bit of high-value employment in the UK, quite a lot of it at banks, accountants and legal firms that provide services to them. And not all of their employees strive night and day to avoid paying UK taxes.
5) Hedge funds were "incentivised regulators", in the ironic phrase coined by one hedge-fund manager. What I mean by that is that hedge funds such as Paulson, Soros, Landsdowne, Kynikos and so on spotted the excessive risks being accumulated in the global financial economy and in individual banks long before alarm bells were ringing at the regulatory authorities and central banks. If the authorities had been awake and spotted the bets these firms were making on financial meltdown, more effective pre-emptive action might have been taken rather earlier.
6) They were much less responsible for the global financial crisis than the big banks and investment banks.
There is also a case for driving them into the sea. It goes like this.
a) They created a market for all sorts of toxic financial products that the world could have done without. The growth of the market in collateralised debt obligations, credit default swaps and so on would have been significantly less without the liquidity provided by hedge funds.
b) Vast numbers of them were primarily a play on the availability of cheap debt at a time of rising asset prices. Their investment prowess has been overstated.
c) Hedge funds increased the vulnerability of the financial system because of the way they provided vital short term finance (liquidity) to investment banks, which they were forced to withdraw at moments of acute stress for the likes of Bear Stearns and Lehman -because they in turn were an ATM for investors who were able to demand their cash back at a moment's notice.
d) Private equity firms who've bought bigger mature businesses were simply placing a bet - which they've lost - on the economy continuing to grow and debt remaining cheap for them. They were not, as they claimed, superior managers of businesses. This year they will suffer record losses. Which in turn will generate substantial losses for the already weakened banks that have lent to them (a big hello to HBOS, RBS and Barclays, inter alia). There could be defaults on more than £40bn of European private-equity loans this year.
e) Their uber-generous remuneration model was unwisely imitated by banks and investment banks, which contributed to bankers taking crazy risks to generate massive bonuses.
f) Some short-selling hedge funds may have contributed to the instability of systemically important banks, by fomenting anxieties about those banks which prompted the withdrawal of vital financial support to them (by the way, no regulator has ever proved malicious behaviour by hedge funds in this respect).
The rational evaluation is that hedge funds and private equity don't provide a particularly socially useful function, but then we tolerate all sorts of institutions and practices that don't conspicuously contribute to public welfare. For me it's important that they've on the whole done a better job of identifying irrational exuberance in markets than regulators, central bankers and politicians that are funded by us, by taxpayers.
It worries me slightly that there's a mood to banish a breed who've shown an ability to shout out that the emperor is striding around buck naked.
Loving them may not be easy, unless you've made a mint by backing the shrewder funds over the years. But exiling them from these shores may be an over-reaction - and, in that sense, the proposed European legislation may be misplaced. 

Bankers more confused

Robert Peston | 14:24 UK time, Wednesday, 8 July 2009


For bankers and insurers today has in some ways been maddening, because in a way they are further from knowing how they'll be regulated in a year's time.

Because there is now a very clear difference between the policy of the government and the policy of the Tories.

And if the opinion polls are to be believed, it's the Tory plan that'll be implemented after the next election.

Which means that the Bank of England will become a lot more powerful.

As I mentioned in a recent note, the shadow chancellor George Osborne will create what's known as a Twin Peaks regulatory system (or a version of it), with the Bank of England monitoring financial risk at banks, building societies and big insurers.

A new consumer and markets regulator would replace the Financial Services Authorities. It would be responsible for making sure financial firms conduct themselves in ways that don't damage their customers.

For those running the FSA right now, this is a pretty fair old nightmare - because it will make it pretty difficult for it to continue the process of upgrading its staff through recruitment over the coming few months (why would you join a regulator that's being dismantled?).

By the way, some of those running the FSA would argue that a flaw in the Tory approach is that in separating prudential supervision and what's known as conduct-of-business regulation, it would be harder to assess risk in the round at any particular bank or insurer.

A big bank can end up being very badly damaged by selling the wrong stuff to the wrong customers. But under the Tory proposal, responsibility for keeping an eye on that wouldn't rest with the re-empowered Bank of England.

As for Mervyn King's disappointment that he hasn't won the right from the current chancellor for the Bank of England to go into banks and demand relevant information, some bankers had been somewhat alarmed at the notion that they might have had to report to two separate regulators (though they'll certainly have to do a bit of this under the Tory prescription).

Surely if the governor asks the FSA nicely enough, it'll supply him with the information on specific banks that he'll be wanting in the weeks to come.

Governor snubbed

Robert Peston | 12:54 UK time, Wednesday, 8 July 2009


The chancellor has today instructed the Bank of England to monitor in a more methodical way the risks building up at any particular moment in the financial sector and the economy.

Alistair Darling

And if the Bank perceives dangerous systemic risks, it will then be charged with recommending "specific actions which could be taken to counter" them.

Also, the Bank - in its regular Financial Stability Report - will have to say whether any necessary remedial actions should be implemented by it, or by the Financial Services Authority, or the government or "whether they require internationally co-ordinated action",

So, on the face of it, the Bank will have more authority to prevent a repetition of the lending binge that precipitated the worst banking crisis since 1913 and the worst global recession since the 1930s.

To use the financial phrase of the moment, it will be setting "macro-prudential policy".

But this will be seen very much as phase one in the creation of an institutional structure to combat overheating in financial markets (as and when that's a problem again - and the more pressing problem is that markets remain semi-frozen).

The Treasury's policy paper, called "Reforming financial markets", says that creating a formal mechanism for curbing future instances of excessive lending will require an international agreement on the appropriate tools (such as whether banks should be required to hold additional capital during periods of strong growth).

But the governor of the Bank of England, Mervyn King, is getting far less than he wanted.

He asked for the legal right to inspect individual banks. And he hasn't got it.

What's more, the FSA has actually received new powers - including receiving a new responsibility for maintaining financial stability. In fact, if anything, the FSA will be perceived as encroaching on territory that the Bank of England cherishes as its own preserve.

In a nutshell, the chancellor is attempting to reinforce the tripartite regulatory system - or the distribution of responsibilities between the FSA, Bank of England and Treasury that was allocated by Gordon Brown as chancellor in 1997.

What that means is that on this issue, voters in the forthcoming general election will have a very clear choice. Because the Tories are pledging to bury the tripartite system.

And, in the process, the Tories would probably give the Bank of England even more power than it may actually want.

Update, 13:15: George Osborne has announced that a Tory government would give prudential supervision of banks, building societies and other significant institutions to the Bank of England. It will create a separate consumer and markets regulator. It would mean the end of the FSA.

Treasury patches up regulatory system

Robert Peston | 23:30 UK time, Tuesday, 7 July 2009


Our big banks may have played a big role in sparking the recession as a consequence of the losses they've incurred on their reckless lending and investing.

And the Financial Services Authority and Bank of England may have failed miserably to curb the City's dangerous excesses during the boom years.

But the Treasury has opted for correcting the flaws in the existing three-pronged regulatory system created in 1997 by Gordon Brown - rather than doing what the Tories want, which is to dismantle the so-called tripartite approach and confer the important powers to prevent bank crises on the Bank of England.

Treasury building

Also, the Treasury's 140-page paper on reforming financial regulation - to be published at last, many weeks after initial deadlines - will say that our big complex banks can be made safe by an FSA which forces them to hold substantially more capital and cash as a protection against losses and runs.

The Treasury will reject demands to break up the likes of Royal Bank of Scotland and Barclays, or to hive off what the governor of the Bank of England calls their casino operations from their state-insured retail arms, the parts that look after our precious savings.

But it will urge the FSA to make good on its promise to penalise banks that give big bonuses to executives that take dangerous risks.

It won't all be patching, re-seaming and darning. There'll be a proposal to give the Bank of England increased formal responsibility for assessing whether financial markets are overheating in a dangerous way, but the decision on how to curb banks in general from lending too much - as and when they're doing so again (if only) - well that's being postponed pending the outcome of international negotiations.

As I said in my note on Monday, everyone seems to agree that the globalised financial economy would be safe to swim in again if only we had lifeguards with macro-prudential tools to curb systemic financial risk, but no two geniuses can agree which tools are best.

Anyway it's clear that the Treasury would want the Bank of England to do macro-prudential policy, as and when the Treasury has worked out precisely what macro-prudential policy might be.

UPDATE, 07:19, 8 July: By the way, I'm very uncertain about whether the governor of the Bank of England will think he's getting the powers he needs from the Treasury.

It's pretty clear, to use his analogy, that the Bank of England's future sermons will have more teeth than hitherto - they'll be more like a papal encyclical than a gentle Sunday morning morality tale.

But whether Mervyn King will still feel he needs more direct powers to intervene in the affairs of banks, well we'll just have to wait for his reaction.

And talking of papal encyclicals, the one published yesterday by Pope Benedict XVl takes quite a swipe at global financial capitalism.

If you're in the mood for reading about how the capitalist system is unjust and needs radical reform, that's where you should look - rather than in a Treasury paper written by a Labour government.

Not just any mess, an M&S mess

Robert Peston | 11:24 UK time, Tuesday, 7 July 2009


There has barely been a moment in the past 12 years or so when Marks & Spencer hasn't been in some kind of boardroom crisis.

From Greenbury, to Salsbury, to Vandevelde, to Holmes, to Myners, to Burns, and finally Rose, this company seems to find it impossible to pick chairmen or chief executives without sparking controversy and alienating important groups of shareholders.

M&S storeIf Harvard Business School wants to do a case study of how not to do succession planning, Marks would be it. How different from all those decades when Marks was the definitive Harvard case study of how to run a retailer.

I used to think M&S governance difficulties stemmed largely from the painful transition it made more than 25 years ago from being a family-controlled business into a mainstream, institutionally owned company.

Now I just fear that the directors have been cursed by a witch who was refused a refund on saturnine underwear.

Anyway M&S went against corporate governance best practice in 2008 (for at least the third time in a decade) when Stuart Rose added the responsibilities of being chairman to his existing role as chief executive.

The board felt that was the best way of preparing for his eventual departure. Many shareholders disagreed.

More than a year later the tension between the owners and the managers is coming to a head in a vote at tomorrow's annual meeting.

A resolution requisitioned by the Local Authority Pension Fund Forum calls on the company to appoint a new independent chairman by July 2010.

To employ the kind of language that was current in the City when I became a journalist in the early 1980s, this represents a discourteous gesture against Stuart Rose - since he is planning to retire in July 2011.

Stuart RoseIn the event that most shareholders were to vote for the LAPFF motion, Rose would almost certainly feel he had to quit now, because the owners would be pronouncing a negative judgement on his leadership of the group.

He wouldn't be legally obliged to go, because the vote is - apparently - not binding on the board. But it's simply impossible for any executive to stay in place when he or she has lost the confidence of the owners.

And if Rose himself weren't minded to go (but he's a proud man, and I'm sure he wouldn't cling on), the non-executives couldn't ignore the revealed preference of the owners. They would have to ease him out.

Two questions follow.

Would shareholders be well served by the premature departure of Rose?

And how likely is it that a majority of them will back the LAPFF resolution?

Ejecting Rose now doesn't look an especially rational thing to do.

First, very few shareholders would argue that he's been a failure. He's had his ups and downs since becoming chief executive in 2004, but most would say M&S is stronger for his tenure. And the last set of figures indicated that the business may be over the worst of the current recession.

Also it's worth investors dwelling for a second on quite how dark a place the business was in before he arrived.

If he were to go now, the UK's largest clothing retailer would be rudderless for an indeterminate period.

By contrast, M&S has promised to find a new rudder - a new chief executive - in an orderly fashion next year.

So it is possible to characterise the LAPFF position as a preference for finding a chief executive in panicky hurry rather than in a methodical and sensible fashion (the LAPFF would of course say that it wouldn't want Rose to evacuate the building immediately).

Which brings us to the question of how investors will vote when it comes to it.

Well, there's bound to be a significant vote in favour of the LAPFF motion.

But I suspect it won't quite get a majority.

What will then be intriguing and important is how many abstentions there are and how the non-executives interpret those abstentions - whether they deem them as irrelevant or as de facto votes of no confidence in Rose.

From what I can gather, the non-execs will rally round Rose so long as the LAPFF doesn't win.

But that is what Margaret Thatcher expected her cabinet colleagues to do after she won her indecisive victory in the first round of voting in the 1990 election for leadership of the Tory party. And something quite different happened.

To coin that awful cliche, this isn't just any mess, it's a very special and very characteristic M&S corporate-governance mess.

Why didn't MG Rover's inspectors call in cops?

Robert Peston | 08:10 UK time, Tuesday, 7 July 2009


It's been bugging me for 48 hours so I have to let it out.

For more than four years a top QC and a leading forensic accountant have been investigating what happened at MG Rover between the moment it was taken over by the Phoenix Four in 2000 and its demise in 2005.

Longbridge factory, Birmingham

The professional-services meter has been ticking over for more than 1200 working days, so the taxpayer has been presented with a bill of more than £16m in respect of their diligent labours.

For that money - and on the basis of their sparkling CVs - it's not unreasonable to assume that they're better qualified than most to spot prima facie evidence of a crime.

So why, in all those years of probing MG Rover, didn't they call in the Serious Fraud Office - or recommend that the Business Department (which used to be the DTI) bring in the SFO?

Apart from anything else, I am told that the Business Department received very regular updates on the progress of the investigation.

Why was it that only after the Business Department received their finished report on 11 June that the First Secretary, Peter Mandelson, determined that the SFO should be asked to investigate whether there's been a criminal act?

More than that, on a reading of the Proceeds of Crime Act, one of the inspectors - Gervase MacGregor of the accountants BDO Stoy Hayward - would actually have been obliged to bring in the police just as soon as he smelled something untoward.

That said, a senior lawyer tells me there's a convention that POCA is suspended for inspectors - which is a bit odd, but there you go.

Anyway, I assume there is a reasonable explanation for why Mr Mandelson felt it necessary to bring in the SFO, but that Mr MacGregor and his QC colleague, Guy Newey, didn't do so at an earlier date.

But of course it's impossible to work out what that might be, because we're not allowed to see the inspectors' report.

And we're not allowed to see the inspectors' report because Mr Mandelson has passed the case to the SFO.

Which is almost a logical paradox of the kind that's designed to make us go batty if we reflect on it too long.

What does seem unsatisfactory is that taxpayers have spent a colossal sum trying to understand more about why a major employer collapsed and yet we remain none the wiser.

It's worth remembering that the failure of MG Rover represented the end of volume car making by British-owned manufacturers.

MG Rover's demise represented the death knell for an industrial policy of propping up an indigenous car industry that went back decades. Even at the end, this government engaged in frantic, fatuous efforts to prop up the business.

Were MG Rover's final, inglorious death throes the consequence of fraud by the Phoenix Four, the quartet who bought the business (the Phoenix Four deny any wrongdoing)?

Did it stem from their incompetence? Or were they just battling against insuperable economic odds?

And why, in the spring of 2005, did the government provide short-term financial support but withhold more substantial aid?

Until the SFO has completed its inquiries, we're not going to know.

Bank of England wins victory - but for what?

Robert Peston | 09:30 UK time, Monday, 6 July 2009


Macro-prudential policy is supposed to be what will prevent future bubbles in credit and asset prices from being pumped up to lethal size.

According to Andy Haldane of the Bank of England (him again) it's a "new ideology and a big idea" that will "shape the intellectual and public policy debate over the next several decades, just as the Great Depression shaped the macroeconomic policy debate from the 1940s to the early 1970s."

Bank of England

And there will be a bit about it in this week's paper on financial regulation from the Treasury.

Also, I can say with near certainty that it will be "done" or "managed" by a new committee attached to the Bank of England - and that the composition of this committee will probably be as set out recently by Lord Turner, chairman of the Financial Services Authority.

In other words the committee would be chaired by the Governor of the Bank of England, Mervyn King, and would contain perhaps eight other members, drawn 50:50 from the Bank of England and the FSA. You'll note however that the Bank would have the majority and would be deemed to be in the driving seat.

So King can put up the bunting in the magisterial parlours of the Bank of England. He appears to have won the argument that macro-prudential policy is something that the Bank of England should do.

But the sharp-witted among you will have noticed that I haven't spelled out what the Bank of England will be doing as and when it actually does macro-prudential policy.

And that's not because the practicalities of macro-economic policy are obvious and boring.

Quite the reverse: as Mervyn King pointed out in a recent speech, macro-prudential would "contain a number of instruments to reduce risk, both across the system and over time" but "we are a long way from identifying precise regulatory interventions that would improve the functioning of markets".

In other words, we know what we want macro-prudential policy to do: we want it to prevent banks and other credit institutions from lending too much for the health of the economy during the boom years, and also - which is the more immediate problem - to discourage them from lending too little during a recession.

But we don't really know how that should be done, what the levers would be to regulate credit at the level both of national economies and of the global economy.

There are plenty of jolly good ideas.

A ceiling could be imposed on all banks in respect of how much they could lend relative to their equity resources, a so-called leverage multiple, which would be raised or lowered according to whether credit markets were over-heating or freezing over.

Or there could be a variable regulatory tax on incremental lending, which would increase the cost for banks of making new loans during a boom period by forcing them to hold more capital relative to those additional loans (and would reduce the cost when the economy slows down).

Which may all sound straightforward. Except that the financial economy is like a great blancmange, and if you squeeze it in one place there's always a risk that it will splurge out where you least expect or want.

So, for example, the Macro-Prudential Committee would have to be constantly watchful to make sure that newfangled credit institutions weren't being created to avoid the new fetters.

There's also a conviction on the part of the Treasury - which some would say is misplaced - that it would be inappropriate to impose these constraints just on banks and institutions operating in Britain, that there would be damaging ramifications for the competitiveness of our economy and of the City if there weren't an international agreement that macro-prudential policy is the future.

And you won't be the least surprised to know that securing such international agreement is proving rather more challenging than herding cats.

Two final points.

First, how will we know when banks are lending too much and that asset prices are rising to unsustainable levels? It's blindingly obvious with 20:20 hindsight vision that this is what happened from 2005-7. But alarm bells were not ringing sufficiently loudly for the super-brains at the Bank of Engand, the Treasury and the FSA at the time.

Second, are we absolutely sure we need a new Macro-Prudential committee armed with new tools and levers, as opposed to giving the Bank of England's Monetary Policy Committee a new and second target - to curb systemically excessive lending - to add to its anti-inflation mandate?

As Howard Davies, director of the London School of Economics and former Deputy Governor of the Bank of England, has pointed out, there is an interesting logical issue here.

As and when a new Macro-Prudential Committee instructs banks that they must lend less, credit will became scarcer. That will have the effect of making loans more expensive, which is another way of saying that interest rates will go up.

But isn't varying interest rates what the Bank of England's Monetary Policy Committee is supposed to do, in order to fulfil its mission of keeping inflation in check.

Of course, we've all discovered in the past couple of years that the MPC's powers to fine tune interest rates in their many and varied forms throughout the economy are more feeble than it believed.

Even so, will the economy really become a safer place if we have one body - the MPC - using its interest-rate tool to achieve one outcome (controlling consumer-price inflation) and another body - the Macro-Prudential Committee - using another interest-rate tool (variable leverage multiples or capital ratios) to achieve a different but related outcome (preventing dangerous asset price inflation).

That said, both committees would - as I've said - be sitting under the expansive roof of the Bank of England. But some may nonetheless fear that their separation would lead to muddle and confusion that could damage the economy.

SFO to probe MG Rover collapse

Robert Peston | 11:09 UK time, Sunday, 5 July 2009


The circumstances leading to the collapse of MG Rover, the Midlands carmaker, are to be investigated by the Serious Fraud Office.

The new probe follows the completion of a four-year enquiry under section 432 of the Company's Act by inspectors appointed by the Department for Business.

The Business Secretary, Peter Mandelson, will make a brief written statement tomorrow confirming that the SFO has decided to take the case.

The involvement of the SFO means that publication of the report by the Business Department inspectors will be delayed pending a decision on whether there will be criminal prosecutions.

MG Rover went into administration under insolvency procedures in April 2005, with debts greater than £1bn. More than 6000 employees lost their jobs and suppliers to the company were also badly hurt.

A quartet of executives known as the Phoenix Four took control of the company in May 2000.

John Towers, Nick Stephenson, Peter Beale and John Edwards are estimated to have taken out more than £40m in pay and pensions in the years before the business went down.

They originally bought MG Rover for a nominal £10. The business came with an interest-free loan of £427m from BMW, the previous owner.

There are likely to be questions raised about why the case has been referred to the SFO only after completion of the inspectors' enquiry, rather than bringing in police at an earlier stage.

A spokesman for the Phoenix Four said: "There has never been any suggestion of improper conduct by the directors and this was confirmed in a report by the administrators PWC six months after they took over the running of the company."

Why bankers aren't worth it

Robert Peston | 09:27 UK time, Friday, 3 July 2009


Some of the most arresting analysis of the causes and consequences of the financial crisis is being made by Andrew Haldane, the executive director of what the Bank of England calls - with no hint of irony - "financial stability".

His latest speech, "Small Lessons from a Big Crisis" [pdf link], is grist for those who believe top bankers are being paid far too much (although this is not a conclusion he draws himself).

Workers in the CityFirst, Haldane looks at the returns generated by UK banks and financial institutions since 1900, to see whether shares in the financial sector have performed better than the market in general.

What this shows is that from 1900 to 1985, the financial sector produced an average annual return of around 2% a year, relative to other stocks and shares.

So for 85 years investing in bank shares was "close to a break-even strategy" (his words), nothing special.

But in the subsequent 20 years, from 1986 to 2006, returns went through the roof: the average annual return soared to more than 16%, which was the best performance by financial-sector shares in UK financial history.

And it's no coincidence that the pay of top bankers also zoomed up to the stratosphere. Which at the time upset only a few, because the bankers seemed to be enriching the owners of the banks, their shareholders (millions of us through our pension funds).

That, of course, is not the whole story.

The collapse of banks' share prices in the past two years has wiped out most of those gains: to March this year, when the low point was touched, the fall in UK bank share prices was more than 80%, an all-time record plunge.

What this means is that in the full period from 1900 to the end of 2008, the annual average return on financial shares was less than 3%, almost identical to the market as a whole.

Which is what common sense would predict should have happened, since banks are to a large extent a utility, serving the needs of the wider economy, and its difficult to see how banks in general can therefore grow significantly faster than the wider economy.

What went so right in 1986 to 2006? Had top bankers become much more brilliant than their predecessors, such that they deserved disproportionate rewards?

Haldane answers this question by breaking down banks' return on equity - the return generated on ordinary shareholders' capital - into its two component parts, which are the return on gross assets and the leverage employed by the bank.

This is slightly complicated, but bear with me, because it is absolutely central to assessing whether bankers merited their lavish remuneration.

Now if you want to know whether bankers are particularly skilful, you have to look at the return on gross assets. If one bank earns consistently bigger margins on the loans and investments it makes, that tells you it is probably doing something cleverer than its rivals.

By contrast, leverage - or the ratio between a bank's gross assets and its stock of shareholders' equity - is the Las Vegas part of the return on equity, the contribution made by a punt or a gamble.

Here's the important point: for any rate of return earned per unit of a bank's gross assets, the return on shareholders' equity rises as the assets-to-equity ratio rises - or, to use the jargon, as leverage rises.

Which is easier to grasp by way of a practical illustration.

Suppose a bank has lent £1,000 and earns a 1% net return on this, or £10. If that £1,000 is backed by £50 of shareholders' equity - which is a leverage multiple of 20 - the return on equity is 10 divided by 50, or 20% (which, for what it's worth, is a handsome rate of return).

Now, suppose another bank lends £1,000 on a leverage multiple of 50, or supported by just £20 of shareholders' equity. In this case, the return on equity is 10 divided by 20, or 50%. So the return to shareholders is a stupendous 50%.

Or to put it another way, increasing leverage is a simple and automatic way of increasing returns to shareholders. And as I hope you've noticed, there's nothing terribly clever about it.

But if all you care about is fat returns, and you're not interested in how they're earned, you'd give the boss of the highly leveraged bank a cigar, a bottle of Krug and a £5m bonus.

As I've observed many times in this column, maximising leverage is the equivalent of buying a house with the maximum amount of debt: it looks like an awfully smart thing to do when everything's going up up up, but is the fastest way to lose money when the economy turns.

Just to prove the point: if our banks were to lose £20 on their £1,000 of loans, the bank with just £20 of equity would be wiped out, it would be bust (a big hello to Royal Bank of Scotland, which at the peak of its lending and investing had a balance sheet that was indeed 50 times the size of its core equity).

So what has Haldane discovered about the golden banking years from 1986 to 2006? Were the super-normal returns of banks the consequence of management skill, viz high returns on gross assets? Or were they casino profits, generated because banks in general increased their leverage, their ratio of assets to equity?

This is what Haldane says:

"Since 2000, rising leverage fully accounts for movements in UK banks' ROE [return on equity] - both the rise to around 24% in 2007 and the subsequent fall into negative territory in 2008."

In other words, in the seven years before the crash, British banks' bumper profits were in aggregate generated wholly by a massive increase in leverage by the industry: and in Haldane's view, these would be returns generated by gamblers' luck, the jackpot from the roulette ball landing on black.

What follows?

Well, it's uncontroversial that we all paid something of a price, in the form of the worst global recession since the 1930s, when the bankers' luck ran out, when the wheel spun to red.

Which means that we all have an interest in preventing bankers from repeating these reckless gambles.

These would be a few useful lessons.

Stephen Hester1) The overall level of bankers' pay was inflated over the past few years by the rewards they scooped from the leverage gamble. It should be cut to a level commensurate with an industry that's closer to a boring utility than to a wealth-creating, entrepreneurial venture. This has not happened yet. In fact, if anything, bankers are pumping up their pay packages again (the recent remuneration deal made by Royal Bank of Scotland with its chief executive, Stephen Hester, would not have looked mean in the boom-boom era).

2) Regulators should impose a legally binding maximum - and at a relatively modest level - for the ratio of a bank's gross assets to its equity, the leverage multiple, to restrict bankers' freedom to gamble.

3) Owners of banks should be very cautious indeed about rewarding bankers for the returns they generate on equity, and should focus rather more on the returns earned on gross assets.

If you're still with me (wakey, wakey), there's one other important related issue I want to explore, which is how to re-introduce moral hazard into banking, how to persuade bank chief executives that they'll really suffer if they place reckless bets that go wrong.

The problem is that no one can possibly any longer believe that there are any circumstances in which our government will let one of our biggest banks collapse.

Which is an enormous comfort to the chief executive of a bank. It means he or she can do something spectacularly stupid, safe in the knowledge that taxpayers will bail out the bank as and when it all goes wrong.

The best deterrent against greed-fuelled gambling by banks is the threat of being sacked when it all goes pear-shaped. But that's not a particularly scary threat to any banker who's earned enough in the preceding years never to need to work again.

That rather implies that bankers should be paid a decent wage, but should not be able to get their mits on any serious wealth for years and years and years.

Arguably they shouldn't be allowed the big haul till they retire and it's clear beyond a scintilla of doubt that they haven't dangerously over-mortgaged their respective institutions.

And once again we're back to the serious critique of Royal Bank of Scotland's board for sanctioning Sir Fred Goodwin's never-have-to-work-again pension.

But Sir Fred is just one embodiment of how banking became a casino run for the benefit of bank executives: the sucker punters were the shareholders and - little did we know it - taxpayers.

Royal Mail in a falling market

Robert Peston | 17:39 UK time, Thursday, 2 July 2009


On 22 October last year, Gerry Sutcliffe, the sports minister, told MPs that the privatisation of the Tote - the horse race betting business - would be shelved for the foreseeable future. These were his reasons:

"In my Ministerial Written Statement on 21 July I said that, whilst the Government remained of the view that it should remove itself from detailed involvement in the affairs of the racing and bookmaking industries, the Government would need to be satisfied that it was right to proceed with a sale in the light of prevailing market conditions.
"After further work over the summer, I have now concluded that it is not appropriate to pursue a sale in these market conditions. I have therefore decided that the Tote should be retained in public ownership for the medium-term, and brought to the market when conditions are likely to deliver value for the tax payer and racing."

Sutcliffe seems to have read the market pretty well.

And market conditions have not yet improved sufficiently for the government to want to flog off the Tote - even though it's widely viewed as a highly attractive business.

Curiously, less than two months after the Tote disposal was shelved, and at a time when the economy was in freefall and credit was almost impossible to obtain, Peter Mandelson took a rather different view of the state of the marketplace.

He embarked on his auction of a sizeable stake in Royal Mail.

Which can only show, I think, that he rather likes making bets on 100-to-1 outsiders.

Perhaps he believed that a tentative offer from TNT, the Dutch post office, was more serious than it turned out to be. But even if he did somehow persuade himself that TNT was unlikely to walk away - which is what it has done - he surely can't have expected there to be any serious competitive tension in the auction.

It was fairly clear at the time that the going would get tougher for almost all possible bidders from the postal industry, such that their appetite for a substantial acquisition could well shrink to nothing.

That said, in view of CVC's sizeable investment in continental postal services, that private-equity firm was always likely to make an opportunistic bid. However CVC's partners did not become stupendously wealthy by overpaying for assets.

So a decent price could not possibly be extracted for the taxpayer if CVC ended up bidding against itself - which was the predictable outcome.

It's possible to say, and not just with the benefit of hindsight, that Peter Mandelson took quite a punt when pressing ahead with the partial privatisation of Royal Mail. And what he wagered - according to some of his colleagues - was the unity of his party at a time when political conditions were as fraught and unstable as market conditions.

Doubtless, now that he's shelved the sale, they'll carry him shoulder high as a hero once more.

Mandelson and markets

Robert Peston | 16:50 UK time, Wednesday, 1 July 2009


Few would deny that these are dreadful market conditions for selling any substantial asset.

The global economy is in recession. Credit is tight. The value of businesses on the stock market remain depressed.

Hand posting letters in letterbox

So when the first secretary says it looks impossible right now to sell a sizeable chunk of Royal Mail at a price and on terms that would secure value for the taxpayer, well that's uncontroversial.

The problem for Peter Mandelson is that market conditions were - if anything - even worse on 16 December last year, when he embarked on his adventure to partly privatise this historic public service.

The economy was in freefall. Credit was almost impossible to obtain. And stock-market prices were more-or-less where they are today.

Which implies one of two things.

Either Mr Mandelson and the government were demonstrating a complete absence of commercial nous in thinking it was a good moment to sell Royal Mail.

Or his real reason for abandoning the sale has as much to do with politics - with the fervent opposition to the deal of much of his own party - as with the scarcity of cash-rich purchasers.

Express exit

Robert Peston | 16:34 UK time, Wednesday, 1 July 2009


There are two ways of looking at the price paid by National Express for walking away from its the East Coast rail franchise.

There's the relatively contained financial cost - a maximum of £72m.

National Express East Coast line trainAnd then there's the difficult-to-quantify but substantial blow to its reputation - and to its ability to win future business from government.

The transport secretary has made it clear that he's not prepared to award any further rail franchises to National Express - and if he can, he'll probably do what he can to frustrate its bus operations.

For National Express that was a price worth paying.

The £1.4bn it had agreed to pay to the government for the seven years of its franchise was predicated on revenues growing by 9% a year.

But since the contract was signed in 2007, there's been an economic event called a global recession.

Revenues on the East Coast line are this year growing at 1%. Which means National Express would have faced crippling losses if it didn't walk away from the contract.

That said, National Express would rather have secured the public consent of Lord Adonis and the Department for Transport for handing back the franchise - so it offered more than £100m by way of compensation, above its contractual liabilitiy.

But alienating Lord Adonis and the government turns out to be less of a concern for National Express than the burden of the East Coast payments.

Which implies that National Express is reconciled to becoming a rather smaller business - and possibly either dismantling itself or selling itself to another transport company.

That said, the newly appointed acting executive chairman, John Devaney, loves a bumpy ride - and he has something of a talent for extracting a decent price for shareholders when the world looks pretty bleak.

I could operate trains

Robert Peston | 09:21 UK time, Wednesday, 1 July 2009


It turns out that I could have been the operator of the East Coast rail franchise.

Well, almost.

What I mean is that the operator of this important rail service is not National Express Group, which is what many of us naively thought, but a so-called special purpose vehicle with only a limited financial connection to the well-known listed transport group.

National Express train

So if I'd shown a bit of imagination a few years ago, perhaps I could have persuaded a few banks to lend a few tens of millions of pounds to PestieCo - my own special purpose vehicle - and then PestieCo could have offered to pay the government £1.4bn in instalments to operate a major rail service for seven years.

Here's my reason for thinking this idea isn't as absurd as it sounds. It's an extract from National Express's trading statement today.

"Under the DfT's [Department For Transport's] model for franchise bidding, the Group's financial obligations under the East Coast franchise are strictly limited. Like all rail franchises, NXEC [National Express East Coast] is a special purpose vehicle, set up to meet the DfT's requirement as a standalone legal entity, with its own assets, management team and franchise agreement with the DfT. National Express is not a party to, or a guarantor of, NXEC's obligations under the East Coast franchise agreement."

What that means is that the parent company, National Express, has very limited financial exposure to the losses being incurred by NXEC, the holder of the East Coast franchise - and believes it can hand back the franchise to the government with near impunity.

These are the relevant numbers.

National Express has made a £40m subordinated loan to NXEC and has also provided a £32m performance bond to it.

What this means is that once NXEC's losses have reached £72m, that's the end of National Express's financial responsibility for the business.

At that point, the parent company can return the franchise to the government and incur no further losses.

And, according to advice National Express has received from leading counsel, in handing back the franchise National Express as a group would not be in default on the contract with the DfT, even though NXEC would clearly be in default.

Which is highly relevant, because it means - according to legal advice received by the company - that the government would have no right to take back the other two profitable rail franchises operated by National Express (East Anglia and c2c).

So the government doesn't seem to have much of a stick with which to beat National Express.

Although the transport secretary, Lord Adonis, implied on the Today programme that he did think he could get those other franchises back. So maybe there will be a punch up in the courts about all this.

Lord Adonis also said that there would be a new tender for the East Coast line, as and when he has it back - which will be before the end of the year.

And he thinks the market for such franchises is lively and buoyant.


If he doesn't lose hundreds of millions on the new auction, then maybe the UK isn't experiencing its worst recession for decades.

Update, 11:19: I have learned that last night Lord Adonis rejected an offer by National Express to pay "well over £100m" to terminate the east coast franchise on a consensual basis.

This termination agreement was negotiated between National Express and Department for Transport officials and was "ready to sign", according to a source.

However Lord Adonis, the transport secretary, refused to sign as a matter of principle, in that he does not want to be seen to be renegotiating the terms of rail franchise agreements.

What this means is that the government may instead receive no more than £72m from National Express, which - as I explained earlier - is the financial guarantee provided by National Express to the special purpose vehicle that holds the franchise.

Some will wonder why Lord Adonis has apparently reduced the potential compensation for taxpayers from the termination of this important rail deal.

Paternoster and what to expect of non-execs

Robert Peston | 00:00 UK time, Wednesday, 1 July 2009


My submission to Sir David Walker's review of the governance of banks, which was commissioned by the Treasury, would have just one word: "Paternoster".

This is an insurance company with the most star-studded line-up of non-executives you could hope to find.

Paternoster's chairman is Ron Sandler, also chairman of nationalised Northern Rock and a former chief executive of the Lloyd's insurance market.

The deputy chairman of Lloyds Banking Group, Lord Leitch - a veteran of insurance - is on Paternoster's board.

And here's the triple gilding of the governance lily: Paternoster wasn't content with having just the former chairman of the Financial Services Authority, Sir Howard Davies, as a non-exec; Lord Turner was on the payroll as a non-executive director until he became the new FSA chairman just last autumn.

These are titans of the financial world, experts with decades of relevant experience and knowledge - just the sort of coves that Walker is bound to say should people the boardrooms of all our important financial institutions.

But if banking disasters such as Royal Bank of Scotland and HBOS show how costly it can be when a board lacks the skills to challenge and rein in executives who go out on a reckless lending and investment bender, Paternoster proves that even super-qualified non-execs can achieve only so much.

Because Paternoster has run out of spare capital and has surrendered its permission to write new insurance business. It has gone into hibernation, not a condition that any business would happily choose.

That said, these non-execs with super-duper CVs have not been the governance equivalent of parsley: they've been more than decorative.

First and perhaps foremost, Paternoster isn't bust. Its long-term liabilities to the 103,000 beneficiaries of pensions that it manages are covered by £2.7bn of assets, with a bit to spare.

Second, Paternoster volunteered to stop growing before the FSA forced it to do so (which is what would have happened). The board pre-emptively took steps to protect the interests of policyholders or pensioners.

Even so, no one can argue that going into the business equivalent of a long deep sleep is exactly a triumph.

So what went wrong?

Well Paternoster is a highly specialist insurer. And it raised £500m of capital from the likes of Deutsche Bank, Eton Park, Jupiter, Polygon and CQS in order to relieve companies of the burden of their respective final-salary pension schemes.

For a while, it was a market leader in taking on responsibility - as an insurer - for the assets and liabilities of closed company pension schemes.

Now there are some who argue that Paternoster did these deals at the wrong price, though it would dispute this.

What's unambiguous is that having grown very rapidly, it was not especially well prepared for the near-meltdown of the banking system last autumn, which - as I think you know - triggered the worst global recession since the 1930s.

And it was this economic contraction which squeezed Paternoster's capital resources till the pips squeaked.

Because the FSA told all insurers that they had to assume that the default rate on corporate bonds would be eight times the historic average, up from just 1.5 times.

I'll translate: the FSA told insurers they had to hold sufficient capital to cover losses that would accrue if a calamitous number of companies went bust and were unable to pay back what these companies had borrowed from the insurers in the form of bonds.

If that weren't bad enough, the unilateral decision by rating agencies to downgrade the ratings on debt issued by most banks was a further drain on insurers' free capital. Paternoster estimates that the reduced value of downgraded bank debt has increased its requirement for capital by 20%, which is very significant.

So the banking crisis and regulatory response to it meant that Paternoster suddenly found it only had sufficient capital to cover its existing obligations. And raising new capital has turned out to be impossible.

What that means is that Paternoster's days as an independent are probably numbered - and as and when it sells out, there'll probably be a loss for its owners.

So here's the thing.

The non-exec grandees have let down one group they're supposed to represent, the providers of equity.

But institutional providers of equity like Deutsche and CQS are in the risk business. Losing money is just what happens from time to time.

By contrast, the interests of a far more numerous and important group, those whose life-savings are managed by Paternoster, seem to have been protected - which is what really matters.

If these innocents had been hurt, then the damage to the reputations of the present and past non-execs - including that of the serving chairman of the FSA - would have been immense, perhaps irreparable.

Update, 15.33: Simply for the sake of tidiness, I should point out that Adair Turner actually left Paternoster on 3 June last year, which was the date it was announced he would become chairman of the FSA (as opposed to the date he actually became the City's top watchdog).

This matters (a little) because Paternoster took on a bit of extra pension business after Turner quit. And so if Paternoster were to become an even bigger mess, not all of that mess could be laid at Turner's door.

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